The Economic Consequences of Firms' Voluntary Submission to Greater External Scrutiny
Posted: 16 Sep 2002
Date Written: September 16, 2002
There is a significant positive market reaction to merger announcements by acquiring firms that use lower quality external auditors. One explanation for the positive performance of these firms is that their cost-of-capital is reduced as a result of their voluntary submission to the intense scrutiny inherent in the merger process. For the lower quality audit firms, I find that the cost-of-capital effect dominates the over-valuation signaling effect of a stock-for-stock merger previously documented in the literature. I also find that a cash bid conveys to the market a stronger positive signal for low quality audit clients as opposed to high quality audit clients. Because the choice of a high quality auditor is already associated with favorable private information, clients of high quality audit firms tend to benefit less from the announcement of a cash acquisition. The results are robust to controlling for the usual determinants of acquirers' abnormal returns, both acquirers and targets' sizes, and potential sample selection biases.
Keywords: merger, auditing, market efficiency, information asymmetry, disclosure, cost-of-capital, auditor switch, audit quality
JEL Classification: G14, G34, M41, M49
Suggested Citation: Suggested Citation