Auditor Selection and Investment Risk

Abstract

This paper investigates the relation between the riskiness of a firm’s investment policies and the firm’s selection of an external auditor. Using a sample of U.S. publicly listed companies from 2004-2018, 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 four measures of auditor quality and four measures of investment policy risk. We find that firms with riskier investment policies are more likely to choose higher quality auditors. Specifically, firms with higher R&D expenditures, a greater number of business and geographic segments, lower capital expenditures and fewer acquisitions are more likely to hire an industry-specialist auditor or a Big 4 auditor. These results are robust to various additional analyses and robustness checks. Our findings support the notion that corporate policies directly determined by firm management still may influence external auditor selection in the post-SOX environment. This may be of interest to regulators and policymakers.

Keywords: auditor choice, investment risk, auditor quality