PCAOB Monitoring and the Information Uncertainty Associated with Fair Value Estimates

Abstract

We study the role of the Public Company Accounting Oversight Board (PCAOB) as a monitor in mitigating uncertainty surrounding fair value (FV) estimates in issuer financial statements. Specifically, we examine whether the FV deficiencies highlighted in PCAOB inspection reports are associated with information uncertainty exhibited by fair value estimates in financial statements. We find a negative relation between information uncertainty (i.e., implied asset-specific betas related to FV disclosures) and the intensity of FV deficiencies in the inspection report and that this result is driven by issuer clients that face the greatest exposure to complex FV assets. To the extent FV deficient reports lead auditors to conduct higher quality audits regarding FV, we expect auditor behavior related to client FV assets to change in response. Consistent with our expectation, we find evidence of decreased transfers into level three FV assets and increased disclosure in the FV footnote (increased number of words and number of asset/liability categories) in response to FV deficient reports. Overall, our evidence suggests that the PCAOB inspection process plays a role in mitigating opacity issues related to fair value.

Keywords: PCAOB Inspection Reports, Fair Value Deficiencies, Fair Value Estimates

JEL Classification: M41, M42, M48