The Effect of Audit Quality and Pre-Audit Financial Reporting Quality on Investor Decision-Making

• In Event: Investor Response to Risk Indicators

Abstract

This study examines how nonprofessional equity investors value variations in audit quality at different levels of audit clients’ pre-audit financial reporting quality. We conduct a between-participants experiment to manipulate (1) audit quality and (2) pre-audit financial reporting quality. Participants assume the role of an equity investor contemplating stock acquisition in a U.S. public company representing different combinations of pre-audit financial reporting quality and audit quality. The results suggest that investors prefer high audit quality over low audit quality. However, we do not find evidence consistent with theory that high pre-audit financial reporting quality attenuates this preference. In fact, nonprofessional investors perceive low audit quality as reducing overall financial reporting quality when pre-audit financial reporting quality is high, making them more reluctant to invest in the audit client. This study separates audit quality’s importance to investor decision-making from an audit client’s post-audit financial report quality. In doing so, this study improves our understanding of audit quality’s economic significance to an audit client’s market value.

Authors

• Bret Sheeley, University of Nebraska-Lincoln

• Todd A Thornock, University of Nebraska-Lincoln