The Association between Audit Quality, Accounting Disclosures and Firm-Specific Risk: Evidence from the Australian IPO Market

Abstract

In an environment where expected litigation costs are relatively low (Australia), we provide evidence strongly consistent with signaling considerations influencing the choice of auditor by initial public offering (IPO) firms. When our analysis is confined to smaller IPOs and/or IPOs using less prestigous underwriters (i.e., those IPOs where the use of a high quality auditor is less "routine"), we find that the probability of selecting a high quality auditor is positively related to IPO firms' riskiness, negatively related to the level of retained ownership by the initial owners and positively related to the decision to voluntarily provide information about expected earnings. these results jointly provide support for the signaling models of Datar, Feltham and Hughes (1991) and Hughes (1986), whereby the choice of a high quality auditor represents a trade-off with the level of retained ownership, but is complimentary to the extent of direct disclosure.

JEL Classification: G24, G32, M41, M44, M49