PurposeThis study aims to examine the association between fair value accounting and the cost of corporate bonds, proxied by bond yield spread. In addition, this study explores the moderating role of auditor industry expertise at both the national and the city levels.Design/methodology/approachThis study first examines the effect of the use of fair value on yield spread by estimating firm-level regression model, where fair value is the testing variable and yield spread is the dependent variable. To test the differential impact of the three levels of fair value inputs, this paper divides the fair value measures based on the three-level hierarchy, Level 1, Level 2 and Level 3, and replace them as the test variables in the regression model.FindingsThis study finds that the application of fair value accounting is generally associated with a higher bond yield spread, primarily driven by Level 3 estimates. The results also show that national-level auditor industry expertise is associated with lower bond yield spreads for Level 1 and Level 3 fair value inputs, whereas the impact of city-level auditor industry expertise on bondholders is mainly on Level 3 fair value inputs.Research limitations/implicationsThe paper innovates by exploring the impact of fair value accounting in a setting that extends beyond financial institutions, the traditional area of focus. Moreover, most prior research considers private debt, whereas this study examines public bonds, for which investors are more likely to rely on financial reporting for their information about a firm. Finally, the study differentiates between city- and national-level industry expertise in examining the role of auditors.Practical implicationsThis research has several practical implications. First, firms seeking to raise debt capital should consider involving auditors, with either industry expertise or fair value expertise, due to the roles that auditors play in safeguarding the reliability of fair value measures, particularly for Level 3 measurements. Second, from standard-setting and regulatory perspectives, the study's findings that fair value accounting is associated with higher bond yield spread cast further doubt on the net benefits of applying a full fair value accounting regime. Third, PCAOB may consider enhancing guidance to auditors on Level 2 fair value inputs, to further enhance audit quality. Finally, creditors can be more cautious in interpretating accounting information based on fair value while viewing the employment of auditor experts as a positive signal.Originality/valueFirst, the paper extends research on the role of accounting information in public debt contracting. Second, this study adds to the auditing literature about the impact of industry expertise. Finally, and more generally, this study adds to the ongoing controversy on the application of fair value accounting.
