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    Client Stock Market Reaction to PCAOB Sanctions Against a...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control 
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    Title:
    Client Stock Market Reaction to PCAOB Sanctions Against a Big 4 Auditor.
    Practical Implications:

    The authors provide evidence on the PCAOB actions by showing that the PCAOB’s sanctions against Deloitte contain information useful to market participants. When public disclosure of a quality control problem is made by the PCAOB, investors react by discounting their valuation of that audit firm’s clients. Clients value disclosures about control weaknesses found at audit firms.

    Citation:

    Dee, C. C., Lulseged, A., & Zhang, T. 2011. Client Stock Market Reaction to PCAOB Sanctions Against a Big 4 Auditor. Contemporary Accounting Research 28 (1): 263-291.

    Keywords:
    quality standards, auditing standards, sanctions, quality of service, quality assurance
    Purpose of the Study:

    Audits are valued by investors, because they assure the reliability of and reduce the uncertainty associated with financial statements. Any such value derived from the audit is related to its perceived quality, and damage to an audit firm’s reputation can reduce the credibility of financial statements audited by the firm. The authors examine the stock market effects of news of the Public Company Accounting Oversight Board’s (PCAOB) sanctions imposed upon Deloitte and Touche, LLP (Deloitte) on December 10, 2007 for actions related to its 2003 audit of Ligand Pharmaceuticals Incorporated (Ligand). Deloitte was censured and fined one million dollars. The engagement partner responsible for the Ligand audit was banned from association with a registered accounting firm. These sanctions mark the first time the PCAOB has used its enforcement powers against a Big 4 auditor (or any national or international firm), as well as the first time the PCAOB has issued a monetary penalty against any individual or registered accounting firm.

    The PCAOB order against Deloitte contains three potentially value-relevant pieces of information. First, it shows that Deloitte did not conduct a quality audit of Ligand’s 2003 financial statements. Second, it highlights serious problems in Deloitte’s quality control policies and procedures that go beyond the Ligand audit failure. Finally, the PCAOB order reiterates the remedial actions Deloitte took to improve its quality control policies, which may alleviate investors’ concerns and signal improvements in the quality of the firm’s future audits.

    Design/Method/ Approach:

    The authors apply the market model to estimate expected returns over the period from 260 days before through 10 days before December 10, 2007  the date the PCAOB made public its sanctions against Deloitte. Using Audit Analytics and COMPUSTAT, the authors build a final sample that includes 707 Deloitte and 2,363 non-Deloitte clients.

    Findings:
    • Deloitte clients have a significantly negative market reaction to news of the PCAOB sanctions over one- and three-day event windows.
    • Non-Deloitte clients show no significant reaction to news of the PCAOB sanctions against Deloitte.
    • The lack of significance for non-Deloitte clients suggests that the results are not driven by uncontrolled factors common to clients of Big 4 auditors. There is no evidence of spillover effects to clients of other Big 4 auditors.
    • The negative effects of information contained in the PCAOB order against Deloitte outweigh any possible remedial effects coming from news of Deloitte’s corrective actions taken after the sanctions.
    • Deloitte clients had no reaction to other events specifically related to the Ligand audit failure that predate the sanctions. Thus, the evidence shows that the PCAOB sanctions revealed value-relevant information about Deloitte’s reputation or insurance value that was not contained in the other Ligand events.
    • The negative market effects observed are most likely the result of the news of the control weaknesses at Deloitte rather than events specific to the Ligand audit.
    • There is more negative reaction to news of the PCAOB sanctions against Deloitte for firms that are financially distressed.
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of PCAOB