We examine the association between permissible non-audit services provided by auditors and the timeliness of earnings announcements. Although earnings announcements are unaudited, audit progress influences management’s ability to release earnings while maintaining confidence in reported results. We posit that non-audit services generate earnings announcement timeliness benefits by improving the efficiency and timing of audits through knowledge transfer. We find that tax non-audit services are associated with timelier earnings announcements while nontax non-audit services are not. These benefits are concentrated in the pre-regulatory period before changes in the mid-2000s. Following these changes, the association persists for firms with weaker information environments, poorer performance, and greater audit-related challenges. Overall, our findings show that auditor-provided tax services are associated with enhanced timeliness of unaudited disclosures and that these benefits vary across firms and over time, highlighting previously undocumented spillovers from non-audit services with implications for academic research and regulation.

A primary argument against fair value measurement is the lack of verifiability, where verifiability is defined as consensus in measurement by independent parties. We evaluate this argument by investigating trends in the consensus of reported fair values. Our findings indicate that consensus increased between 2005 and 2019, as evidenced by reductions in the fair value range and standard deviation. Further analyses suggest that enhanced data availability-driven by public dissemination of trade information-serves as a mechanism for this trend. We also document that securities subject to testing by larger external auditors with more resources to take advantage of enhanced data availability are associated with a stronger trend in increasing consensus. Finally, this trend appears to be stronger in situations when management has a heightened opportunity to record a biased estimate. While conventional arguments express concern over management's ability to manipulate fair values, our results demonstrate patterns consistent with improved verifiability.

SUMMARY We examine the consequences of firms' disaggregation choices for auditor effort and audited financial statements. We document a significant positive association between disaggregation and audit fees, our proxy for auditor effort. Using separate measures of disaggregation of smaller line items versus larger, obviously material, line items, we provide evidence that one of the avenues through which disaggregation may increase auditor effort is through changes in auditors' assessments of materiality for smaller line items, especially when financial statement scrutiny is high. We also find disaggregation (and the audit fees associated with disaggregation) constrain the ability of managers to manipulate earnings in the audited financial statements compared to the unaudited financial statements, suggesting the fee response to disaggregation is due to auditor effort. Last, we provide evidence that our results are not fully explained by client litigation risk or other client attributes driving disaggregation choices. JEL Classifications: M41; M42.

We examine whether PCAOB inspection deficiencies related to management review controls (MRCs) affect financial reporting decisions. Using the goodwill impairment setting, we find that firms with book value greater than market value are more likely to record goodwill impairments when their auditors have received more goodwill-related PCAOB MRC inspection deficiencies. The observed association is more apparent when inspection deficiencies are more likely to lead to changes to the design or implementation of an internal control (i.e., when MRC goodwill deficiencies occur for more than one year or when deficiencies relate to the auditor’s assessment of the level of “precision” of the MRC). We observe some evidence that MRC inspection deficiencies lead to an increase in the likelihood of impairment for firms with book value in excess of market value even when the MRC deficiencies are not specifically related to goodwill, indicating that a broad focus on improving the audit of MRCs can affect financial reporting decisions in other areas.

Despite issuing extensive guidance related to the evaluation of accounting estimates, the PCAOB continues to identify deficiencies related to the audit of estimates through their inspections process. We examine whether PCAOB inspections lead to more accurate audited accounting estimates, defined as those that more closely match economic reality, by examining a significant estimate within the banking industry. We find that in contrast with the PCAOB’s goal of more accurate and unbiased estimates, allowance for loan loss (ALL) estimates become less accurate and more conservative with higher levels of ALL-related inspection findings for public company audits. We find no evidence of auditor response to PCAOB inspection findings for private-company audits, which are not subject to PCAOB inspection. Overall, our findings cast doubt on the efficacy of PCAOB inspections in improving estimate accuracy and suggest that firms are managing inspection risk to the potential detriment of audit quality.

PCAOB inspections and field studies consistently highlight difficulties faced by auditors when testing fair value estimates, but the root causes of these deficiencies are less understood. One strategy to reduce bias and improve audit quality is to enhance auditors’ effectiveness in incorporating cues into their risk assessment process. In this study, we seek to understand whether and when auditors incorporate cues indicating increased risk into their evaluation of fair value estimates. Consistent with concerns about auditors’ performance in this area, we find that more than one-third of fair value estimates in our security-level dataset differ from the true fair value by a non-trivial amount that should warrant further auditor consideration. If auditors effectively incorporate cues, we predict a negative association between observable risk cues and fair value errors. Our findings indicate auditors’ ability to integrate cues depends on the nature of the cue and expertise of the auditor. We fail to find evidence that either experts or non-experts incorporate indirect cues identified in the planning stage of the audit, which require drawing connections across accounts or time. In contrast, experts appear to outperform non-experts only in incorporating direct cues identified during substantive testing. These analyses enhance our understanding of variation in auditors’ performance and highlights potential areas for improvement.

In this study, we empirically examine whether expert auditors are better able to constrain management bias in fair value estimations, and in particular when presented with cues suggesting a heightened risk of material misstatement. Situations where auditor professional skepticism can be heightened is a focus of the PCAOB’s recently issued standard on auditing estimates. Using security-level fair value estimates for property and casualty insurers, we examine the two different types of auditor expertise (Big 4 and local-level industry expertise) and the interaction of these expert auditors with three different cues highlighting enhanced risk of misstatement (opportunistic fair value level classification, internal as opposed to third-party pricing method, and evidence of prior period bias in another significant estimate). We find that auditors with greater expertise reduce both inflation and deflation of fair values. Moreover, the auditor’s ability to effectively identify and incorporate information from the cues varies based on the type of cue and auditor experience, with both Big 4 and local-level industry experts constraining management bias in the presence of cues in certain circumstances.

