We study changes in borrower accounting recognition surrounding initiation of loans requiring the provision of aging schedules to the lender. Our purpose is to understand how scrutiny by lenders of underlying transactions affects financial reporting incentives. We find that allowance for doubtful accounts increases significantly after loan initiation controlling for current and future write-offs, receivable turnover, and the beginning allowance balance. This increase is more pronounced for loans with increased monitoring frequency. We also find that write-offs are less persistent following implementation of bank monitoring, consistent with increased timeliness. Further study of the customer base finds customer concentration declines and credit quality of largest customers improves after initiation of borrowing base loans. Lastly, we find borrowers increase the frequency of allowance-for-doubtful-accounts disclosure in their quarterly financial statements after loan initiation. Our results confirm two notions. Banks add to the oversight that already exists for public, audited companies and banks influence borrowers to adopt more conservative accounting policies. JEL: G14, G21, G24, G28

This paper examines whether auditor fees are associated with earnings management and the market reaction to the disclosure of auditor fees. Using data collected from proxy statements, we present evidence that nonaudit fees are positively associated with small earnings surprises and the magnitude of discretionary accruals, while audit fees are negatively associated with these earnings management indicators. We also find evidence of a negative association between nonaudit fees and share values on the date the fees were disclosed, although the effect is small in economic terms.

We examine the relation between accounting conservatism and creditor recovery rates for firms in default. We also test the link between conservatism and the length of bankruptcy resolutions. We find that creditors of firms with more conservative accounting before default have significantly higher recovery rates, and that this positive relation is more pronounced for default firms that violated covenants before the default. We also find that conservative firms have higher asset productivity, shorter bankruptcy resolution, and a significantly higher probability of emerging from bankruptcy. These results suggest that accounting conservatism preserves firm value, leading to higher creditor recovery upon borrower default.

We view audit-quality choice as one among many that managers make to maximize firm value. We question whether audit-quality differences among publicly traded companies are of significant interest to investors, clients, and auditors and ask for research on this topic. Relatedly, we ask for research on whether auditors and their clients show behavior consistent with regulated audit quality exceeding the audit quality level demanded absent regulation. We propose that researchers incorporate the competitive advantages of auditors and the institutional features of the audit process into the definition of audit quality. We propose that audit quality research test for externalities and inefficiencies to understand whether auditors and their clients are choosing the efficient level of audit quality. We note the legislative, judicial, and executive powers residing in the PCAOB.

Prior literature presents various perspectives on the role of financial reporting. One view is that mandatory periodic reporting disciplines managers and encourages timely voluntary disclosure. We examine this “confirmation hypothesis” using the shock to financial reporting quality experienced by Arthur Andersen clients forced to switch auditors. Consistent with the confirmation hypothesis, we find that former Andersen clients increase disclosure after they change auditors. They increase forecasting frequency and enhance forecasting precision and specificity. We present additional cross-sectional evidence that shows Arthur Andersen clients with larger increases in financial reporting quality increased their disclosure by relatively more, even within the sample of Arthur Andersen clients. We supplement our main findings with a battery of tests to reduce the possibility that alternative shocks and uncertainty drive our results. Our findings support complementarity between financial reporting quality and voluntary disclosures.