Microstructure theory contends that dealers' bid-ask spreads should vary intertemporally with changes in the asymmetric information component of the spread. Corporate theory suggests that stock repurchase announcements signal management's private information to the securities markets. An examination of dealers' spread behavior around firms' open market repurchases in the NASDAQ market reveals a decline in spreads adjusted for dealers' inventory-holding and order-processing costs. This decline is attributed to a reduction in informed trading risk associated with the open market repurchase announcements.
This study investigates how litigation against an audit firm affects the market value of its publicly traded clients. We examine the impact of private litigation alleging audit failure on the audit firm's clients not involved in the lawsuit. Our results indicate that clients not involved in the litigation experience significant negative returns at the announcement of litigation against their audit firm. These results suggest that the market interprets litigation against an audit firm as a signal of decreased audit quality and that the market places a value on audit quality when pricing a firm's securities. The results are also consistent with an audit insurance explanation, which views the audit firm as a source of potential financial indemnification to investors and predicts that damage to the auditor's underwriting ability will be reflected in reduced securities prices for the firm's clients. When the analysis was restricted to companies in the same industry where the alleged audit failure occurred, the market response is significantly more negative when the audit firm is considered a specialist in that industry than when the audit firm is not a specialist. Finally, the market response is weaker later in the sample period, consistent with the findings of prior research that the frequency of nonmeritorious suits has increased over time.
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