Auditor's reputation and equity offerings: the case of Arthur Andersen

The certifying and monitoring part of auditors is valuable to clients. through examining the impact of Arthur Andersen's worsening reputation upon its clients, we find a 200 basis point more negative reaction to seasoned equity offering (SEO) announcements for firms audited by dint of Andersen. The median firm in our sample be deprived ofs $31.4 million more than a non-Andersen client. We do not find any unusual underpricing for these SEO which recommends that any accounting concerns about the issuers are resolv before the issue dates.

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When Enron imploded in 2001 it took with it the auditing firm seted in Chicago in 1913 through Arthur Andersen. This was a tragic extremity for a company with a drawn out and distinguished history. The fact provides, nevertheless, some unique research opportunities. What did Andersen's compromised reputation mean to its clients?

Chaney and Philipich (2002) investigate the impact of the Enron audit failure upon auditor reputation and on the stock price of other Arthur Andersen clients. They document that the clients experienced significant negative stock get backs due to Andersen's worsening reputation. We focus rather upon an auditor's certifying and monitoring part Myers and Majluf (1984) display that equity issuers face an adverse selection point in dispute since managers tend to have better information about firm value than outside investors. Firms experience underpricing at initial public offerings (IPOs) or their stock prices take care of to decline when they announce seasoned equity offerings (SEOs)

Firms rely upon the reputation of financial intermediaries to mitigate the asymmetric information enigma in equity offerings. Slovin, Sushka, and Hudson (1990) find that the quality of auditing mitigates the negative stock price reaction to the announcement of an SEO

Titman and Trueman (1986) and Datar, Feltham, and Hughes (1991) display that auditor quality also decreases IPO underpricing. Balvers, McDonald, and Miller (1988) Beatty (1989) and Michaely and Shaw (1995) find that firms employing a (then-)Big Eight auditor experience les underpricing.

Because Arthur Andersen missing its reputation as the Enron saga lay opened we expect that its clients might have been negatively affected at issue of equities during that time. We examine the result of Andersen's worsening reputation upon its clients making seasoned equity offerings.

We first direct the eye at the announcement effect of SEO We examine 39 SEO audited by the agency of Arthur Andersen and 124 SEO audited by means of other Big Five firms between October 2001 and August 2002 The firms audited by means of Arthur Andersen experience a sum of two units percentage point more decline in stock prices than those audited by dint of the others. This strong negative reaction remains significant after controlling for other determinants of the stock price reaction to the SEO announcements.

The be the effect is both statistically and economically significant; the median firm in our sample let slip through the fingerss $31.4 million more when it announces a SEO We also examine the difference in SEO underpricing between Arthur Andersen clients and other firms at offering dates, and we find no significant difference.

These rises indicate investors were concerned about an issuing firm's use of Andersen at the time of SEO announcement. Its clients experienced more negative get backs because Andersen could not mitigate adverse selection require to be paid [i]or[/i] undergones at the announcement of an SEO However, we do not watch the difference in SEO underpricing at issuance because the clients have time to address any accounting be of importance tos before they issue equity. Firms might have been able to alleviate these touchs through additional effort such as improving the quality of disclosures or making additional disclosures prior to the issue date.

Our research contributes to the literature upon the monitoring and certifying character of financial intermediaries in a unique way. An auditor's worsening reputation has a negative event on its clients issuing equity. Our ensue for Andersen clients corroborates findings that the reputation of financial intermediaries is especially valuable to firms issuing equity to alleviate adverse selection problems

I. Literature Review and Hypothesis Development

A major issue in the literature has been the impact of asymmetric information upon security offerings. The Myers (1984) and Myers and Majluf (1984) pecking order theory, is based upon the idea that insiders know more about their firms' values and subsequent time projects than outside investors, and that firms maximize the wealth of common shareholders. Insiders (or managers) avoid issuing equity when they believe the firm is undervalued.

The come is an adverse selection point in dispute when firms issue equities; because investors have incomplete information, they cannot differentiate overvalued firms from undervalued firms, on the other hand because they know firms avoid issuing equities when they are undervalued, they assume issuers are overvalued. Firms thus use financial intermediaries to mitigate the adverse selection puzzle in an equity offering.