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    Do Industry-Specialist Auditors Influence Stock Price Crash...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.07 Attempts to Measure Audit Quality 
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    Title:
    Do Industry-Specialist Auditors Influence Stock Price Crash Risk?
    Practical Implications:

    This study shows that industry specialists reduce a specific type of risk, stock price crash risk, which has become increasingly important following the Enron scandal and the recent financial market crisis. It also shows that the effects of opacity and conservatism on crash risk are moderated by auditor quality, furthering the emerging literature on the determinants of crash risk. 

    Citation:

    Robin, J. Ashok and Hao Zhang. 2015. Do industry-specialist auditors influence stock price crash risk? Auditing: A Journal of Practice and Theory 34 (3): 47-79.

    Keywords:
    Auditor quality, industry specialization, crash risk
    Purpose of the Study:

    In the past, a great deal of research has been done examining the idea that high-quality auditors benefit reporting quality in a variety of ways.  Other research has been done to focus on direct economic consequences for investors.  Some of this research has found that high-quality auditors can reduce the cost of debt, lower equity costs, diminish IPO underpricing, and even influence loan syndicate structure.  One issue that has not been examined, however, is whether high-quality auditors can reduce the crash risk for equity investors.  This paper focuses on this question.  Because crash risk is primarily caused by bad news hoarding, the authors believe that high-quality auditors can function as information mediators and reduce the crash risk in the following ways:

     

    • High-quality auditors are more likely to uncover bad news and suppress the mangers’ bad-news hoarding activities due to their greater capability
    • High-quality auditors have stronger incentives to disclose bad news in a timely manner and suppress managers’ bad-news hoarding activities

     

    In addition to mediating some of the bad news, the authors also believe that high-quality auditors also reduce crash risk by decreasing agency costs, decreasing malfeasance by managers, improving operating decisions, and decreasing expropriation.  This study could prove very valuable to investors, as crash risk is an important consideration in portfolio management. 

    Design/Method/ Approach:

    The research evidence is collected from a twenty-year sample period ranging from 1990-2009.  The authors obtained stock return data from the Center for Research in Security Prices (CRSP) database.  Accounting data and auditor characteristics were obtained from the Standard and Poor’s Compustat database. After making exclusions based on a number of criteria, the final sample amounted to 58,365 firm-year observations. Regression models were run on these observations to arrive at the author’s findings. 

    Findings:
    • The authors find that across all six models tested, to a statistically significant degree, stock price crash risk is lower for firms audited by industry-specialist auditors.
    • Results also indicated that crash risk is higher in firms with higher standard deviation and mean of stock returns, younger age, higher ROA, greater intangible assets, greater share turnover, and lagged negative skewness.
    • Concentrated institutional ownership can induce effective monitoring and lead to lower further crash risk.
    • Conservatism is negatively and significantly related to crash risk.
    • Auditor specialization provides benefits beyond reporting benefits.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality