ABSTRACT

Purpose – According to agency theory, managers have incentives to adjust firm revenues to meet earnings expectations or delay bad news disclosure because of performance-based compensation and their reputation in the market. When the bad news accumulates, stock prices fail to reflect all available information. Thus, market prices of stocks are higher than their intrinsic value. After all, bad news crosses the tipping point, it comes out all at once. That results in stock crashes. Auditors can decrease stock crash risk by reducing agency costs through their informational role. Especially, stock price crash risk is expected to be lower for firms adopting high-quality audits. We focus on distribution and service industry to examine the relation between audit quality and stock price crash risk. Industry specialization and auditor size are used as proxies for auditor quality. Research design, data and methodology – Our sample contains distribution and service industry firms listed in KOSPI and KOSDAQ during a period of 2004-2011. We use a logistic regression to test whether auditor quality influences crash risk. Auditor quality was measured by industry specialist auditor and Big4 / non-Big4 dichotomy. Following the approach in prior researches, we use firm-specific weekly returns to measure crash risk. Firms experiencing at least one stock price crash in a specific week during year are classified as the high risk group. Results – The result of analyzing 429 companies in distribution and service industry is summarized as follows: Above all, it is shown that higher audit quality has a significant negative(-) effect on the crash risk. Crash risk is alleviated for firms audited by industry specialist auditors and Big 4 audit firms. Therefore, our results show that hypotheses are supported. Conclusions – This study is very meaningful as the first study which investigated the effects of high audit quality on stock price crash risk. We provide evidence that high-quality auditors reduce stock price crash risk. Our finding implies that the risk of extreme losses can be reduced through screening of high-quality auditors. Therefore investors and regulators may utilize our findings in their investment and rule making decisions.

KEYWORD

Audit Quality, Big4 Auditor, Industry Specialist Auditor, Stock Crash Risk, Distribution & Service.

REFERENCES(39)open

  1. [jounal] Ball, R. / 2009 / Market and political/regulatory perspectives on the recent accounting scandals / Journal of Accounting Research 47 (2) : 277 ~ 323

  2. [jounal] Balsam, S. / 2003 / Auditor industry specialization and earnings quality / Auditing: A Journal of Practice and Theory 22 : 71 ~ 97

  3. [jounal] Becker, C. L. / 1998 / The effect of audit quality on earnings management / Contemporary Accounting Research 15 (Spring) : 1 ~ 24

  4. [jounal] Bleck, A. / 2007 / Market transparency and the accounting regime / Journal of Accounting Research 45 (2) : 229 ~ 256

  5. [jounal] Cahan, S. F. / 2013 / Damaged auditor reputation and analysts'forecast revision frequency / Auditing : A Journal of Practice and Theory 32 (1) : 33 ~ 60

  6. [jounal] Casterella, J. / 2004 / Auditor industry specialization, client bargaining power, and audit pricing / Auditing : A Journal of Practice and Theory 23 (1) : 123 ~ 140

  7. [jounal] Chen, J. / 2001 / Forecasting Crashes : Trading Volume, Past Returns, and Conditional Skewness in Stock Prices / Journal of Financial Economics 61 : 345 ~ 381

  8. [jounal] DeAngelo, L. E. / 1981 / Auditor size and audit quality / Journal of Accounting & Economics 3 : 183 ~ 199

  9. [jounal] Dechow, P. M. / 1995 / Detecting earnings management / The Accounting Review 70 : 193 ~ 225

  10. [jounal] DeFond, M. L. / 2015 / Does mandatory IFRS adoption affect crash risk? / The Accounting Review 90 (1) : 265 ~ 299

  11. [jounal] Diamond. D. / 1985 / Optimal release of information by firms / Journal of Finance 40 : 1071 ~ 1094

  12. [jounal] Dunn, K. A. / 2004 / Audit firm industry specialization and client disclosure quality / Review of Accounting Studies 9 (1) : 35 ~ 58

  13. [jounal] Fan, J. P. H. / 2005 / Do external auditors perform a corporate governance role in emerging markets? Evidence from East Asia / Journal of Accounting Research 43 (1) : 35 ~ 72

  14. [jounal] Francis, J. R. / 1999 / The role of big 6 auditors in the credible reporting of accruals / Auditing: A Journal of Practice and Theory 18 (Fall) : 17 ~ 35

