What If Auditing Was Not 'Low-Margin Business'? Auditors and Their IPO Clients as a Natural Experiment

36 Pages Posted: 9 Aug 2004

See all articles by Ramgopal Venkataraman

Ramgopal Venkataraman

University of Texas at Arlington

Joseph Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Michael Willenborg

University of Connecticut - Department of Accounting

Date Written: July 30, 2004

Abstract

We use the IPO setting to examine the relation between the auditor's exposure to legal liability, audit fees and audit quality. Consistent with the increase in litigation liability that an IPO audit implies, we find that auditors earn much higher fees for IPO engagements than for first-year, post-IPO engagements. Moreover, these higher fees are strongly associated with our proxy for the auditor's litigation exposure under the 1933 Act, the size of the IPO. In addition, we find that pre-IPO accruals are significantly less than first-year post-IPO accruals. Overall, we find no evidence to suggest that IPO companies engage in opportunistic earnings management. Taken together, IPOs do not appear to be "low-margin" engagements for auditors, nor does it seem that auditors permit their IPO clients an increase in accounting discretion.

Keywords: Auditing, Litigation, Litigation risk, Abnormal accruals, Audit fees, Earnings management, Initial public offerings

JEL Classification: M49, M41, M43, K22, G24

Suggested Citation

Venkataraman, Ramgopal and Weber, Joseph Peter and Willenborg, Michael, What If Auditing Was Not 'Low-Margin Business'? Auditors and Their IPO Clients as a Natural Experiment (July 30, 2004). MIT Sloan Working Paper No. 4508-04. Available at SSRN: https://ssrn.com/abstract=573443 or http://dx.doi.org/10.2139/ssrn.573443

Ramgopal Venkataraman

University of Texas at Arlington ( email )

415 S West St Apt no 205
Arlington, TX 76019
United States

Joseph Peter Weber (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

Michael Willenborg

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269
United States
860-486-3020 (Phone)
860-486-4838 (Fax)

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