Voluntary Quarterly Audit Reviews and Debt Financing: International Evidence

(1)

Voluntary Quarterly Audit Reviews and Debt Financing:

International Evidence

Name: K.J. EENKHOORN Student number: S2240777 Supervisor: V.A. PORUMB

Year: 2017-2018

Abstract

In this thesis I examine the association between the voluntary purchase of audited quarterly reviews and access to debt finance in an international setting. Given the lack of consensus on the usefulness of interim reviews, I analyse their potential debt-market benefits. Using hand-collected international data across 25 countries over a period of 11 years, I find that firms that purchase an interim review have access to larger loans. Further, I assess the moderating effects of firm size and countries’ legal systems. My results indicate that firms that (1) are smaller in size and (2) originate in countries with codified legal system (code law) benefit more from the voluntary purchase of interim reviews when accessing finance. Taken together, my results represent the first international empirical test of debt market benefits obtained through the interim review.

Keywords: interim review; debt; access to finance; common law; code law; legal codes; JEL Classification: M23, Q15

(2)

Motivated by numerous accounting scandals, regulators have increased the involvement of external auditors in providing assurance of firms’ financial statements. For example, the Sarbanes-Oxley Act of 2002 (SOX) requires a statement from the auditor on a firm’s internal controls over financial reporting. Moreover, in 1994, the Securities and Exchange Commission (SEC) introduced the interim review of financial statements at the end of each quarter (Bédard & Courteau, 2015). The main objective of the audit of quarterly financial statements is to increase their quality. Nonetheless, the relevance of interim reviews has been questioned by accounting researchers (McEven and Schwartz, 1992; Wiedeman, 2007). According to Bedard and Courteau (2015), while there are costs associated with interim reviews in the form of increased audit fees, there are also cost reductions applicable for the necessary year-end audit work. They attempt to identify the benefits of an audited review of quarterly financial statements and found no significant improvement in quality of reviewed financial statements. They nonetheless assert that an interim review may be associated with a reduction in the information-risk premium included in their cost of capital. In similar vein, Allee and Yohn (2009) state that the interim review might allow the company easier access to financing. This effect is expected, since debt holders are important users of financial information and are likely to value the additional verification that the interim review brings (Minnis 2011). Therefore, in this paper I extend previous literature and draw on an international sample to assess if the reviews bring benefits from a debt-market perspective.

While the study of Allee and Yohn (2009) found that privately held businesses have easier access to credit having undergone an interim review, this study differs from previous research as it examines public companies that voluntarily purchase reviews. Specifically, in this study, I examine companies’ access to finance when they purchase an audit review in countries

(4)

where interim reviews are not mandatory. Furthermore, I identify whether differences between countries affect the benefits associated with loan contracting of the audit review.

Debt providers incur costs that are positively associated with the information asymmetry between them and borrowers (Diamond 1991). They may be uncertain whether borrowers can repay their debt, as this depends on the value of a company’s assets and its future cash flows. Research indicates that high quality accounting information can reduce this problem (Dye 1990; Verrecchia 2001). It is therefore likely that the audit review would be able to provide more reliable and timely information to debt holders (Barton and Waymire 2004). Diamond (1984) developed a theory that banks have great ability to minimise the cost of monitoring, which is useful for resolving incentive problems between the banks and organisations which need the money. In line with Diamond (1984), when organisations make use of an interim review, it is easier for banks to collect the information they need, so this may have a positive relation to the costs of debt.

In order to test my contentions, I draw on an hand-collected international data sample of countries where an interim review is not mandatory. Specifically, I calculate estimations on a sample of 2,830 observations from 2005 to 2015. My results indicate that the loan amount is positively associated with the interim review. Specifically, firms that purchase an interim review have access to larger loans. Moreover, small firms that purchase an interim review have the advantage of accessing larger loans compared to larger firms. The latter finding adds to the debate regarding the asymmetry between large and small firms with regard to the benefits of reviews in the Canadian setting (Porumb & Karaibrahimoglu, 2017).

Furthermore, I analyse whether country characteristics have an impact on the association between the purchase of the review and access to finance. I therefore follow La

(5)

Porta, Lopez-de-Silanes, Shleifer and Vishny, (1998) and divide the countries in my sample into two groups, those implementing codified legal systems and those implementing common law. I expect an effect of the rule of law as firms from countries with codified legal systems are in general financed through the debt market and may benefit more from an interim review than firms in common-law countries, which are generally financed through equity (La Porta et al. 1998). In line with this expectation, I find that the loan amounts of firms reviewed in countries with codified legal systems are significantly higher relative to those reviewed from common-law countries. I therefore document a significant benefit for firms from countries with codified legal systems that voluntarily purchase an interim review.