  15. [jounal] Godfrey, J. M. / 2005 / The impact of R&D intensity on demand for specialist auditor services / Contemporary Accounting Research 22 (1) : 55 ~ 93

  16. [jounal] Graham. J. / 2005 / The economic implications of corporate financial reporting / Journal of Accounting and Economics 40 : 3 ~ 73

  17. [jounal] Healy, P. M. / 2001 / Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature / Journal of Accounting & Economics 31 : 405 ~ 440

  18. [jounal] Hong, H. / 2003 / Differences of opinion, shot-sales constraints, and market crashes / The Review of Financial Studies 16 : 487 ~ 525

  19. [jounal] Huang, W. / 2012 / Extreme downside risk and expected stock returns / Journal of Banking and Finance 36 (5) : 1492 ~ 1502

  20. [jounal] Hutton, A. P. / 2009 / Opaque financial reports, R2 and crash risk / Journal of Financial Economics 94 : 67 ~ 86

  21. [jounal] Ibragimov, R. / 2007 / The limits of diversification when losses may be large / Journal of Banking and Finance 31 (8) : 2551 ~ 2569

  22. [jounal] Jensen, M. C. / 1976 / Theory of the firm : Managerial behavior, agency costs and ownership structure / Journal of Financial Economics 3 : 305 ~ 360

  23. [jounal] Jin, L. / 2006 / R2 around the world : New theory and new tests / Journal of Financial Economics 79 : 257 ~ 292

  24. [jounal] Khurana, I. K. / 2004 / Litigation risk and the financial reporting credibility of Big 4 versus non-Big 4 audits : Evidence from Anglo-American countries / The Accounting Review 79 (2) : 473 ~ 495

  25. [jounal] Kim, J. B. / 2011 / Corporate tax avoidance and stock price crash risk : firm-level analysis / Journal of Financial Economics 100 : 639 ~ 662

  26. [jounal] Kothari, S. P. / 2009 / Do manager withhold bad news? / Journal of Accounting Research 47 : 241 ~ 276

  27. [jounal] Krishnan, G. / 2003 / Audit quality and the pricing of discretionary accruals / Auditing: A Journal of Practice and Theory 22 : 109 ~ 126

  28. [jounal] Mansi, S. A. / 2004 / Does auditor quality and tenure matter to investors?. Evidence from the bond market / Journal of Accounting Research 42 (4) : 755 ~ 793

  29. [jounal] Mayhew, B. / 2003 / Audit firm industry specialization as a differentiation strategy : Evidence from fees charged for firms going public / Auditing : A Journal of Practice and Theory 22 : 33 ~ 52

  30. [jounal] Morck, R. / 2000 / The information content of stock markets : Why do emerging markets have synchronous stock price movement? / Journal of Financial Economics 58 : 215 ~ 260

  31. [jounal] Myers, J. / 2003 / Exploring the term of the auditor–client relationship and the quality of earnings : a case for mandatory auditor rotation? / The Accounting Review 78 (3) : 779 ~ 799

  32. [jounal] Nagar. V. / 2003 / Discretionary disclosure and stock-Based incentives / Journal of Accounting and Economics 34 : 283 ~ 309

  33. [jounal] 나종길 / 2005 / 회계감사인의 산업별 전문성이 회계이익의 질에 미치는 영향 / 회계ㆍ세무와 감사 연구 (41) : 261 ~ 297

  34. [jounal] Palmrose, Z. V. / 1989 / The relation of audit contract type to audit fees and hours / Accounting Review 64 : 488 ~ 500

  35. [jounal] Romer, D. / 1993 / Rational asset price movements without news / American Economic Review 83 (5) : 1112 ~ 1130

  36. [jounal] Santa-Clara, P. / 2010 / Crashes, volatility, and the equity premium : Lessons from S&P 500options / Review of Economics and Statistics 92 (2) : 435 ~ 451

  37. [confproc] Sunder, S. / 2010 / Riding the accounting train: From crisis to crisis in eighty years / Presentation at the Conference on Financial Reporting, Auditing and Governance

  38. [jounal] Verrecchia, R. / 2001 / Essays on disclosure / Journal of Accounting and Economics 32 : 97 ~ 180

  39. [jounal] Willenborg, M. / 1999 / Empirical analysis of the economic demand for auditing in the initial public offerings market / Journal of Accounting Research 37 (1) : 225 ~ 238