The Price of Stock Liquidity: The Effect of Investor Disagreement on Audit Risk
58 Pages Posted: 5 Sep 2018
Date Written: August 21, 2018
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 (see e.g., Edmans et al. 2009). However, liquidity may also impede internal governance via the loss of active blockholders (Bhide 1993). 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 relationship 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 and investor information demand play a mediating role. Additional analysis indicates that higher stock liquidity is associated with more costly non-audit service fees and a higher issuance of going concern opinions. Taken together, our findings suggest that stock liquidity is positively associated with auditor risk due to its effect on audit litigation risk and investors’ demand for disclosure.
Keywords: Stock Liquidity, Investor Disagreement, Internal Governance, Audit Risk
Suggested Citation: Suggested Citation