Overall, my findings bring multiple contributions to the literature. I contribute to the current literature by determining whether public companies should invest in voluntary reviews. Moreover, I extend the previous literature as my study is the first to use a multi-country setting. First, the results of this study suggest that there are debt-market benefits derived from the purchase of an interim review. Reviewed firms can access larger loans, suggesting that banks value the additional verification that external auditors provide through the timely assessment of quarterly financial statements. Second, small firms benefit to a greater extent from purchasing an interim review as, relative to larger firms reviewed, they gain more, in the form of access to larger loan amounts. Third, firms from countries with codified legal systems derive greater benefit from the purchase of an interim review compared to common-law countries. Thus, an investment in an interim review by firms from countries with codified legal systems is likely to bring significant benefits in the form of larger loans.

The rest of the paper is structured as follows: scientific relevance, institutional background, theoretical background, hypotheses development, sample selection, methodology,

(6)

results, robustness, implications of the findings and conclusions, and limitations and further research.

2. Scientific relevance

Previous research has focused on the relevance of interim reviews. For example, the study of Ernstberger, Link, Stich and Vogler (2015) describes how mandatory quarterly reporting affects firms’ business decisions in terms of real activities manipulations. They find that greater reporting frequency induced real activities manipulations are conditional on capital-market pressure and on the level of interim management-statement disclosure, and that they are associated with a long-term decrease in the firm’s operating performance. Furthermore, Bedard and Courteau (2015) described the benefits and costs of interim reviews from an investor perspective. They did not find any improvements in any aspect of the quality of financial statements associated with interim reviews. Nonetheless, they did not look at the benefits that the review might bring to debt holders. Porumb and Karaibrahimoglu (2017) address this gap in the literature and examine whether there is a benefit for firms in terms of the cost of debt when they have their quarterly reports reviewed. Their results indicate that companies that undergo an interim review have a lower cost of debt than companies that do not. They also suggest that companies that have their quarterly financial statements reviewed benefit through a lower cost of financing. Nonetheless, they use a single country setting to test their contentions; I extend their study by analysing an international sample. Allee and Yohn (2009) found that private firms that undergo auditing benefit in the form of greater access to credit and that firms with accrual-based financial statements benefit in the form of a lower cost of credit. While companies benefit from audited financial statements in the access to credit, it is reasonable that

(7)

they also benefit from audited quarterly financial statements.1_{In this study I therefore examine} if public firms which audit their quarterly reports have greater access to financing and what the differences between countries with voluntary interim reviews is. Allee and Yohn (2009) showed that there is a relation between audit reviews and access to credit, but this study was done for small privately held firms. I examine this for public firms and in an international setting, meaning that there are two contributions to the existing literature.

3. Institutional Background

Certain companies provide quarterly financial statements. In the US, quarterly financial statements for listed firms have been mandatory for decades (Fu, Kraft and Zhang, 2012). In Europe, interim reviews are not mandatory. Nonetheless, the accounting rules were aligned in 2005, which has likely increased the degree of homogeneity in European firms’ financial reporting. With regard to the interim review, there are still large differences between countries, which is an interesting prospect for research. The use of an external auditor for quarterly financial statements is not mandatory in many countries; in this study, I attempt to prove that there are some benefits for firms that use an external auditor for their quarterly financial statements.

According to Bedard and Courteau (2015), the main objective of the interim review is to increase the quality of interim financial statements. Regulators and commentators state that the

1_{Florou and Kosi (2015) examine if the adoption of mandated International Financial Reporting Standards (IFRS) has a positive relation on}

the access to financing. They find that mandatory IFRS adopters pay a lower bond yield spread, but no lower loan spreads after the mandate. So there might be also a link between the voluntary audit of financial statements and the access to financing.

(8)

interim review allows the timely consideration of significant accounting matters affecting the quarterly financial statements. It also provides an opportunity for the early resolution of issues affecting the annual report as it is believed to reduce the risk of material misstatements in the audited annual documents, as the external auditor has more information and knowledge of the client (Boritz 2006). Blackwell (1998) suggests that the interim review reduces the overall costs of information gathering for creditors that result in lower interest rates.

Interim reviews are not the same as the year-end audits – with an interim review the external auditor does different work and provides another level of assurance. A review primarily tests the internal controls of the client. The auditor attempts to test these using analytical procedures, because the scope of the interim review is also smaller than the year-end audit. The auditor normally conducts some standard tests such as inventorying, confirmation of third parties, and analytical procedures of the financial statements. The statutory audit of year-end financial statements provides a positive assurance that the financial statements are free of material mistakes. In contrast, the audit on quarterly financial statements provides a negative assurance that there is no evidence that the financial statements have material mistakes (Gay, Schelluch, & Baines 1998).

Probably the biggest difference between the interim and annual financial report is that they differ in terms of information they contain. Interim information is reported sooner, thus there is less time to prepare this information and for the external auditor to audit it. Therefore, the auditor makes greater use of estimates and the interim review contains expectation-based estimates of what will happen in the rest of the fiscal year. Because of this there is larger change of material mistakes. In this study, I examine whether providers of finance value external audits of the quarterly financial statements.

