Lending Relationships, IPOs, and the Effect of Auditor Quality on the Cost of Debt

In this paper, we use a sample of U.S. initial public offerings (IPOs) from 1986 to 1998 to re-examine the question of whether firms that go public can benefit from the presence of a Big Six auditor in the form of lower cost of debt financing. We attempt to incorporate in the study thenewly issued public firms' existing banking relationships and their degree of debt dependence prior to IPO. Additionally, we consider use of equity proceeds in debt reduction, as another factor suggested by Pagano et al. (1998) to affect costs of debt at IPO time. Consistent with prior literature, we find that:

1. firms that are young and highly-debt dependent at IPO time pay higher interest rates
2. use of equity proceeds in debt reduction is significantly associated with lower costs of debt financing
3. after accounting for use of equity proceeds, firms' pre-existing relationships with its creditors, and level of pre-IPO debt dependency, auditor reputation plays a very significant role in lowering the cost of debt financing
4. highly debt-dependent and older firms benefit the most from the presence of a reputable auditor.  

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Paolo Perego

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Anna Nöteberg

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