5. Conclusion
In this study, we investigate whether the term of the auditor-client relationship is associated with future stock price crash risk. Using a large sample of U.S. public firms with Big 4 auditors from the years 1981 to 2011, we find robust evidence that auditor tenure is negatively related to one-year-ahead stock price crash risk. Our empirical results are consistent with the monitoring-by-learning perspective that developing client-specific knowledge over the term of the auditor-client relationship enables auditors to detect and deter bad news hoarding activities by audit clients, thus reducing future stock price crash risk. Also, using data from the option market, we document that option market investors do not fully recognize the information contained in the term of audit-client relationship in predicting future stock price crash risk.
From a methodological perspective, by focusing on stock price crash risk, a comprehensive market-based outcome measure, our study provides more robust findings regarding the relation between auditor tenure and managerial manipulation of bad news in comparison to prior literature that centers on a specific manipulation channel such as accruals or classification shifting. Research that centers on one specific channel could easily lead to false inferences about this relation. Our paper in this regard responds to the call from the PCAOB for evidence on the role that auditors played in corporate financial disclosures during the recent financial crisis (PCAOB 2011c, 2012).
