Auditor Choice by IPO-Firms and Capital Market Reactions to Auditor Choice in Germany

When subscribing newly issued stocks (Initial Public Offerings, IPO), investors are faced with the risk of adverse selection due to asymmetrical information among the relevant groups of agents involved with the issue. Furthermore, agency problems increase after the IPO. The choice of a high-quality auditor may reduce information asymmetry and agency problems. First, we analyze if IPO-firms with specific characteristics (e.g. high-risk firms, low retained ownership, underwriter reputation) choose a high audit quality as a means to reduce conflict of interests and information asymmetry. This should have a positive influence on the prices, which investors are willing to pay for newly issued shares. We then turn our attention to the question of whether investors and underwriters actually perceive different audit qualities and incorporate this perception into their decisions. We have analyzed the auditor choices of all the IPO of German firms between 1990 and 1999. The sample is comprised of 318 firms. We assume that the former Big Six auditors are perceived as high-quality firms. We found that high-risk IPO