The Price of Stock Liquidity: The Effect of Investor Disagreement on Audit Risk

64 Pages Posted: 5 Sep 2018 Last revised: 22 Mar 2019

See all articles by John L. Campbell

John L. Campbell

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

Wei Shi

Deakin University

Derrald Stice

Hong Kong University of Science & Technology (HKUST) - Department of Accounting

Date Written: March 18, 2019

Abstract

Higher levels of stock liquidity can reduce firm misstatement risk by enhancing corporate governance through, for example, the increased possibility of an exit by blockholders (e.g., Edmans 2009). However, liquidity may also impede internal governance via the loss of active blockholders (Bhide 1993; Back et al. 2015). In addition, higher stock liquidity might be associated with higher information demand from investors as well as higher expected litigation costs. In this study, we examine how auditors respond to a client’s stock liquidity. We provide evidence of a positive relation between stock liquidity and audit fees, suggesting that stock liquidity increases audit risk. These results hold using an instrumental variables approach, using stock splits as exogenous shocks, and using alternative liquidity measures. The effect of stock liquidity on audit fees is more pronounced for firms with weaker internal governance and firms with smaller (non-Big N) auditors. Path analysis indicates that auditor litigation exposure, investor information demand and misstatement risk play a mediating role. Additional analysis indicates that higher stock liquidity is associated with more costly non-audit service fees, a higher issuance of going concern opinions, and lower financial reporting quality. Taken together, our findings suggest that stock liquidity is positively associated with auditor risk because of its effect on audit litigation risk and investors’ demand for disclosure.

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

Suggested Citation

Campbell, John L. and Shi, Wei and Stice, Derrald, The Price of Stock Liquidity: The Effect of Investor Disagreement on Audit Risk (March 18, 2019). 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)

Wei Shi

Deakin University ( email )

Burwood 3125, VIC
Melbourne, 3125
Australia
0404383819 (Phone)

Derrald Stice

Hong Kong University of Science & Technology (HKUST) - Department of Accounting ( email )

Clear Water Bay
Kowloon
Hong Kong

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