Auditor Selection and Investment Risk.

• In Event: Auditor Choice and Audit Quality

Abstract

Using a sample of U.S. publicly listed companies for the 2004-2014 period, we investigate the relation between the riskiness of a firm’s investment policies and the firm’s appointment of an external auditor. 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. With two measures of auditor quality (Big 4 and industry specialized auditors) and three measures of investment policy risk (research and development (R&D) expenditure, standard deviation of monthly stock returns and diversification), we generally find that firms with riskier investment policies choose higher quality auditors. Specifically, a firm with a higher ratio of R&D expenditure over sales is more likely to hire a Big 4 and/or industry specialist auditor. Firms with a higher standard deviation of monthly stock returns are more likely to select industry specialist auditors. We also find that more diversified firms are more likely to appoint a Big 4 auditor. Our paper expands prior research on auditor selection by potentially identifying a previously unidentified determinant: investment policy risk.

Authors

• Benjamin Hoffman, Kent State University

• Trung Huy Pham, Kent State University - Kent

• Mai Dao, University of Toledo