Expanded Auditor's Report Disclosures and Loan Contracting

Starting in October 2013, auditors of premium-listed firms in the United Kingdom are mandated to prepare an expanded auditor's report that provides details on audit procedures, risks of material misstatement (RMMs), and materiality thresholds. This regulatory change is important to study, because it aims to increase the informational value of the traditional, highly standardized, pass-or-fail auditor's report. We examine whether the disclosures in the expanded auditor's report provide information that is relevant for adopting firms' loan contracting terms in the post-adoption period. Our results indicate that the introduction of the expanded auditor's report is associated with reduced loan spread and longer maturity for loan facilities of adopting firms relative to non-adopting UK firms. When we focus on adopting firms in the post-adoption period, we find that the number of “unique RMMs” mentioned in the auditor's report, but not in the audit committee report, are positively associated with loan spread but are not associated either with loan maturity or the number of lenders in the loan syndicate. Additional tests show that the benefits, in terms of a reduced spread, of having a lower number of “unique RMMs” accrue mostly to adopters with a poor information environment. Taken together, our results provide preliminary evidence that the expanded auditor's report disclosures contain relevant information for loan contracting in the United Kingdom. This study highlights the unique role of the expanded auditor's report in providing information relevant to lenders and supports standard setters' efforts to enrich its informational content.