Impact of CDS initiation on corporate debt and audit fee

What is it about?

Credit default swaps (CDS) on corporate debt have been widely adopted over the last decade and have gained notoriety during the financial crisis. Studies find that CDS change the incentives and the strategic behavior of corporate debtors. We study whether auditor engagement risk changes when client debt is referenced by CDS. Specifically, we investigate whether external auditors increase their audit fees for those client firms with their debt referenced by CDS.

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Why is it important?

Theoretical models predict that CDS reduce debtors’ monitoring and debtors’ willingness to renegotiate distressed debt. By examining how auditors perceive the effect of CDS on engagement risk, we contribute novel insights to the emerging literature on debtor governance.