Stock Price Crashes and Auditors’ Client-Retention Decisions

Abstract

This study examines auditor resignations around a client firm’s stock price crash. Overall, the study suggests that a firm’s crash risk is one of the key factors influencing auditors’ client-retention decisions. A stock price crash increases the likelihood of lawsuits and financial restatements in the future. After controlling for risk factors that contribute to resignation decisions, I document a positive association between auditor resignations and stock price crashes. Further findings indicate that auditor size affects auditor–client relationship decisions before a crash occurs: Big auditors tend to resign more often from client firms with high crash risk compared with smaller auditors. However, auditor size becomes irrelevant once a crash occurs, as the client firms then become risky clients to both large and small auditors. This study therefore provides evidence that auditors of different sizes face different incentives to alter their relationship prior to a stock price crash and that these incentives change following a crash.