Real Effects of Financial Reporting Quality and Credibility: Evidence from the PCAOB Regulatory Regime

56 Pages Posted: 2 Oct 2015 Last revised: 31 Dec 2015

Nemit Shroff

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: December 2015

Abstract

I examine whether financial reporting quality and credibility affect a company’s financing and investing behavior. I use PCAOB inspections of non-U.S. auditors as exogenous shocks to the reporting quality of non-U.S. companies audited by PCAOB inspected auditors. I then use the subsequent public revelation of the inspection as exogenous shocks to the reporting credibility of non-U.S. companies that employ PCAOB inspected auditors. Using a difference-in-differences design, I find that although PCAOB inspections improve accrual quality for non-U.S. companies audited by the inspected auditors, there is no evidence that these improvements in accrual quality lead to changes in investment, investment efficiency or debt financing. However, when PCAOB inspection reports are subsequently made public, non-U.S. companies audited by inspected auditors increase their long-term debt (investment) by 11.5% (10.9%) and become more responsive to their investment opportunities. These effects are stronger for financially constrained companies and companies with non-big four auditors. Overall, the evidence in this paper suggests that regulatory oversight of the auditor helps improve reporting credibility, which in turn facilitates corporate investment by increasing companies’ external financing capacity.

Keywords: Investment, Debt capacity, financial accounting, earnings quality, credibility, real effects, PCAOB, audit

Suggested Citation

Shroff, Nemit, Real Effects of Financial Reporting Quality and Credibility: Evidence from the PCAOB Regulatory Regime (December 2015). Available at SSRN: https://ssrn.com/abstract=2667969 or http://dx.doi.org/10.2139/ssrn.2667969

Nemit Shroff (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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