Do statutory internal auditors influence stock price crash risk? Firm-level evidence from Korea

Abstract

PurposeBased on 1,798 firm-year observations from 2009 to 2013, using publicly available disclosure data for Korean listed firms, this study aims to examine whether statutory internal auditors influence firm-level stock price crash risk.Design/methodology/approachBased on the bad news hoarding theory of crash risk, the authors investigate the association between the quality of statutory internal auditors and one-year-ahead stock price crash risk. The quality of statutory internal auditors is measured as the compensation of statutory internal auditors and the financial expertise of statutory internal auditors. Stock price crash risk is measured as an indicator variable whether a firm experiences one or more crash weeks during the fiscal year period.FindingsThe authors find that higher quality of statutory internal auditors – measured through greater compensation and greater financial expertise – is associated with lower possibilities of future stock price crash risk. These results indicate that high-quality statutory internal auditors mitigate bad news hoarding of managers because of their greater capability and stronger incentive to lower litigation risk and preserve their reputation. The results are mostly robust to different measures for stock price crash risk and the quality of statutory internal auditors.Practical implicationsThe findings of this study regarding stock price crash risk are important for investors because such risk can significantly affect investor welfare. The results indicate that statutory internal auditors play an important role in controlling future stock price crash risk and maintaining stability in the equity market.Originality/valueThis study adds to the extant literature on the determinants of stock price crash risk and is the first to examine the impact of internal auditors on stock price crash risk. Moreover, this study also contributes to the existing literature on internal auditor quality by showing that high-quality statutory internal auditors reduce risks in financial markets.