Auditor Tenure and Stock Price Idiosyncratic Volatility: The Moderating Role of Industry Specialization

Abstract

SUMMARY In this study, we examine how investors perceive the quality of financial reports audited by auditors with long tenure. We argue that auditor tenure is an important characteristic that influences the effectiveness of audits and thus affects the amount of firm-specific information that is included in stock prices by investors. Based on a sample of U.S. firms from 2003 to 2012, we show that longer tenure is associated with higher stock price idiosyncratic volatility. Further analyses reveal that this effect is only present for industry-specialist auditors, suggesting that the effect of tenure on idiosyncratic volatility is contingent on industry expertise. Our results have a number of implications for the financial markets and the accounting and auditing professions.

Auditor Tenure and Stock Price Volatility: The Moderating Role of Auditor Industry Specialization

“…Similarly, Su et al (2016) also demonstrated that with the increase of auditor tenure, because of auditor's familiarity and better understanding of the business operations, accounting systems and reporting issues improved, and thus, there was an improvement of audit quality. The quality of companies' financial reporting and audited financial statements wass enhanced and, therefore, investors will experience less uncertainty in investment decisions and forecasting return with long auditor tenure, which in turn, reduces the volatility of stock returns.…”

“…Based on the literature available, with the increase of auditor tenure, because of auditor's familiarity and better understanding of the business operations, accounting systems and reporting issues and thus, the improvement of audit quality, the quality of companies' financial reporting and audited financial statements is increased.Therefore, investors, will have less uncertainty in investment decisions and in forecasting returns, which will, in turn, reduce the volatility of stock returns (Su et al, 2016). In addition, recent empirical evidence (Stanley & Deseret, 2007;Lim and Tan, 2010) shows that the use of auditors specializing in the client's industry, enhances the relationship between the length of auditor tenure and the quality of financial reporting.…”

“…In order to compete on a basis other than remuneration, audit firms are looking to differente their services from their competitors. One of the aspectswheret audit firms are trying to distinguish themselves from other institutions is the quality of audit services provided (Su et al, 2016). Audit quality is a concept for which different definitions have been provided.…”

“…Since audit quality is not directly visible, different criteria for measuring it have been introduced. Among these criteria, auditor tenure and auditor's specialization in industry can be referred to as "specialization" (Symonic & Stein, 1996;Su et al, 2016).…”

“…In this regard, Roll (1988) states that a great amount of the inconsistency in stock returns can be informed by firmspecific information. Firm-specific information is composed of public information, for example, financial reporting, which is straightforwardly included in stock prices, and private information, which is accumulated by investors and therefore included in stock prices through cognizant business (Su et al, 2016). Although auditors are prominent in the production of trustworthy financial reports, unexpectedly few studies have scrutinized auditors' impact on stock price idiosyncratic volatility.…”