The Informational Impact of Auditor Choice

A change in auditors is commonly observed in firms which are selling shares nationally for the first time. One impetusfor this is said to come from underwriters who advise their clients to switch from a local to national auditing firm known for higher quality standards in order to receive a higher price for the shares sold. This statement implicitly reflects the belief that the audit quality chosen by a firm's owner will convey to the market something about the firm's intrinsic value. In this paper a model is presented which gives theoretical support to this belief. Under plausible condition it is shown that owners of firms with higher true value will choose higher quality quality audits than will those in firms of lower true value. Investors, observing this relation, will then assign higher market values to those firms that choose higher quality audits.