Economic Consequences of PCAOB Inspections: Impact on Information Asymmetry over Time

• In Event: Continental Breakfast - Research and Education Forum
  In Roundtable Session: Table 5: Risk Signals and the Market's Response

Abstract

This study examines whether and how the publication of inspection reports over time of triennially inspected audit firms change client-company information asymmetry among investors. We focus on audit firms subject to triennial inspection because they show variation in the inspection outcome. If the publication of inspection reports provides an accurate single about audit quality or change investors’ perception of future audit quality, it can have direct capital market consequences. We find that information asymmetry among investors increases after the disclosure of the first round inspection results and decreases after the publication of the second and third round inspection reports. This confirms the information value of inspection reports and implies a learning process in the capital market. We further find that the increase in information asymmetry after the first round inspection is larger for client companies of auditors with identified audit deficiencies than for client companies of auditors without deficiencies, consistent with the argumentation that investors are less likely to reach consensus towards negative information without prior experience. For second-round and third-round inspection reports, we also observe a larger magnitude of decrease in information asymmetry for deficient audit firms, implying that investors expect more improvement in audit quality for companies with deficient auditors. Overall, our results imply that after the first experience with exposure to the inspection results, investors value inspection reports of triennially inspected audit firms, and information asymmetry among investors decreases.

Authors

• Ann Vanstraelen, Universiteit Maastricht

• Patrick Vorst, Universiteit Maastricht

• Lei Zou, Universiteit Maastricht