Audit Regulation and the Cost of Equity Capital

• In Event: Audit Regulation

Abstract

This study investigates the relation between audit regulation and the cost of capital. At a fundamental level, auditing serves to reduce information risk for users of financial statements, and the PCAOB has mentioned one of its missions is to lower the cost of capital. Measuring the effect of audit regulation on the cost of capital is difficult, given changes in audit regulation are frequently accompanied by other regulatory changes. While the PCAOB is mandated to inspect all foreign and domestic auditors of SEC registrants, certain foreign governments have prohibited inspections, citing sovereignty control. This provides a setting with variation in the extent of PCAOB oversight. Using a difference-in-differences design, we find that SEC registrants from countries that allow PCAOB inspections experience a lower cost of capital, relative to SEC registrants from countries that prohibit inspections. This effect is magnified for companies with low quality auditors, low analyst oversight, and in countries with lower rule of law. Taken as a whole, our results suggest that improvements in auditor oversight reduce information risk and correspondingly lower the cost of capital.

Authors

• Phillip T Lamoreaux, Arizona State University - Tempe

• Landon Mauler, Florida State University

• Nathan Newton, University of Missouri-Columbia