(9)

4. Theoretical Background

The SEC requires public companies with more than $10 million (USD) in assets and more than 500 shareholders to produce financial statements. However, there may be other incentives for producing financial statements, for example, to mitigate agency problems or those with other parties that make contracts with the firm (Jensen & Meckling 1976). This include contracts for loans or others forms of financing. The public firms, I investigate often have troubles with moral hazard and inside information. This means that the managers have more information the other stakeholders. When companies undergo audited quarterly financial statements, the auditor ensures that the information provided by the management of the firm is complete and correct, with no material mistakes. The latter entails that stakeholders make no other decision based on the financial information when there are some small mistakes in the financial statements. With the audited financial statements, auditors give an audit report where they state that the financial statements are correct and that the stakeholders can trust the financial statements. When companies have their quarterly financial statements audited by an external auditor, the stakeholders who provide the finance have more timely and relevant information about the financial situation of the firm. As a result of this, there is a positive relation between quarterly financial statements audited by an external auditor and firms’ access to finance.

For the international setting of my research I divide the countries within my sample in 2 different groups:

(10)

Countries with codified legal systems are those in which the legal system originates in Roman civil law. The laws are codified and statutory. The most continental European countries, and countries that were colonies of these, have a codified legal system. Such a legal system prescribes law which everyone must follow. Countries with codified legal systems have an accounting system that aims to disclose information to creditors or to the state (in order to collect taxes).

In contrast, common-law countries are those in which the legal system originates in English law, primarily that dating after the Norman conquest (La Porta et al. 1996). Common law is less abstract than the codified law, and seeks to provide an answer to a specific case rather than formulate a general rule for the future (Altintas & Yilmaz 2012). Common-law legal systems are found in countries influenced by England, such as the United States and Ireland. Common-law countries have an accounting system that aims to disclose information for investors and shareholders.

5. Development of the Hypotheses

This study consists of two parts. The first assesses whether the voluntary purchase of an auditor’s review of quarterly financial statements affects firms’ access to private finance. In recent research, significant attention is paid to the dynamics of the debt market; this derives from the financial crisis of 2008. Specifically, accounting researchers began to investigate the role of auditing in assisting lending decisions.2 The main tenor of this stream of the literature is

2 The following researchers investigated the role of an interim review and the relation with lending and debt: Fu et al. (2012) Florou and Kosi (2015), and Porumb and Karaibrahimoglu (2017).

(11)

that when auditors provide assurance that financial statements are free from material mistakes, information asymmetry between the lenders and the borrowers is reduced (Minnis 2011). Consequently, when companies purchase a quarterly financial-statement audit in order to aid the decision-making process of the users of financial information, the information asymmetry between them and lenders should also decrease.

More specifically, when companies undergo a quarterly audit by an external auditor, lenders have more timely and reliable information about possible financial misstatements; furthermore, it is easier and cheaper for the providers of debt to assess firms’ ability to repay loans. The cost reduction on the lenders’ side is important as they need to undertake costly monitoring of borrowers (Diamond 1984; Fama 1985) in the absence of external verification of financial statements. I therefore expect that the providers of debt value the interim review, as it makes it easier to monitor a company that needs to be financed. Consequently, companies would have easier access to finance and to larger loan amounts if they purchase an audit of quarterly financial statements. I formulate the following hypotheses:

H1: Firms with voluntarily audited quarterly financial statements have an easier access

to private finance relative to firms with no reviews.

H2: Firms with voluntarily audited quarterly financial statements have access to larger

loans relative to firms with no reviews.

Larger firms disclose relatively more information than smaller firms as their operations they are more visible, and they have a larger stakeholder base. Consequently, debt holders have more information available regarding larger firms when making a decision about lending. When smaller firms make use of audited quarterly financial statements, they provide relatively more information than larger firms who already disclose much information. I therefore expect that

(12)

smaller firms benefit more in terms of access to finance as a result of audited quarterly financial statements. Given that companies that are relatively smaller might benefit more from the use of a quarterly audit when they attempt to access finance, I formulate the following hypotheses:

H3: Smaller firms with voluntarily audited quarterly financial statements have easier

access to private finance relative to large firms.

H4: Smaller firms with voluntarily audited quarterly financial statements access larger

loans relative to large firms.

The second part of the study harvests the international structure of the data I collected. Specifically, I investigate the moderating effect of differences in country characteristics on the relation between the auditor’s review of quarterly financial statements and access to finance.

One of the reasons that accounting varies across countries concerns their legal systems. La Porta et al. (1998) identify two main systems of law: Roman codified law and common law (Alexander and Nobes 2010). Common law originates in medieval England and code law from the 19th_{century codifications in France, Germany and Scandinavia Graff (2008). Most}

continental Europe countries have a codified legal system.

In general, countries that have a codified legal system use private capital to a greater degree to finance businesses. Providers of private capital need timely and relevant information in order to make an investment decision. When firms that require capital undergo a quarterly audit by an external auditor, the requisite information is more readily available and investment decisions are much easier.

