Audit Quality and Short-Side Mispricing

• In Event: Audit Markets and Capital Markets

Abstract

Auditors may affect short-side mispricing because under a risk-based audit, auditors seek to limit overstated performance and gain more assurance on the completeness of income-decreasing accounting entries and the occurrence of income-increasing accounting entries. We find that Big 4 (specialist) auditors are associated with a reduction in annual short-side accounting-anomaly returns of 1.5 (0.9) percentage points. Inferences are robust to using a difference-in-differences design that exploits shocks to audit quality and to using entropy balancing. In placebo tests, we do not find an association between high-quality auditors and finance anomaly returns. In cross-sectional analyses, we find that high-quality auditors are (are not) associated with a reduction in short-side accounting-anomaly returns in subsamples where information asymmetry is high (low). Finally, evidence suggests that high-quality auditors help analysts incorporate accounting-anomaly information. Overall, our evidence suggests that high-quality auditors reduce short-side mispricing by improving the timeliness and credibility of financial reporting.

Authors

• Matthew Stephen Ege, Texas A&M University

• Jeremiah Green, Texas A&M University

• Lisa Tiplady, Texas A&M University