Audit process, private information, and insider trading

Abstract

While the shareholder benefits of audits are well documented, evidence on whether audits can facilitate opportunistic behavior by corporate insiders is scarce. In this paper, we examine whether the audit process facilitates one particular form of opportunism: informed trading by corporate insiders. We focus our analysis on insider trading around the audit report date. We find an increase in trading around the audit report date and that the increase is abnormally large for firms that subsequently report modified opinions. The abnormal increase in trading is concentrated among officers and non-audit committee independent directors, and most pronounced in first-time modified opinions and modified opinions in years where financial results are subsequently restated. These trades are highly opportunistic: they predict restatements, and as a consequence, we show they avoid significant losses. Collectively, our findings provide novel evidence that insiders appear to exploit private information about the audit process––a process ostensibly designed to protect shareholders––for opportunistic gain.

Does mandatory audit rotation affect insider trading? Evidence from China

“…Additionally, Beneish and Vargus (2002) provided evidence that one year ahead of income, accruals are significantly lower when accompanied by abnormal insider selling and greater when accompanied by abnormal insider buying. Hallman et al (2020) and Arif et al (2022) investigated the association between insider trading and audit opinions. In particular, Hallman et al (2020) found that insider sales increased two to four years before the issuance of audit going-concern opinions but dropped significantly in the year of such opinion due to the early communication between auditors and their most important clients (i.e.…”

“…insiders’ firms) regarding their audit opinions. Similarly, Arif et al (2022) identified that the size of insider trading surges around the audit report date, and such an increase is greater for firms that will receive modified opinions. As a result, insider trading is encouraged when firms anticipate possible modified auditor opinions.…”

“…In addition, our study develops the literature from Hallman et al (2020) and Arif et al (2022), which explore how auditors affect firm insider trading behaviors by exploiting unique mandatory audit rotation practices. Our study also follows the literature on the determinants of insider trading and perceived stock risks (He et al , 2021).…”

Do adjustments bring auditors peace of mind? The effect of previous audit adjustments on current-year audit pricing

“…We share Arif et al ’s (2022) view that, during their audit engagement, auditors produce and accumulate private information concerning their clients. In this paper, we argue that audit adjustments represent one element of such private information pertinent to audit risk, especially, the persistence aspect of it.…”

“…We share Arif et al's (2022) view that, during their audit engagement, auditors produce and accumulate private information concerning their clients. In this paper, we argue that audit…”