In contrast, common law countries use in general more public, equity capital, and these investors do not need timely information as shareholders already have a greater degree of power

(13)

and information, because they normally have voting rights. Thus, an interim review will be less relevant for common-law countries than for countries with codified legal systems. Consequently, I expect that companies from codified law countries will benefit more from the use of audited quarterly financial statements as their legal system aims more at finance by creditors and less by public investors. This leads to the following hypotheses:

H5: Firms with voluntary interim reviews in countries with codified legal systems have

easier access to private finance compared to firms with voluntary interim reviews in common law countries.

H6: Firms with voluntary interim reviews in countries with codified legal systems have

access to larger loans compared to firms with voluntary interim reviews in common-law countries.

(14)

6. Sample selection

I begin my sample selection process by selecting from the Datastream database financial information from 2004 to 2014 on all listed firms for the following countries: Austria, Australia, Bulgaria, Canada, Czech Republic, Cyprus, Denmark, Finland, France, Germany, Hong Kong, Hungary, Ireland, Italy, Slovenia, Slovakia, Malta, Netherlands, New Zealand, Norway, Philippines, Poland, Singapore, Sweden and the United Kingdom. I used the annual reports or the quarterly reports from these firms to analyse, by means of hand-collection, whether companies voluntarily undergo a quarterly review of financial statements. This collection resulted in a sample of 3,560 observations. Due the absence of some information in the database, and other information I could not find with reasonable effort in the course of data collection, the final sample consists of 2,830 hand-collected observations.

Table 1 provides an overview of the base sample.

---*Insert Table 1: Sample*

---As indicated above, I use the study of La Porta et al. (1998) to separate the countries into two different groups, countries with codified legal systems and common law countries. Table 2 provides an overview.

---*Insert Table 2: Common law and Codified law countries*

(15)

---I made use of multiple data sources, such as the primary data that ---I collected, and secondary data which I used from other studies and data from databases. The combining of data in this manner is referred to as data triangulation, and is ideal for preventing overreliance. It also aids in differentiating this study from others.

Before performing my tests, I winsorise all continuous variables at the 1st and 99th percentiles in order to eliminate the effect of outliers in the analysis of the data. In this manner, all the ratios are corrected, and the effect of outliers the regressions and results is eliminated.

7. Methodology

In order to test my expectations, I build on the previous literature to develop the empirical model. First, I assess the predictions of Hypothesis 1 and Hypothesis 2, that a voluntary interim review has a positive effect on firms’ access to private finance in terms of (1) the number of loans and (2) the size of individual loans, respectively. In the first two models described below, I test these hypotheses based on the specifications of Florou and Kosi (2015) and Porumb and Karaibrahimoglu (2017):

LOANNMBRt= β0+ β1REVIEWt-1 +β2LOANAMTt-1 + β3SIZEt-1 + β4ROAt-1 + β5MATURITY t-1+ β6TANG_t-1 + β7CR_t-1 + β8 AC_t-1 + β9MTB_t-1 + INDUSTRY_t + YEAR_t +

COUNTRYt + ε (1)

LOANAMTt = β0+ β1REVIEW_t-1 + β2SIZE_t-1 + β3MATURITY_t-1 + β4ROA_t-1 + β5TANG_t-1 +

(16)

Here, LOANNMBRt is defined as the number of loans (facilities) that a company accessed

during the 2002–2014 period. I define LOANAMTt as the total amount of the loan (facility) that

a company accessed during the 2002–2014 period. REVIEW is a dummy variable that takes the value of 1 if a firm has had an interim review, and 0 otherwise. There may also be other variables that influence the access to finance. According to Francis et al. (2016), when a firm is audited by a ‘Big 4’ auditor, the quality of the audit is greater than that of non-Big 4 audits. I use Firm

Size (SIZE) as a control variable. According to Karaibrahimoglu and Porumb (2016), when the

size of the firm increases, the costs of borrowing are relatively lower. In addition, I include return on assets (ROA) in my models, as access to finance will be greater when a firm makes a larger profit. When a firm has the ability to meet their short-term obligations, access to finance will be easier, so I add this as a control variable. Florou and Kosi (2015) state that the cost of debt is negatively associated with the quantity of tangible assets, as the providers of debt see the assets as an insurance for the loan or loans they have made available. For this reason, I include Tangibility (TANG) as a control variable. According to Porumb and Karaibrahimoglu (2017), the cost of borrowing also decreases when a firm can meet its short term obligations more easily; thus I add Current Ratio (CR) as an control variable. According to Florou and Kosi (2015) access to finance is lower when a firm has a low market-to-book ratio, so I include

Market-to-Book (MTB) as a control variable. According to Jensen and Meckling (1976), when

a firm grows and has relatively more debt, agency costs grow; for this reason I include agency costs (AC) as a control variable.

In the models 1 and 2, the most important variables are REVIEW and REVIEW*SIZE. When a firm undergoes an audit of its quarterly financial statements, it gets the value 1; when the firm does not do so, it gets the value of 0.

