Crash Risk and the Auditor-Client Relationship
Jeffrey L. Callen
University of Toronto - Rotman School of Management
Georgia State University - J. Mack Robinson College of Business
January 18, 2012
This study examines whether the term of the auditor-client relationship (i.e., auditor tenure) is associated with future stock price crash risk. Using a large sample of U.S. public firms from the years 1980 to 2008, we find robust evidence that auditor tenure is negatively related to one-year ahead stock price crash risk. This evidence is consistent with monitoring by learning perspective, namely, that the development of client-specific knowledge over the term of the auditor-client relationship effectively enhances auditors’ ability to detect and deter bad news hoarding activities by clients, thereby reducing future stock price crash risk. Additional analysis shows that the negative relation is moderated for firms audited by industry specialist and for firms during the post-SOX (Sarbanes-Oxley Act) period. We also present additional evidence that when the term of the auditor-client relationship is excessively long, the cognitive-incentive effect dominates the effect of monitoring by learning. Our evidence has important policy implications for regulators in ensuring the functioning of independent auditors in capital markets.
Keywords: crash risk, external monitoring, auditor-client relationship
JEL Classification: G32, G34, M42
Date posted: February 6, 2012 ; Last revised: February 8, 2012
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