Audit Regulation and Cost of Equity Capital: Evidence from the PCAOB’s International Inspection Regime

Abstract

This study investigates the relation between audit regulation and cost of equity capital. There is scant empirical evidence on this relation because changes in audit regulation are frequently accompanied by other major regulatory changes. We exploit variation in the timing of regulatory changes induced by foreign governments’ staggered allowance of PCAOB inspections. Using a difference-in-differences design, we find that foreign SEC registrants with auditors from countries that allow PCAOB inspections enjoy a lower cost of capital, relative to foreign SEC registrants with auditors from countries that prohibit inspections. Furthermore, we find that this cost of capital effect is attenuated for companies with higher quality governance mechanisms. Finally, we document that inspection access is associated with higher quality analyst forecasts, which suggests that this change in audit regulation reduces information risk for market participants.

Keywords: audit regulation, audit policy, PCAOB, cost of capital, international