(17)

LOANNMBRt= β0+ β1REVIEW t-1 + β2LOANAMT t-1+ β3REVIEW*SIZE t-1+ β4MATURITY t-1 +β5BIG4_t-1 + β6SIZE_t-1 + β7ROA_t-1 + β8TANG_t-1 + β9CR_t-1 + β10 AC_t-1 + β11

MTB t-1 + INDUSTRYt+ YEARt + COUNTRYt+ ε (3)

LOANAMTt= β0+ β1REVIEW_t-1 + β2REVIEW*SIZE_t-1 +β3MATURITY_t-1 + β4SIZE_t-1 + β5ROA

t-1 + β6TANGt-1 + β7CRt-1 + β8 ACt-1 + β9MTBt-1 + INDUSTRYt + YEARt +

COUNTRYt+ ε (4)

In order to test Hypothesis 3, that there are differences between countries with codified legal systems and with common-law systems that influence the relation between the voluntary quarterly audit and access the finance, I use the following models:

LOANNMBRt= β0+ β1REVIEW_t-1+ β2REVIEW_t-1*COMMON_LAW_t-1 + β3COMMON_LAW_t

+ β4LOANAMTt-1 + β5SIZEt-1 + β6ROAt-1 + β7MATURITYt-1 + β8TANGt-1 +

β9CR_t-1 + β10AC_t-1 + β11MTB_t-1 + INDUSTRY_t-1 + YEAR_t+ ε (5)

LOANAMTt= β0+ β1REVIEWt-1 + β2REVIEW *COMMON_LAWt-1 + β3COMMON_LAWt+

β4 MATURITY_t-1 + β5SIZE_t-1 + β6ROA_t-1 + β7TANG_t-1 + β8CR_t-1 + β9 AC_t-1 +

β10MTBt-1 + INDUSTRYt + YEAR + ε (6)

In models 5 and 6, I introduce the variable COMMON_LAW. By having it interact with

(18)

the relation between the use of an audited review and access to finance. I give the companies the value of 1 if they are a codified- or a common-law country and the value of 0 when they are the other. So when it is a company from a codified country is gets a 1 for codified law and a 0 for common law.

---*Insert Table 3: Variable definition*

---8. Results

In Table 4, I provide an overview of the means and standard deviation per variable, and implement a Pearson’s correlation matrix. Overall, the most important variables in this study are LOANNUMBER, LOANAMOUNT and REVIEW. The results indicate that only 11% of companies opt for an interim review.

In addition, I implemented a Pearson’s correlation for the explanatory variables. According to Smith (2015), Pearson’s correlation is one of the best ways of obtaining preliminary diagnostics. It determines the direction of any relationship and the relation between two specific variables. Pearson’s correlation indicates that REVIEW is negatively and significantly correlated with LOANNUMBER, and positively and significantly correlated with

LOANAMOUNT. This implies that firms that undergo an audited review have fewer but larger

loans.

---*Insert Table 4: Correlation matrix*

(19)

---The correlation between the control variables and REVIEW are all in line with previous research; however, CURRENT RATIO is only positive, while in the research of Porumb and Karaibrahimoglu (2017) it is smaller than zero.

Table 5 presents all the ordinary least squares (OLS) regressions to test the six hypotheses. With these regressions, I test whether an interim review has an impact on debt financing and whether there are differences relating to specific countries and to the size of the firms.

---*Insert Table 5: Regression results*

---Column 1 of Table 5 presents the OLS regression for testing Hypothesis 1, whether a firm that undergoes an interim review has access to a greater number of loans than a firm that does not. The results show no statistically significant evidence for this hypothesis, so we can conclude that this relation does not exist: a firm that undergoes an audited review does not have relatively more loans than a firm does not. According to this regression, the loan amount is significantly lower for firms that have a higher number of loans.

Column 2 of the table presents the OLS regression for testing Hypothesis 2, whether a firm that underwent an audited quarterly review has access to larger loans compared to firms that did not. This relation is significant (p = <0.01) and provides strong evidence for accepting the predictions of the second hypothesis. This means that there is an advantage in terms of accessing larger financial loans for firms that undergo an audited interim review.

Column 3 of the table presents the OLS regression for testing Hypothesis 3, whether a smaller firm that undergoes an audited interim review has access to relatively more loans than

(20)

a firm that did not. This relation is significant (p = <0.01), but the coefficient is positive (2.08e-11). This means that there exists a significant relation: only larger firms benefit from this relation. This means that there is an advantage for larger firms undergoing an interim review, in the form of accessing more loans. I thus reject the third hypotheses.

Column 4 of the table presents the OLS regression for testing Hypothesis 4, whether a smaller firm that undergoes an audited interim review have access to larger loans than a larger firm that does not. This relation is significant (p = <0.01), this provides strong evidence for accepting the fourth hypothesis that, relative to larger firms, smaller firms benefit more from an interim review as far as the size of the loans they can access is concerned.

Column 5 of the table presents the OLS regression for testing Hypothesis 5, that firms from countries with codified legal systems have access to more loans when they undergo an audited interim review than do firms from common-law countries. This relation is not significant and there is no evidence to support this hypothesis, thus it must be rejected.

