Abstract

     Using a sample of U.S. seasoned equity offering (SEO) during the period 2002–۲۰۱۷, we document that audit quality is associated with SEO issuance method choice. Specifically, firms with higher quality auditors are more likely to adopt the accelerated offerings issue method instead of using other seasoned equity offering methods. We also identify that audit tenure and industry audit specialization influence the relation between audit quality and the likelihood of undertaking accelerated SEO offerings, and that the relationship is more pronounced in the presence of weaker firm-level information and governance environments. Extending from the conclusion that accelerated offerings serve as a quality certification mechanism, we also find that firms completing accelerated offerings enjoy lower audit fees in subsequent years. These firms also exhibit superior post-SEO-issue long-term abnormal stock performance. Overall, our study shows that the certifying and monitoring role of auditors is valuable to clients, underwriters, and investors in SEO transactions.

Introduction

     It has long been theoretically recognized that the asymmetry of information between firms and outside investors can determine firms’ financing choices because higher information asymmetry results in higher external financing costs (Myers, 1984 and Myers & Majluf, 1984).1 In the literature on seasoned equity offerings (SEOs) where firms raise additional capital from the equity market, the certification hypothesis (Beatty & Ritter, 1986; Booth & Smith, 1986; Carter & Manaster, 1990) proposes that asymmetric information between issuing firms and investors implies that any quality certification mechanism that helps investors verify SEO issuing firms should be especially valuable. Because firms’ financial statements play an important role in reducing information asymmetry in capital markets and auditors provide the key accredited service assuring the integrity of this information, we expect that the quality of audit services serves as an important governance and certification mechanism in SEOs. Furthermore, we propose that this certification mechanism is relevant to SEO issuing firms in terms of increasing the likelihood of successfully completing shorter issue processes through attracting both underwriter and investor participation, with audit quality having an important role in reducing underwriter engagement risk and acting as a substitute for more extensive due diligence assessment of issuing firms. In this study, therefore, we examine the role of firm auditor quality in determining the choice of SEO issue methods as a certification and monitoring mechanism and also aiding in underwriter attraction. We also examine the relation between SEO methods and post-SEO firm outcomes – in terms of audit fees and longterm stock performance.

Conclusion

     Despite the prominence of auditor quality in certifying financial information in the capital market (Blackwell, Noland, & Winters, 1998; Hogan, 1997; Pittman & Fortin, 2004), the relation between auditor quality and the choice of SEO issue method has not been thoroughly examined in the prior literature. Our study provides new insights into the role of auditor status as a certification mechanism in SEOs and the impact of issuance choice of SEOs on audit pricing and long-run performance.

      We document evidence that auditor quality, based on Big 4 auditor status, has a significant association with the design features of SEO offerings. Specifically, firms with high quality auditors are more likely to use the accelerated offering SEO method rather than the traditional firm commitment offer process and other issue methods. We confirm this finding using audit fees, accrual levels and mid-tier audit firms as alternative proxies for audit quality and also find that the role of audit quality in facilitating accelerated offering use is more prominent in cases of shorter audit tenure, the appointment of non-specialist auditors and in the presence of weaker firm-level information and corporate governance environments.

     We also provide support for a certification role for accelerated offerings in the post-SOE period. We document that firms completing accelerated offerings pay lower subsequent audit fees relative to firms using firm commitment and other offering methods. These firms also exhibit higher long-term post-issue abnormal share price performance. This is in stark contrast with the negative signalling implications of equity capital raisings generally documented in the SEO literature.