Effects of Auditing: Semi-annual Audits and Inter-investor Information Divergence

We develop a model to show that auditing can reduce information divergence among investors to the extent that it increases the relative weight they place on common financial statement information as opposed to diverse non-accounting information. Therefore, both variability of stock returns and turnover are expected to be lower for firms with audited financial statements. Consistent with our predictions, we find that audited firms display lower stock returns variability and lower volumes of turnover than non-audited firms, subsequent to their announcement of semiannual financial statements. These results are robust to variations in event window length and specification of empirical measures. Our findings show the benefits of auditing in that it reduces perceived information risk in audited financial statements as well as reducing information divergence among investors.