Column 6 of the table presents the OLS regression for testing Hypothesis 6, that firms from countries with codified legal systems have access to larger loans when undergoing an audited interim review than do firms from common-law countries. This relation is significant (p = <0.01), and provides strong evidence to accept the sixth hypothesis. That is, firms from countries with a codified legal system, which is more aimed at public finance, can access significantly larger loans than firms from countries with a common-law system, which is more aimed at private finance.

(21)

9. Robustness

In order to assure the robustness of the findings, I also run all my estimations by clustering standard errors by borrower and by auditor. I do this as previous research has found that the access to finance is affected by both borrower characteristics and auditor quality. Specifically, I perform the cluster analysis to prevent unobserved borrower-specific and auditor-specific characteristics affecting the main findings. As expected, the results of the cluster analyses are similar to those of the main tests.

10. Implications of the Findings

While Bedard and Courteau (2015) attempt to analyse the benefits of an interim review from an equity market perspective, yet they could not find such an effect. In contrast, Porumb and Karaibrahimoglu (2017) found that firms with voluntary interim reviews have a lower cost of debt. Boritz (2006) indicated that an audit makes financial statements more reliable and useful, but there was no international evidence that provides proof of the specific benefits of an interim review.

The results of this study suggest that there are benefits to be derived from such an undertaking. Firms which undergo an interim review can access larger loans. This indicates that firms that invest more in financial statements are rewarded for that investment when they attempt to access a larger loan.

Small firms benefit to an even greater degree from undergoing an interim review: they obtain relatively more benefits than larger firms when accessing a loan.

Firms from countries with codified legal systems also accrue greater benefits from an interim review compared to those from common-law countries: they can access larger loans. Thus, firms from the former countries would be wise to invest in such an undertaking.

(22)

Regulators can make use of the results of this study when they consider mandating the interim review in a specific country. This is especially the case for regulators in countries with codified legal systems, who may employ the international evidence in this study. They would be able to observe that providers of private finance attach value to the interim review. In addition, smaller firms benefit from an interim review when they want to attract private finance. Thus, should regulators wish to mandate such reviews, they can claim this as one of the benefits for firms.

Furthermore, managers also can make use of the results of this study when deciding to undertake an interim review. When their firm requires finance, they can use the evidence presented here as one of the benefits of such an undertaking.

11. Conclusions, Limitations and Further Research

In this study, I have analysed the effects of an audited interim review on debt financing in an international setting. The international setting is unique and has never before been a component of such a study. I analysed international differences by differentiating between countries with codified legal systems and those with common-law systems (La Porta 1998). Furthermore, I analysed the effects of the size of companies on debt financing.

The results indicate no relation between the number of loans a company can access, or the size of the company, and undergoing an interim review. Thus, according to these results, the total number of loans a firm can access is not influenced by the matter of an interim review. In my opinion, the more important relation is the size of the loan, as the variable concerning the total number of loans accessible does not relate to value. The size of the loan shows a strong relation with undergoing an interim review: firms that undergo an interim review

(23)

have access to larger loans. Small firms that undergo an interim review have the advantage in accessing larger loans relative to larger firms, as I hypothesised.

Firms from countries with codified legal systems, which are in general are financed by private capital, accrue greater benefits from the interim review than common-law countries, in which firms are in general are financed by public capital. The size of the loans firms from the former countries that undergo an interim review can access is significantly larger than those of firms from common-law countries. There is thus a benefit for firms from the former group of countries to undergo an interim review.

The lack of sufficient observations across all the countries included in the study is due to underrepresented samples for some of the countries, and is a major limitation of this study. In addition to hand-collecting the interim review data, I also made use of data from databases. Thus, the integrity of the data I collected depends to a certain extent on the integrity of the processing of the data into the databases that I used to collect the financial data.

In this study, I analysed the total number of loans and the size of the loans firms accessed, and the effects of an interim review on these variables in an international setting. A suggestion for future research is to research the manner in which the cost of a loan is affected when a company undergoes an interim review. As at this time, this factor has not been investigated in an international setting.

Another suggestion for future research is extend the data collection of this study to include a greater number of countries, and to categorise these countries differently, making use of other characteristics other than their legal systems. In this manner, a different set of results would be obtained, providing regulators with more evidence concerning the mandating of interim reviews.

(24)

12. References

Alexander, D., & Nobes, C. (2004). Financial accounting: an international introduction. Pearson Education.

Allee, K. D., & Yohn, T. L. (2009). The demand for financial statements in an unregulated environment: An examination of the production and use of financial statements by privately held small businesses. The Accounting Review, 84(1), 1-25.

Altintas, N., & Yilmaz, F. (2012). The accounting profession: A descriptive study of the common and code law countries. Journal of Modern Accounting and Auditing, 8(7), 932.

Barton, J., & Waymire, G. (2004). Investor protection under unregulated financial reporting. Journal of Accounting and Economics, 38, 65-116.

Bédard, J., & Courteau, L. (2015). Benefits and costs of auditor's assurance: Evidence from the review of quarterly financial statements. Contemporary Accounting Research, 32(1), 308-335.

