Subjectivity in Fair Value Estimates, Audit Quality and Informativeness of Other Comprehensive Income

Abstract

This study empirically examines whether difference in audit quality is reflected in the pricing of other comprehensive income (OCI). Specifically, we first investigate whether OCI measures of Big 4 clients are more-value relevant than those of non-Big 4 clients. Considering different degrees of subjective management judgment involved in OCI reporting process, we then explore whether the differential valuation effect of OCI between Big 4 and non-Big 4 clients is more pronounced for more subjective OCI components (e.g., minimum pension liability and foreign currency translation adjustment) than less subjective component (e.g., marketable securities adjustment). We predict that aggregate OCI of a Big 4 auditor is more value-relevant than that of a non-Big 4 auditor. We also hypothesize that the differential valuation effect between Big 4 and non-Big 4 clients can be attributable to the amount of subjective assumption and judgment required in estimating the OCI. Consistent with our predictions, we find that aggregate OCI audited by a Big 4 auditor has incremental information content over earnings, compared to OCI audited by a non-Big 4 auditor. Our results also show that the differential valuation effect between Big 4 and non-Big 4 clients is stronger for OCI components with more subjective nature.

Keywords: Other Comprehensive Income, Audit Quality, Subjectivity in Fair Value Estimate

JEL Classification: M41, M42