Market-Based Incentives for Optimal Audit Quality

Abstract

We document that equity markets react to the public release of audit-firm level audit inspection reports by a regulator if and only if the reports can be easily linked to the issuer being audited. In that case, issuers whose audit was not found to be deficient significantly outperform issuers whose audit was found to be deficient. We find no evidence that identifiable issuers as a group experience negative stock market returns. These findings provide a first empirical basis for an ongoing policy debate that affects $60 trillion of equity capital and illustrate the potential feasibility for regulators to create market-based incentives for optimal audit quality.

Keywords: Audit Quality, Audit Regulation, Event Study, Abnormal Returns, Inspection Report JEL Classification: M41, M42, M48, G18, G14

JEL Classification: M41, M42, M48, G18, G14