The Association Between Stock Liquidity and Audit Pricing

AUDITING: A Journal of Practice & Theory, Forthcoming

46 Pages Posted: 5 Sep 2018 Last revised: 1 Sep 2022

See all articles by John L. Campbell

John L. Campbell

University of Georgia - J.M. Tull School of Accounting

Jonathan Duchac

Wake Forest University - Schools of Business

Wei Shi

Deakin University

Derrald Stice

The University of Hong Kong - School of Business; HKU Business School, The University of Hong Kong

Date Written: August 23, 2022

Abstract

Prior research finds that the liquidity of a firm’s equity shares is associated with that firm having more aggressive discretionary accruals and revenues, suggesting that firms face pressure to make more aggressive accounting decisions when liquidity is high. However, the literature has yet to examine whether the effects of liquidity on financial reporting quality are severe enough to impact audit risk. We address this gap and offer three main findings. First, we find a positive association between stock liquidity and the probability of a financial statement restatement. This finding suggests that the pressures from liquidity to engage in aggressive reporting decisions are severe enough to result in outcomes that increase audit risk. Second, we find a positive association between the stock liquidity and audit fees, suggesting that auditors at least partially incorporate the increased audit risk from liquidity into their pricing decisions, and possibly how much audit effort to exert. Finally, we find that the positive association between stock liquidity and audit pricing is concentrated in firms with poor corporate governance mechanisms. Overall, our results suggest that the effects of liquidity on financial reporting incentives are strong enough to increase audit risk, that liquidity is positively associated with audit pricing, and that these effects are diminished when firms have otherwise strong corporate governance mechanisms.

Keywords: Stock Liquidity, Investor Disagreement, Internal Governance, Audit Risk

Suggested Citation

Campbell, John L. and Duchac, Jonathan and Shi, Wei and Stice, Derrald, The Association Between Stock Liquidity and Audit Pricing (August 23, 2022). AUDITING: A Journal of Practice & Theory, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3236279 or http://dx.doi.org/10.2139/ssrn.3236279

John L. Campbell (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706.542.3595 (Phone)
706.542.3630 (Fax)

Jonathan Duchac

Wake Forest University - Schools of Business ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States

Wei Shi

Deakin University ( email )

Burwood 3125, VIC
Melbourne, 3125
Australia

Derrald Stice

The University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

HKU Business School, The University of Hong Kong ( email )

Hong Kong
China

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