The Effect of Audit Quality on the Valuation of Stocks in an IPO

In the wake of the Industrial Revolution, accounting emerged as a crucial tool for ensuring accountability to capital owners, shifting the focus of companies towards satisfying their interests. With the advent of stock trading, information about public companies became highly valuable to investors, who sought efficient investment decisions based on accurate information. However, the interests of capital owners, managers, and investors often diverged, raising questions about the impact of audit quality on firm value.

Firm value reflects investor perceptions of a company's performance and achievements. Investors utilize stock prices as a benchmark to evaluate a company's investment potential and stability. Companies with higher share prices are generally perceived as more stable and less risky, attracting greater investor interest. The price-to-book value ratio is a common metric for measuring firm value, comparing the stock price to the book value per share. Overvaluation occurs when investors ascribe a value to a company that exceeds its equity value.

Publicly listed companies are legally mandated to publish financial statements, including the balance sheet, income statement, statement of changes in equity, cash flow statement, and accompanying notes. These statements serve as a means for investors and stakeholders to evaluate a company's financial health, make investment decisions, assess tax compliance, and determine the company's ability to repay loans.

Audit quality, defined as the likelihood of an auditor identifying and reporting accounting irregularities, plays a significant role in firm value. Competent and independent auditors can reduce investor concerns about bias in financial reporting, narrowing the information asymmetry between management and investors. Studies have shown that companies audited by Big Four accounting firms tend to have higher firm values, as the capital market reacts positively to their audited financial statements. Audit quality has also been found to have a positive impact on the value of manufacturing companies listed on the IDX.