The impact of audit firm industry differentiation on IPO underpricing

Abstract

PurposeThe purpose of this paper is to investigate the relationship between auditor industry differentiation (specialization) and the underpricing of initial public offerings (IPOs). The intention is to determine whether IPO firms – particularly those in the small firm segment of the market where information asymmetry is likely to be greatest – can benefit from significantly better IPO pricing by engaging the services of differentiated auditors.Design/methodology/approachThe paper examines a broad sample of initial public offerings made between 1991 and 2000. It also conducts univariate and multivariate tests to assess the relationship between IPO underpricing and auditor industry specialization.FindingsThe paper finds that IPOs audited by Big 6 firms experience significantly less underpricing than IPOs audited by non‐Big 6 firms, particularly among small clients. It also finds an additional (and significantly larger) reduction in underpricing when the client engages an auditor that has established itself as the clear leader in its industry.Research limitations/implicationsThe results in this paper may not be generalizable to different countries. They do, however, appear to be robust in the USA throughout the ten‐year sample period.Practical implicationsThe paper shows that it may not be feasible for all clients in the small‐firm segment of the market to engage specialist auditors. However, if they can, the results suggest that they could benefit from better IPO pricing.Originality/valueThe paper combines the auditor specialization literature with the IPO underpricing literature and also documents a significant economic benefit to smaller IPO firms.