Client Stock Market Reaction to PCAOB Sanctions Against a Big Four Auditor

56 Pages Posted: 2 May 2010

See all articles by Carol Callaway Dee

Carol Callaway Dee

University of Colorado Denver

Ayalew A. Lulseged

Florida State University - Department of Accounting

Tianming Zhang

Florida State University - Department of Accounting

Date Written: March 30, 2010

Abstract

We examine client stock market reaction to news of PCAOB sanctions imposed upon Deloitte and Touche, LLP - the first against a Big 4 auditor. The PCAOB Order against Deloitte contains three potentially value relevant pieces of information. First, it shows that Deloitte did not conduct a quality audit of Ligand’s 2003 financial statements (the “Ligand audit failure”). Second, it highlights serious problems in Deloitte’s quality control policies and procedures that go beyond the Ligand audit failure. Finally, the PCAOB Order reiterates the remedial actions Deloitte took to improve its quality control policies, which may alleviate investors’ concerns and signal improvements in the quality of the firm’s future audits. Using Schipper and Thompson (1983) methodology, we find that Deloitte (non-Deloitte) clients had a significantly negative (an insignificant) market reaction to news of the PCAOB sanctions. The results suggest that the negative effects of the sanctions outweigh the possible remedial effects of Deloitte’s corrective actions taken after the sanctions. In cross-sectional analysis using the Sefcik and Thompson (1986) portfolio weighting approach, we find a more negative reaction for Deloitte clients that are financially distressed. Our findings are consistent with both the reputation and insurance hypotheses, as in Baber et al. (1995). Since the severity of Deloitte’s quality control problems was made public for the first time by the PCAOB sanctions, we conclude that the negative market effects we observe are most likely the result of disclosure of the quality control weaknesses at Deloitte.

Keywords: PCAOB, auditor reputation, insurance hypothesis, litigation risk, audit quality, Big 4

JEL Classification: M41, M42, M48

Suggested Citation

Dee, Carol Callaway and Lulseged, Ayalew A. and Zhang, Tianming (Tim), Client Stock Market Reaction to PCAOB Sanctions Against a Big Four Auditor (March 30, 2010). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1598401

Carol Callaway Dee (Contact Author)

University of Colorado Denver ( email )

1475 Lawrence St.
Campus Box 165, PO Box 173364
Denver, CO 80217-3364
United States

Ayalew A. Lulseged

Florida State University - Department of Accounting ( email )

Rovetta Business Bldg. (RBA)
College of Business
Tallahassee, FL 32306-1110
United States

Tianming (Tim) Zhang

Florida State University - Department of Accounting ( email )

Rovetta Business Bldg. (RBA)
College of Business
Tallahassee, FL 32306-1110
United States

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