Does Net Insider Selling Affect Auditors’ Risk Assessments? Evidence from Audit Pricing

• In Event: Audit Risk, Auditor Discipline, and Audit Pricing

Abstract

Recent audit regulations require auditors to consider insider trading as part of their assessment of and response to the risk of material misstatement. Moreover, empirical research finds that net insider selling provides information about audit-relevant outcomes such as weak internal controls and fraud. Thus, we investigate whether audit fees reflect the increased risk revealed by net insider selling. We posit that any association between audit fees and net insider selling will vary depending on the types of insiders engaged in net selling activity (e.g., officers versus non-officer directors) and the extent of net selling activity. Consistent with our expectations, we find that audit fees are approximately 2 percent higher among companies with net insider selling, relative to companies with net insider buying. In subsequent tests, we find that the positive association between audit fees and net insider selling is driven by officer net selling and that the magnitude of the association between audit fees and officer net selling increases with the extent of officers’ net selling activity. Collectively, these results suggest that auditors’ risk assessments are sensitive to information reflected in net insider selling, consistent with regulatory requirements for auditors to consider non-traditional risk characteristics. In addition, our evidence suggests that auditors’ ability to process information reflected in net insider selling activity is sophisticated.

Authors

• Caroline Burke, University of Arkansas

• Cory Alan Cassell, University of Arkansas

• Sabrina Chi, University of Arkansas

• Linda Ann Myers, University of Arkansas