Auditors and Client Investment Efficiency

Abstract

This study examines the relation between auditors and their clients' investment efficiency. We hypothesize and find that auditor characteristics that proxy for an auditor's knowledge and resources are associated with higher client investment efficiency, after controlling for the auditor's effect on financial reporting quality. This result is consistent with auditors providing informational advantages to their clients in a generalized investment setting. We find that this auditor effect is more pronounced for clients who have a higher demand for information as measured by client size, industry competition, and client complexity. The effect is also more pronounced for clients of longer-tenured auditors. Overall, the results suggest that auditors may be one component to the management information environment and, as such, appear to influence capital investment behavior. JEL Classifications: M4; M42. Data Availability: All data are publicly available.

Auditing Research: A Review of Recent Research Advances

“…Fitzgerald et al (2018) found that internal control reporting quality deteriorates with audit partner tenure. On the other hand, longer-tenured have also positive effects as studies like those conducted by Goldie et al (2018) and Bae et al (2017) documented. However, using hand-collected data from SEC filings, Goldie et al (2018) found that the positive association between reported performance and investment flows is stronger for funds with auditors who are industry specialists and are longer-tenured.…”

“…However, using hand-collected data from SEC filings, Goldie et al (2018) found that the positive association between reported performance and investment flows is stronger for funds with auditors who are industry specialists and are longer-tenured. Bae et al (2017) found that auditor's knowledge and resources are associated with higher client investment efficiency and this effect is more pronounced for clients of longertenured auditors. Francis et al (2017b) suggested that voluntary auditor changes increase information risk, which is due to be priced in private credit markets.…”

Managerial incentives and investment efficiency in high technology firms

“…Chen, Xie, and Zhang (2017) focus on the role of financial analysts who provide investors with earnings forecasts of high quality, thereby reducing firms' propensity to over-or under-invest. Finally, Bae, Choi, Dhaliwal, and Lamoreaux (2016) investigate client firms' investment efficiency in the context of auditing literature.…”

Market Interactions between Audit and Non-Audit Services: Bundling, Bans, and Competition

“…Because the client firm benefits from an audit even absent these incentives, we suppress them for simplicity. Bae et al (2017) provide empirical evidence that auditors improve investment efficiency.…”