Stock price crash risk and auditor-client contracting

Using a large sample of Chinese-listed firms for the period of 2001–2014, we find that the auditors of clients with higher crash risk tend to charge higher fees, are more likely to issue modified audit opinions, and have a higher turnover tendency, which is consistent with the notion that a client’s exposure to higher crash risk imposes greater engagement risk on its auditor. Consistent with crash risk increasing auditor engagement risk, we find that crash risk is associated with a client’s poor accounting quality and high frequency of restatements, although auditors exert higher efforts when observing clients’ high crash risk. Taken altogether, our results suggest that a client’s crash risk serves as an informative signal for engagement risk, and that this factor plays a crucial role in shaping auditor-client contracting relationships.