The auditor designation system is a system that has been implemented to enhance the independence of audits and increase the reliability of accounting transparency. However, despite the implementation of the auditor designation system, problems such as accounting fraud arose, and South Korea's accounting transparency was evaluated as low. Such Efforts were needed to improve accounting quality, for low accounting transparency weakens national competitiveness. As part of that effort, it was decided to revise The External Audit Act in 2018, and new grounds for designation as financial standards auditors were established.
The newly established criteria for designating auditors are when a company has three consecutive business years of operating cash flows less than 0, operating income less than 0, or interest compensation ratio less than 1. However, contrary to the intent of The Revised External Audit Act, companies with poor financial performance for two consecutive years had adjusted operating income or operating cash flow.
The reason why companies are trying to avoid the designation of auditors is that they are concerned about such an increase in the cost of debt due to negative signaling effect. Bond investors will assess a company's earnings as reported in its financial statements and will demand a risk premium if the earnings start to be untruthful to them.
Therefore, this study examines the cost of debt of companies that have been designated as auditors under the newly established financial standards, and companies that are suspected of avoiding the designation of auditors by adjusting their operating income and operating cash flows in the final year. Furthermore, we are trying to see the difference between the costs of debt of the auditor-designated companies for that fiscal year and the previous year of that.
As a result of the empirical analysis, the cost of debt of the companies suspected of avoiding auditor designation was lower than that of the designated companies. In this study, we expected that bond investors would impose penalties by perceiving avoidance of the auditor designation. But in reality they rated the information risk of firms with the auditor designation higher. In other words, we believe companies do not recognize the strategic choice to avoid auditor designation in the bond market.
As a result of additional analysis, the cost of debt in the fiscal year of the auditor designation was lower than that in previous year. This is not a negative perception of companies designated with auditors in the bond market, but it is interpreted that the quality of accounting information has been improved, reducing information risk and lowering the cost of debt.
Summarizing the research results, this is the first study to examine the impact of the newly established financial standards about auditor designation on the cost of debt. It also suggests that corporate operating income adjustments do not affect bond investors despite the enforcement of the The External Audit Act. This study suggests that supplementary measures should be established so that interested parties can systematically recognize companies' intentional adjustments.
The limitation of this study is that the disclosure of information about the change of auditors in the audit report and the description method are inconsistent. Also, the scope of that was not wide at the early stage of the revision of the law. We are looking forward to seeing more accurate and diversified research being conducted based on the extended analysis period and supplemented content of the law when the enforcement of the revised law is finally stabilized.