Financial Constraints, Auditing, and External Financing

Abstract

This paper examines the role of costly audit signals in future external financing activity of financially constrained firms. We document that when facing higher financial constraints, firms pay higher audit fees and have their audit reports completed sooner. Equally important, we find that costlier and timelier audits are associated with a greater amount of future financing raised by equity-seeking, but not debt-seeking, constrained firms. Our results are robust to controlling for various audit characteristics and risk factors. Additional analyses show that equity-seeking constrained firms that underwent costlier audits exhibit more favorable outcomes with respect to long-run stock performance and investment efficiency following seasoned equity offerings. Our findings suggest that while financially constrained firms are pressured to make cuts across various expenditure categories, negotiating lower audit fees in the face of higher financial constraints may not be a wise strategy.