The self-contagion effect of a stock crash on the market response of the auditor’s other client

Abstract

ABSTRACT This study aims to find out how information regarding a firm’s stock crash affects the stock price of other firms with the same auditor using 3,916 corporations listed in Korean stock market. The result shows that at the time of a stock crash within the industry, information regarding the crash is contagious via the auditor, as the market leverages the information audited for the crashed firm to additionally evaluate the auditor’s other clients within the industry. Moreover, the contagion effect of the crash within the same auditor to other client firms was found to not be related to the information quality of the client firm. When taking out information quality, however, a high positive discretional accruals quality is observed, and the greater the contagion effect of the crash. The results recognize and reflect the future risk of a stock crash for firms with a high amount of positive discretionary accruals due to the opportunistic incentives of managers in the market as well as market participants’ use of crash information audited by the same accounting firm. These results demonstrate that the market appreciates the audit effect on the crash and uses it for actual decision-making.