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    Auditor Tenure and Stock Price Idiosyncratic Volatility: The...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
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    Title:
    Auditor Tenure and Stock Price Idiosyncratic Volatility: The Moderating Role of Industry Specialization
    Practical Implications:

    This study shows that auditor tenure is associated with the incorporation of firm-specific information into stock prices, and it contributes to the debate on whether the mandatory rotation of audit firms is necessary, finding in favor of the learning effect of auditor tenure. In other words, this study suggests that audit firm rotation should not necessarily be mandatory. This study is also related to recent studies on the moderating effect of industry expertise on the relationship between tenure and audit quality; however, this study stands out from others because it focuses on investors’ perceptions of audit quality instead of actual financial reporting quality. Finally, the study contributes to the growing literature on the determinants of stock price idiosyncratic volatility, finding that auditor tenure is another important characteristic.

    Citation:

    Su, L., Zhao, X., and Zhou, G. 2016. Auditor Tenure and Stock Price Idiosyncratic Volatility: The Moderating Role of Industry Specialization. Auditing: A Journal of Practice and Theory 35 (2): 147-166.

    Keywords:
    auditor tenure, auditor industry specialization and stock price idiosyncratic volatility
    Purpose of the Study:

    Higher stock price idiosyncratic volatility conveys firm-specific information to the financial markets, which enables investors to make better financial decisions. This leads to the more efficient allocation of capital. Auditors are instrumental in this process, yet there are few studies that examine the effect of auditors on stock price idiosyncratic volatility. This paper furthers the few studies that have been completed on this subject by examining the economic consequences of auditor tenure, which is another important auditor characteristic in terms of stock price idiosyncratic volatility. The authors decided to investigate the effects of auditor tenure as opposed to the effects of auditor brand name on stock price idiosyncratic volatility because relatively few studies examine the economic consequences of tenure compared with the large body of literature on auditor brand name. Also, limiting the sample to Big N auditors, the authors can focus on a largely homogenous group of auditors that provides a better setting in which to examine other audit characteristics such as tenure. 

    Design/Method/ Approach:

    The authors empirically examine a sample of U.S. Big 4 clients from 2003 to 2012. 

    Findings:
    • The authors find that clients that have a longer relationship with their auditors exhibit greater stock price idiosyncratic volatility after controlling for the actual financial reporting quality, supporting the notion that investors perceive longer tenure to produce more credible financial reporting and encourage more specific information.
    • The authors find that the aforementioned effect is present only for auditors who are industry specialists, consistent with the interpretation that investors perceive that auditors with longer tenure produce higher quality audits through their industry expertise.
    • The authors’ results confirm the conjecture that audit quality and auditor characteristics play an important role in investors’ perceptions and incentives to collect private information, as reflected by the idiosyncratic volatility of stock prices.
    • The authors’ findings suggest that elongated auditor tenure contributes to the learning effect enhancing audit quality, as opposed to harming audit quality through overfamiliarity.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Industry Expertise – Firm and Individual