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    Investor Reaction to the Prospect of Mandatory Audit Firm...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 01.06 Impact of PCAOB, 04.07 Audit Firm Rotation 
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    Title:
    Investor Reaction to the Prospect of Mandatory Audit Firm Rotation
    Practical Implications:

    The implementation of a mandatory audit firm rotation in the United States would have large implications within the accounting industry. This study provides the PCAOB and other regulators with relevant information regarding the potential policy. The evidence indicates that the majority of investors would have a negative reaction to a mandatory audit firm rotation. It is possible the investors believe the potential benefits of rotation are outweighed by the costs, direct and indirect.

    Citation:

    Reid, Lauren C., and J. V. Carcello. 2017. “Investor Reaction to the Prospect of Mandatory Audit Firm Rotation”. The Accounting Review. 92.1 (2017): 183.

    Keywords:
    mandatory audit firm rotation; event study; PCAOB; investor perception
    Purpose of the Study:

    In recent years the PCAOB has considered implementing a mandatory audit firm rotation in order to better align auditors’ interests with investors’ interests. This study examines investor reactions to a mandatory audit firm rotation in the United States. It is important to understand investor reactions because the implementation of such a policy would be enacted for their benefit. Due to the fact that it is still a potential policy, it is difficult to determine how investors will react if the PCAOB moves forward. Broadly, the authors test the overall stock market reaction. However, the primary focus is on whether certain markets react differently based on a company’s auditor characteristics. The characteristics considered were industry specialization, audit firm tenure, Big 4/non-Big 4, and audit quality.

    Design/Method/ Approach:

    The sample contains 3,688 companies and represents over 75% of the entire market capitalization of U.S. companies. The authors obtained U.S. company returns through CRSP and the prices for the MSCI World Index excluding the U.S. through DataStream. The auditor tenure and fee data were collected through Compustat and Audit Analytics. The authors determined 10 main dates to observe investors’ reactions and how that affected the markets for the following 3 days. 

    Findings:

    Overall, the authors find a significant negative market reaction to events that increased the likelihood of rotation.

    Specifically, the authors find the following:

    • Companies that were audited by Big 4 firms were significantly more likely to have a negative reaction on dates that increased the likelihood of rotation.
    • Similarly, companies that were audited by an industry-expert were significantly more likely to have a negative reaction on dates that increased the likelihood of rotation.
    • Companies with a lower-audit quality experienced a negative market reaction on dates that decreased the likelihood of rotation.
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Audit Firm Rotation, Impact of PCAOB
    Home:

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