Investor Sentiment and Audit Opinion Shopping

• In Event: Audit Opinion Shopping

Abstract

Prior research finds that during high investor sentiment periods, managers have stronger incentives to manage earnings and withhold bad news in order to maintain inflated valuations of their firms’ stock prices. The purpose of this study is to examine the role of audit opinion shopping in this context. Using the opinion shopping framework of Lennox (2000), we show that internal control opinion shopping is more prevalent when investor sentiment is high. Further tests reveal that the effect of sentiment on internal control opinion shopping is concentrated among “uncertain” or “difficult to value” firms and firms with low institutional ownership. We also examine how the motivation for opinion shopping varies with the level of investor sentiment by comparing the internal control reporting conservatism of the clients’ outgoing and incoming auditors. We find that during high sentiment periods, clients’ outgoing auditors have a significantly higher reporting conservatism score compared to the incoming auditor. These relationships do not persist during low sentiment periods. Lastly, we document that clients are significantly more likely to undertake downward switches (i.e., Big 4 to non-Big 4 auditor) when sentiment is high. Overall, the results suggest that firms’ opinion shopping behavior during high sentiment periods is opportunistic.

Authors

• peng guo, Michigan Tech University

• John Daniel Eshleman, Michigan Tech University

• Keval U Amin, Stony Brook University