Audit Quality and Properties of Analysts' Information Environment

Abstract

Prior research (Behn et al. 2008) suggests that higher audit quality is associated with increased accuracy and reduced dispersion in earnings forecasts issued by sell-side analysts. We extend this work to consider how audit quality impacts the information environment in which analysts operate. Using the method outlined by Barron et al. (1998), we examine whether higher audit quality (proxied as an industry specialist auditor) is associated with differences in the weight analysts place on common information relative to private information, as well as the extent to which audit quality separately impacts on the precision of analysts’ private and common information. Our results show that higher audit quality results in analysts placing increased weight on public information, but also that the precision of private (as well as public) information is improved. These results extend our understanding of how audit quality impacts on attributes of analysts’ forecasts and provides support for the argument that audit quality impacts users of audited financial reports.

Keywords: audit quality, earnings forecasts, information environment, analysts

JEL Classification: M41, G34