The merits and economic consequences of reputation: Three essays

In business, agents are exposed to both hidden information and hidden action. Occasionally, reputation for credibility is valuable in solving or mitigating the economic consequences of these problems. A ‘good’ firm can distinguish itself from a ‘bad’ firm by sending a signal about its quality to the market or by attracting scrutiny. In three related essays, I examine topics revolving around this strategy. The first essay builds on the notion that management makes a trade-off between the expected costs and benefits of selecting a large audit firm. Given the geography of the audit market, the costs of selecting a large audit firm (that is typically located further away than a small audit firm) are increasing in client-auditor distance. I study how geographical distance influences the auditor selection process and the economic benefits of auditor reputation. Evidence documented in this study is consistent with a differentiated market for audit services where management of private firms selects the type of auditor minimizing the sum of expected benefits and costs. The second essay examines systematic differences in audit quality across audit firm size. Previous studies examine the effect of audit firm size on audit quality with the client-firm as the unit of analysis. I show that drawing inferences at the audit firm level from client-firm level analysis can be inaccurate. The third essay examines the consequences of commitment to the New York Stock Exchange (NYSE) disclosure standards on former NASDAQ firms’ information environments. I find that former NASDAQ firms change the level of disclosure within a relatively short event window around the decision to list on the prestigious NYSE.