Audit Process, Private Information, and Insider Trading
51 Pages Posted: 2 Nov 2018 Last revised: 12 Aug 2020
Date Written: August 5, 2020
While the shareholder benefits of audits are well documented, evidence on whether audits can facilitate opportunistic behavior by corporate insiders is scarce. In this paper, we examine whether the audit process facilitates one particular form of opportunism: informed trading by corporate insiders. We focus our analysis on insider trading around the audit report date. We find an increase in trading around the audit report date and that the increase is abnormally large for firms that subsequently report modified opinions. Abnormal increase in trading is concentrated among officers and non-audit committee independent directors, and most pronounced in first-time modified opinions and modified opinions in years where financial results are subsequently restated. These trades are highly opportunistic: they predict restatements, and as a consequence, avoid significant losses. Collectively, our findings provide novel evidence that insiders appear to exploit private information about the audit process––a process ostensibly designed to protect shareholders––for opportunistic gain.
Keywords: audit opinions, audit process, audit report, private information, insider trading, opportunism
JEL Classification: G34, J33, K31, M52
Suggested Citation: Suggested Citation