Blackwell, D. W., Noland, T. R., & Winters, D. B. (1998). The value of auditor assurance: Evidence from loan pricing. Journal of Accounting Research, 36(1), 57-70.

Boritz, J. E. (2006). Maintaining Quality Capital Markets through quality information:

Summary of a Discussion Paper Prepared for the Capital Markets Leadership Task Force. Capital Markets Leadership Task Force.

Boritz, J. E., & Liu, G. (2006). Why do firms voluntarily have interim financial statements reviewed by auditors. Unpublished manuscript, University of Waterloo and Ryerson

University.

Diamond, D,W. (1984). Financial Intermediation and Delegated Monitoring. The Review of

Economic Studies, Volume 51, Issue 3, Pages 393–414.

Dye, R. A. (1990). Mandatory versus voluntary disclosures: The cases of financial and real externalities. The Accounting Review, 1-24.

Ernstberger, J., Link, B., Stich, M., & Vogler, O. (2016). The real effects of mandatory quarterly reporting. The Accounting Review.

(25)

Fama, E. F. (1985). What's different about banks?. Journal of monetary economics, 15(1), 29-39.

Florou, A., & Kosi, U. (2015). Does mandatory IFRS adoption facilitate debt financing?. Review of Accounting Studies, 20(4), 1407-1456.

Francis, B., D. Hunter, D. Robinson, M. Robinson, and X. Yuan. (2016). Auditor Changes and the Cost of Bank Debt. The Accounting Review In-Press.

Fu, R., Kraft, A., & Zhang, H. (2012). Financial reporting frequency, information asymmetry, and the cost of equity. Journal of Accounting and Economics, 54(2), 132-149.

Gay, G., P. Schelluch, and A. Baines. (1998). Perceptions of messages conveyed by review and audit reports. Accounting, Auditing and Accountability Journal 11(4): 472-494.

Graff, M. (2008). Law and finance: Common law and civil law countries compared—An empirical critique. Economica, 75(297), 60-83.

Jensen, M.C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics,3(4), 305-360.

Lennox, C. S., & Pittman, J. A. (2011). Voluntary audits versus mandatory audits. The

Accounting Review, 86(5), 1655-1678.

McEwen, R. A., & Schwartz, B. N. (1992). Are firms complying with the minimum standards for interim financial reporting?. Accounting Horizons, 6(1), 75.

Minnis, M. (2011). The Value of Financial Statement Verification in Debt Financing: Evidence from Private U.S. Firms. Journal of Accounting Research, 49: 457–506.

Porta, R. L., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1998). Law and finance. Journal of political economy, 106(6), 1113-1155.

Porumb, V., and Karaibrahimoglu, Y, (2017). Spend Money to Make Money? Voluntary Audit Reviews and Firms’ Cost of Debt.

Smith, J. A. (Ed.). (2015). Qualitative psychology: A practical guide to research methods. Sage. Verrecchia, R. E. (2001). Essays on disclosure. Journal of Accounting and Economics, 32(1),

(26)

Wiedeman, C. I. (2007). Improving Interim Reporting/L'Amélioration de L'Information Financière Intermédiaire. Accounting Perspectives, 6(3), 279-289.

(27)

Table 1: Sample

Total firm-year review observations 3,560 observations

Firms with missing information 730 observations

Base sample 2,830 observations

Overall, due the absence of certain information in the database and other information that could not be retrieved from data collection, the final sample consists of 2,830 observations.

(28)

Table 2: Countries with Common Law and with Codified Legal Systems

Codified Legal System Common-Law System

Austria Bulgaria Czech Republic Denmark Finland France Germany Hungary Italy Slovenia Slovakia Australia Canada Cyprus Hong Kong Ireland New Zealand Singapore United Kingdom Malta Netherlands Norway Philippines Poland Sweden

(29)

Table 3: Variable Definition

Loan Number (LOANNMBR) The total number of loans a company has in year t.

Loan Amount (LOANAMT) The size of the loan a company has in year t. Audit Review(REVIEW) Variable = 1 if a firm undergoes an external

audit of quarterly financial statements, and 0 otherwise.

Maturity (MATURITY) The maturity of the facility.

Common-Law Countries (COMMON) Variable = 1 if a firm is from a common-law country, and 0 otherwise.

Countries with Codified Legal Systems

(CODE)

Variable = 1 if a firm is from a country with a codified legal system, and 0 otherwise. Big-4 Auditor (BIG4) Variable = 1 if a firm employs one of the

Big 4 auditors, and 0 otherwise.

Firm Size (SIZE) The total assets of a company in year t. Return on Assets (ROA) Profit divided by total assets in year t. Tangibility (TANG) Fixed assets divided by total assets in year t. Current Ratio (CR) Current assets divided by current liabilities

in year t.

Agency Costs (AC) Total liabilities divided by total assets in year t.

Market-to-Book Ratio (MTB) The market value of a firm divided by the book value of the firm in year t.

Industry Dummy (INDUSTRY) A dummy variable based on a one-digit SIC code.

