An Empirical Investigation of IPO Underpricing and the Change to the LLP Organization of Audit Firms

15 Pages Posted: 4 Oct 2006

See all articles by Steven R. Muzatko

Steven R. Muzatko

University of Wisconsin - Green Bay

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems

Larry Rittenberg

University of Wisconsin - Madison - Department of Accounting and Information Systems

Abstract

This paper examines the relationship between the 1994 change in audit firm legal structure from general partnerships to limited liability partnerships (LLPs) on underpricing in the initial public offering (IPO) market. The change in legal structure of audit firms reduces an audit firm's wealth at risk from litigation damages and reduces the incentives for intrafirm monitoring by partners within an audit firm. Prior research suggests that underpricing protects underwriters from litigation damages, and that the level of underpricing varies inversely with both the amount of implicit insurance provided by the audit firm and the quality of the audit services provided. We hypothesize the change in audit firm legal structure reduced the assets available from audit firms in IPO-related litigation and indirectly reduced audit quality by lowering intrafirm monitoring. As a result, underwriters have incentives as a joint and several defendant with the audit firms to increase IPO underpricing, particularly for high-litigation-risk IPOs, following audit firms' shifts to LLP status. Our findings are consistent with this hypothesis.

Keywords: audit firm limited liability, initial public offering (IPO), underpricing, insurance hypothesis, audit quality

Suggested Citation

Muzatko, Steven R. and Zehms, Karla M. and Mayhew, Brian W. and Rittenberg, Larry, An Empirical Investigation of IPO Underpricing and the Change to the LLP Organization of Audit Firms. Auditing: A Journal of Practice and Theory, Vol. 23, No. 1, pp. 53-67, 2004, Available at SSRN: https://ssrn.com/abstract=934170

Steven R. Muzatko (Contact Author)

University of Wisconsin - Green Bay ( email )

2420 Nicolet Drive
MAC B321
Green Bay, WI 54311

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-234-1052 (Phone)
608-265-5031 (Fax)

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-2714 (Phone)
608-263-0477 (Fax)

Larry Rittenberg

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

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