Auditor Pricing of Reverse Stock Split Firms: Delisting Risk, Effort, or Both?

• In Event: Auditing

Abstract

Stock splits are corporate events that often involve either increasing the share price by reducing the number of shares outstanding (a reverse split) or reducing the share price and increasing the number of shares outstanding (a forward split). In theory, as the size of a pizza does not vary no matter how many slices one cuts it into, the market value of shareholders’ equity should not change when a firm does a stock split. However, research indicates that while stock splits are in theory value irrelevant, they contain relevant signals to market participants regarding the cash flow prospects of the splitting firm. In this paper, we investigate whether auditors price the signal embedded in a reverse stock split. We examine whether audit fees are higher for reverse stock split (RSS) firms versus non-RSS firms. We find that auditors assign a statistically and economically significant fee premium to RSS firms. However, we do not find evidence that the fee premium reflects assessed warranty expenses for the auditor related to anticipated litigation risk arising from client bankruptcy or default.

Authors

• Kathleen Rankin, Morgan State University

• Deborah Smith, Cleveland State University

• Kimberly C Gleason, American University of Sharjah

• Bilal Makkawi, Morgan State University