Disclosure as a Double-Edged Sword: Financial Constraint, Corruption, and Auditing

Sk Md Barkat Ullah, University of Texas at El Paso
Jagadish K. Dandu, University of Texas at El Paso
Zuobao Wei, University of Texas at El Paso

Dandu, Jagadish K ; Ullah, Sk Md Barkat ; Wei, Zuobao - (2013). "Disclosure as a Double-Edged Sword: Financial Constraints, Corruption, and Auditing". 2013 FMA Annual Meeting . Volume Chicago, IL.


In this paper, we study the effect of financial information disclosure through auditing on firm level financial, legal, and corruption obstacles. We analyze a large-scale World Bank Enterprise Survey (WBES) data collected from 2006-2011 for over 40,000 firms in 97 mostly developing countries. We find that auditing can be a double-edge sword. On the one hand, audited firms exhibit significantly lower level of financial obstacle than unaudited firms. On the other hand, audited firms face higher level of corruption and legal obstacles than unaudited firms. To gain access to credit, firms are required to have their financial statements audited and verified by external auditors. Auditing also helps mitigate the information asymmetry between insiders and other external stakeholders (e.g. suppliers and customers). On the flipside, the information disclosure can also attract more demands for bribes by corrupt officials and subject the firm to more legal obstacles (such as lawsuits). We further examine the effect of auditing on firm growth. We find that, after controlling for firm size, industry effects and country fixed effects, information disclosure through auditing has an overall positive but insignificant effect on firm growth. However, the positive effect is statistically significant for firms in OECD countries but not for firms in non-OECD countries. OECD countries in general have more efficient institutions and better governance than non-OECD countries. Information disclosure is not always beneficial if firms operate in a business environment without efficient institutions.