The paper highlighted last week showed the relationship between stock price crash risk and a long delayed audit. To remind, the principal reason for stock price crashes is managers hoarding bad information which, ultimately, comes out all at once.
The authors of the paper highlighted today, Hua Feng from the Xi’an Jiaotong University et al, wondered if auditor characteristics could mitigate stock price crash risk? Particularly if industry specialization could help prevent stock price crashes by forcing bad news out more reliably in the audit process?
It can/does. Previous research has shown that an industry specialist audit produces higher earnings quality, fewer accounting restatements and higher disclosure quality which all lead to a lower cost of equity. What the team found here, on top of all that good stuff, is stocks of companies audited by industry specialists tended to crash less.
They then took their study another layer down and asked the question does the individual auditor doing the work have any explanatory power? They were able to interrogate a public database on audit professionals and looked at four characteristics. Sex, partner/non-partner, experience and educational level to see if any of these characteristics had a relationship with future crash risk; and they all do.
So what does an auditor who indicates the smallest stock price crash risk look like? She’s a younger partner with a basic education.
Referencing other work the authors suggest that because women have been found to be more risk averse and thorough in their analysis than male peers these characteristics lead to better audits and therefore less risk.
Partners are on the hook both reputationally and financially and for those reasons probably take a tougher line with companies wanting to hide information in the shadows.
Younger auditors are still building a track record and less likely to take the broad-brush approach that more seasoned older hands may often employ. It helps if you don’t think you’ve seen it all before.
Finally, studies have shown that people with higher educational attainment tend to be more aggressive and the researchers here find a statistically significant link between auditors with Master’s Degrees and future stock price cash risk.
The weakest audit then you’re going to come across, at least in China, is the one carried out by a non-specialist firm who has tasked an older male with an outstanding academic record to perform it.
We have been warned.
You can access the paper in full via this link Auditor Industry Specialization and Stock Price Crash Risk.
Happy Sunday