The Importance of Information Asymmetry to Auditor Choice, Audit Fees, and Going Concern Opinions: Evidence from Exploiting Exogenous Shifts in Analyst Coverage

Abstract

We analyze whether information asymmetry affects three major aspects of the audit process using an instrumental variables research design that exploits exogenous increases in information asymmetry stemming from brokerage house mergers and closures. Consistent with our predictions, we find that a rise in information asymmetry leads to: (i) a higher (lower) probability that firms switch to a higher (lower) quality auditor, implying that information asymmetry stimulates demand for auditing, (ii) higher audit fees, implying that worse information asymmetry is a priced audit risk, and (iii) a higher probability that auditors render a going concern opinion, implying that auditors’ reporting decisions are sensitive to this risk. In another approach to confronting the endogeneity threat that undermines reliable identification in extant research, our core evidence holds in a difference-in-difference framework that involves examining the three auditing outcomes surrounding the brokerage house merger/closure window.

Keywords: Information Asymmetry, Demand for Auditing, Audit Fees, Going Concern Opinions

JEL Classification: M41, M42