Market-Based Incentives for Audit Quality

Abstract

We examine how investors respond to public inspection reports issued by the U.S. audit regulator. Our analysis exploits variation in company identifiability, where small client portfolios make inspection outcomes quasi company-specific. Using hand-collected publication dates and an event-study design, we find that identifiable companies experience positive abnormal returns following non-deficient inspection outcomes and negative returns following deficient ones. In contrast, companies that cannot be linked to specific inspection results show no price response. The return differentials persist across a battery of robustness tests and are stronger when inspection information is more timely. Overall, our findings show that markets incorporate audit-quality information when inspection outcomes can be credibly mapped to individual companies, suggesting that greater transparency enhances the informational role of audit oversight and strengthens market-based incentives for audit quality.

Keywords: Audit Quality, Audit Regulation, Event Study, Abnormal Returns, Inspection Report JEL Classification: M41, M42, M48, G18, G14

JEL Classification: M41, M42, M48, G18, G14