Review of Empirical Literature on Audit Quality and Cost of Debt Capital

Abstract

This paper reviews empirical studies over the past decades in order to assess what researchers have done about the impact of audit quality on the cost of debt capital. Audit quality encompasses of an external mechanism intended to mitigate information asymmetry by increasing the monitoring of management's actions, limiting managers' opportunistic behavior, and improving the quality of firms' information flows.A stream of literature explains that audit quality of external auditor mechanisms such as auditor size, audit fees, non-audit services and auditor industry specialization are able to contribute towards improving the firm's performance and reducing information asymmetry. The other dimension of value creation is the reduction in the cost of debt capital raised by firms. Theoretically and empirically to some extent, high audit quality of external auditors will lead to lower firm risk, information asymmetry and subsequently, a lower cost of debt capital. This paper aims to provide a critical review of the empirical literature on the effect of audit quality on the cost of debt capital.