Year Dummy (YEAR) Indicator variable = 1 if the observation took place in the relevant year, 0 otherwise. Country Dummy (COUNTRY) Indicator variable = 1 if the observation took

place in the corresponding country, 0 otherwise.

(30)

Variable Mean ST. DEV (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

LoanNMBR (1) 0.7098489 0.0120738 1

LoanAMT (2) 6.00e+08 1.98e+07 -0.0228 1

Maturity (3) 5450799 0.553324 0.1769 -0.0832 1 *** *** REVIEW (4) 0.113596 0.0059797 -0.0393 0.0554 -0.0166 1 ** *** COMMON_LAW (5) 0.5683351 0.0093338 -0.1149 -0.1694 -0.1145 0.1210 1 *** *** *** *** BIG4 (6) 0.9549166 0.00391 0.1129 0.0802 -0.0097 0.0071 -0.0261 1 *** ***

SIZE (7) 3.34e+09 4.12e+08 -0.0237 0.3873 -0.0397 0.0277 -0.0814 0.0226 1

*** ** *** ROA (8) .0645769 0.0013721 -0.1624 0.0251 0.0364 0.0010 0.0260 0.0367 -0.1323 1 *** ** ** *** Tang (9) 7363847 8417558 0.0093 -0.0421 0.0460 0.0254 -0.0301 -0.0076 -0.0245 -0.0016 1 ** ** * CR (10) 1350442 0.0128179 -0.1362 -0.0883 0.0129 0.0101 0.0640 -0.0747 -0.0715 0.1203 -0.0638 1 *** *** *** *** *** *** AC (11) 0.3127555 0.0031046 0.2619 -0.0859 0.0869 0.0014 -0.0096 -0.0148 -0.2810 -0.1532 0.0533 -0.1654 1 *** *** *** *** *** *** MTB (12) 2229144 0.0513463 0.0058 0.0596 0.0170 0.0285 -0.0082 0.0177 -0.0606 0.2938 -0.0472 -0.0245 0.0871 *** *** *** ***

(31)

Table 5: Regression Results (M1) (M2) (M3) (M4) (M5) (M6)

LOANNMBR LOANAMT LOANNMBR LOANAMT LOANNMBR LOANAMT

REVIEW -0.003 2.48e08*** -0.092 2.80e+08*** -0.009 4.25e+08***

(-0.111) (5.54e+07) (0.113) (5.61e+07) (0.204) (1.01e+08)

LOANAMT -8.01e-11** -7.96e-11** -8.71e-11**

(3.79e-11) (3.86e-11) 3.80e-11

REVIEW*SIZE 2.08e-11*** -0.007*** (4.26e-12) (0.002) COMMONLAW 0.563*** 3.33e+07 (0.188) (9.37e+07) COMMONLAW*REVIEW 0.014 -2.54e+08** (0.245) (1.22e+08)

MATURITY 0.008*** 1.28e08*** 0.008*** 1.30e+08*** 0.279***

-1.26e+08***

(0.001) (2.88e+07) (0.001) (2.87e+07) (0.059) (2.87e+07)

BIG4 0.862***

(32)

Robust standard errors in parentheses: ***p < 0.01, **p< 0,05, *p < 0,1. This table shows the estimation results for equation (1) – (6), as described in chapter 7

Methodology. All variables are defined in Table 3.

SIZE 2.28e-12 0.020*** -1.43e-12 0.021*** 2.51e-12 0.020***

(1.86e-12) (0.001) (2.02e-12) (0.000) (1.87e-12) (0.001)

ROA -3.856*** 1.43e09*** -4.241*** 1.43e+09*** -3.804*** 1.40e+09***

(0.531) (2.65e+08) (0.534) (2.64e+08) (0.534) (2.65e+08)

TANG 7.43e-06 1008.929 0.000 919.840 9.80e-06 1201.477

(8.15e-06) (4072.628 (8.45e-06) (4065.103) (8.17e-06) (4071.234)

CR -0.171*** -5.20e+07* -0.160*** -5.13e+07* -0.171*** -5.35e+07*

(0.056) (2.79e+07) (0.056) (2.78e+07) (0.056) (2.79e+07)

AC 2.224*** 2.21e+08* 2.114*** 2.24e+08* 2.261*** 2.30e+08**

(0.234) (1.17e+08) (0.236) (1.17e+08) (0.235) (1.17e+08)

MTB -0.0022041 1941021 -0.003 2129189 -0.004 2076022

(0.014) (6869163) (0.014) (6856552) (0.014) (6865349)

Constant -3.039 -1.94e+09* -0.252 -1.72e09*** -1.197 -1.63e+09**

(-2.260) (1.14e+09) (1.306) (6.69e+08) (1.356) (6.75e+08)

COUNTRY effects Yes Yes Yes Yes No No

INDUSTRY effects Yes Yes Yes Yes Yes Yes

YEAR effects Yes Yes Yes Yes Yes Yes

Observations 2,830 2,830 2,762 2,830 2,830 2,830

Voluntary Quarterly Audit Reviews and Debt Financing: International Evidence