Auditor Selection and Investment Risk

Abstract

Purpose: This paper investigates the relation between the riskiness of a firm’s investment policies and the firm’s appointment of an external auditor.

Design/Methodology/Approach: Using a sample of U.S. publicly listed companies from 2004- 2014, we hypothesize that firms with riskier investment policies are more likely to choose a higher quality auditor to reduce information asymmetry and increase the credibility of financial reports. We use logit regression analysis, applying two measures of auditor quality (Big 4 and industry specialist auditors) and four measures of investment policy risk (research and development expenditure, diversification, capital expenditures, and acquisitions).

Findings: We generally find that firms with riskier investment policies choose higher quality auditors. Specifically, firms with higher R&D expenditures and acquisitions are more likely to hire a Big 4 and/or industry specialist auditor, while firms with lower capital expenditures are more likely to select a Big 4 auditor.

Practical Implications: Our findings support the notion that management characteristics and policies still may have influence over external auditor selection. This may be of interest to regulators and policymakers.

Originality/Value: There is only limited research examining the effect of a firm’s investment policies on that firm’s decision

Keywords: Auditor choice, investment risk, auditor quality