The Association Between Stock Liquidity and Audit Pricing

Abstract

Prior research has yet to examine whether the effects of liquidity on financial reporting quality are severe enough to impact audit risk. We address this gap and offer three main findings. First, we find a positive association between stock liquidity and the probability of a financial statement restatement. This finding suggests that the pressures from liquidity to engage in aggressive reporting decisions are severe enough to result in outcomes that increase audit risk. Second, we find a positive association between the stock liquidity and audit fees, suggesting that auditors at least partially incorporate the increased audit risk from liquidity into their pricing decisions, and possibly how much audit effort to exert. Finally, we find that the positive association between stock liquidity and audit pricing is concentrated in firms with poor corporate governance mechanisms.