THE ECONOMIC EFFECT OF DIFFERING LEVELS OF AUDITOR ASSURANCE ON BANKERS LENDING DECISIONS

Since 1979, Statement on Standards for Accounting and Review Services No.1 allows CPAs to perform compilations and reviews, in addition to t raditional audits for nonpublic companies. An experiment was conducted to determine if these increasing levels of auditor assurance have an economic effect on decision making by users of financial statements. A hypothetical loan application was evaluated by 67 experienced bank lo an officers with the level of auditor assurance manipulated across the se three levels of assurance from low (compilations) to medium (review s) to high (audits). The argument is that increasing levels of assuran ce reduce information risk about the applicant and should therefore af fect economic decision making. Loan officers made two decisions: wheth er or not to make the loan and the interest rate over prime to be char ged on the loan. The results indicate that on average loans were more likely to be made and a lower interest rate charged as the level of as surance increase: specifically the likelihood of making the loan incre ased from 26% with compilations, to 48% with reviews, to 62% with audi ts, while the interest rate premium was 2.24% for compilations, 1.96% for reviews, and 1.71% for audits. These results are consistent with h igher levels of assurance reducing information risk and having an econ omic effect on the loan decision process. In addition, loan approval r ates were higher and interest rates were lower for loan security via c ollateralized assets relative to loan security via debt covenants. How ever, neither loan approval rates nor interest rates were significantl y different between provision of MAS by auditors versus no-MAS conditi ons.