Combined Effects of Auditing and Discretionary Accruals on the Cost of Debt: Evidence From Spanish SMEs

Abstract

Previous literature shows mixed evidence on the effect of discretionary accruals and auditing on the cost of debt. We hypothesize that, in the SMEs setting, auditing can act as a substitute for accruals quality, and thus audits may mitigate the effect of discretionary accruals on the cost of debt. Using a sample of Spanish SMEs, we find that auditing is negatively related with the cost of debt, while higher discretionary accruals are related with a lower cost of debt. Nonetheless, this effect is lower than that one observed for audits. When considering the combined effect of both variables, the effect of discretionary accruals is replaced by that of auditing. These results suggest that, among SMEs, discretionary accruals do not have a relevant effect on the cost of debt when companies are audited, supporting the hypothesis that there exists a substitution effect between discretionary accruals and auditing. JEL Classification: M42; G32