The Role Of Audit Quality In The Valuation Of Initial Public Offerings

This study provides an empirical examination of the theoretical model proposed by Datar, Feltharn and Hughes (1991) on the demand for audit quality in an initial public offering (PO) environment by utilizing data from Malaysian IPO market. Consistent with the model, two hypotheses are developed; (I) there is a positive association between audit quality and firm-specific risk, and (2) financial reports attested to by higher quality auditors should have a greater marginal effect on current market value than the reports associated with low quality auditors. Two models are used to test these predictions. The first one is the author choice model, whch is a multivariate logistic regression model, while the second one is the valuation model developed by Datar et al. (1991). No evidence is found to support the predicted positive relationship between audit quality and firm-specific risk. The results are consistent with the expectation that there is a significant effect of audit quality on the market valuation of PO stocks. This reflects a greater degree of confidence placed by investors on reports approved by high quality auditors. The results are also not sensitive to alternative definitions of variables, omitted variable problems, the presence of outliers or the size effect. Overall, the findngs indicate the role of audit quality as a signaling mechanism in the valuation of PO in Malaysia