Market-Based Incentives for Optimal Audit Quality

Abstract

We examine how equity markets respond to the public release of audit-firm inspection reports by the U.S. regulator. Investors react differently based on the identifiability of the public issuers whose audits are covered in the inspection report. Auditors with identifiable issuer clients show positive abnormal returns for non-deficient reports and negative reactions for deficient ones. In contrast, issuers less easily linked to specific auditor inspections experience muted responses. More timely publication of inspection reports intensifies market reactions, while delays reduce their informativeness. The findings highlight how regulatory transparency can enable investors to better in- corporate audit quality information into equity prices. We discuss implications for market-based incentives for issuers and auditors.

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