Do Banks Care About Litigation Against Auditors of Borrower Firms?Evidence from Bank Loan Pricing

This study examines how banks respond to litigation against auditors of borrower firms. We focus on a sample of borrower firms that are not involved in litigation but audited by auditors involved in litigation related to alleged audit failures. We find that banks charge higher interest rates on loans to borrower firms when the auditors of these firms are sued. Auditor litigations at both the audit firm-level and office-level are associated with higher interest rates on loans. We also find that the positive association between auditor litigation and interest rates disappears for the borrower firms in a transparent information environment, and it is more pronounced for the borrower firms audited by non-Big 4 auditors. These findings suggest that litigation against auditors is considered as an important information for banks’ assessment of credit risk. The findings provide important insights into the effect of litigation against auditors on the behavior of banks that are the major provider of debt capital.