ABSTRACT We investigate whether PCAOB-identified audit deficiencies lead to higher audit fees or turnover likelihood for clients of Big 4 auditors. To examine this, we identify areas of GAAP related to PCAOB deficiencies for each auditor. We then use textual analysis to identify how important the deficiencies are to clients to measure each client's exposure to deficient auditing. We find that this measure positively relates to audit fees and that this association is moderated by client bargaining power. Auditor turnover is also higher when deficiency exposure is high relative to what it would be for peer auditors, but we only observe this relation for smaller clients and do not find it is affected by client bargaining power. Finally, we find that companies switching Big 4 auditors tend to select an auditor resulting in lower deficiency exposure. These results have implications for understanding how PCAOB inspection reports affect the market for audit services. JEL Classifications: M41; M42. Data Availability: We obtain all data from publicly available sources.

Mandatory existence disclosure rules require an organization to disclose a policy's existence, but not its content. We examine policy adoption frequencies in the year immediately after the IRS required mandatory existence disclosure by nonprofits of various governance policies. We also examine adoption frequencies in the year of the subsequent change from mandatory existence disclosure to a disclose-and-explain regime that required supplemental disclosures about the content and implementation of conflict of interest policies. Our results suggest that in areas where there is unclear regulatory authority, mandatory existence disclosure is an effective and low cost regulatory device for encouraging the adoption of policies desired by regulators, provided those policies are cost-effective for regulated firms to implement. In addition, we find that disclose-and-explain regulatory regimes provide stronger incentives for policy adoption than do mandatory existence disclosure regimes and also discourage "check the box" behavior. Future research should examine the impact of mandatory existence disclosure rules in the year that the regulation is implemented.

Prior studies find that audit fees are higher for cross-listed firms, and these studies primarily attribute the incremental fees to added litigation costs. In this study, we investigate whether the higher audit fees that foreign firms cross-listed in the United States pay are also attributable to incremental audit effort associated with U.S. disclosure requirements and a more stringent U.S. auditing environment. By comparing audit fees of foreign cross-listed firms to U.S. domiciled firms and to non-cross-listed foreign firms, we are able to decompose incremental audit fees into portions attributable to added audit effort and to added litigation costs. We find that, on average, foreign firms cross-listed in the United States pay significantly higher fees than domestic U.S. firms and foreign firms that do not cross-list. Furthermore, we find that audit effort is almost as important as litigation costs in explaining the higher fees associated with foreign cross-listed firms; our estimates suggest that between 29 percent and 48 percent of the incremental fees are attributable to incremental audit effort. In addition, the total cross-listing premium is increasing in the difference between the U.S. auditing regulatory environment and that of the home country of the cross-listed firm. Our study improves our understanding of the role of audit effort in explaining the added fees charged by auditors when foreign firms cross-list in the United States.

This study investigates factors associated with restatement-related litigation against U.S. audit committee members. Using a sample of restatement-related litigation in the U.S. over the period 1999-2012, we find that the likelihood of audit committee litigation is higher in the post-SOX time period when financial reporting and auditor oversight responsibilities were significantly increased. This finding suggests that increased legal liability post-SOX could reduce the pool of qualified candidates willing to serve on the audit committee. We find that directors serving on the audit committee for a longer portion of the class action period and those with net insider selling activity during the class action period are more likely to be named as defendants. However, audit committee chairs, financial experts, and audit committee members serving on the compensation committee are no more likely to be named as defendants than other audit committee members, contrary to the perceptions of many officers and directors. Overall, our study provides insights into when audit committee members face higher litigation risk and useful information for the recruitment and retention of audit committee members.

We examine whether regulations requiring accelerated filing deadlines and internal control reporting and testing affect financial statement reliability. Unlike prior research, we examine whether these regulatory changes are associated with an increase in the likelihood that misstatements originate in the period following the respective change. If the implementation of these rules causes a misstatement, then the misstatement would most likely occur in the period immediately following the rule change. We provide evidence that accelerated filers (AFs) experience an increase in the likelihood of an originating misstatement following the acceleration of filing deadlines from 90 to 75 days. Large accelerated filers (LAFs), however, do not experience a similar increase following this acceleration or the subsequent acceleration from 75 to 60 days. After the implementation of the SOX Section 404 internal control requirements, we find that the likelihood of an originating misstatement declined for AFs but not for LAFs. Taken together, the findings suggest that, although AFs experienced an initial decrease in financial statement reliability, this decrease was temporary.

SUMMARY We examine the impact of PCAOB Auditing Standard No. 5 (AS5) and the economic recession on risk characteristics and degree of auditor/client misalignment in the publicly traded client portfolios of Big 4 firms. AS5 and the economic recession both likely resulted in an increase in audit firm personnel capacity as well as a decline in current and future revenue prospects, leading to concerns that the Big 4 firms may pursue clients that present greater risk to the portfolio. We find that the overall portfolio in 2009 presents greater financial risk, attributable to the impact of the recession on continuing clients. A net decrease in audit and auditor business risks is also attributable to continuing clients over this period, as increases for new clients are offset by reductions due to departing clients. Overall, the results, which should be of interest to regulators, indicate that Big 4 firms continued to balance their portfolio with risk in mind. Data Availability: Data are publicly available from sources identified in the paper.

Although the Sarbanes-Oxley Act of 2002 imposes internal control disclosure and certification requirements on management, regulators are concerned that companies are not disclosing material internal control weaknesses on a timely basis. This study investigates whether litigation risk could act as a mechanism to incentivize timely material weakness disclosure. Examining material weakness and restatement disclosures from 2003 – 2011, we find that restatement-related litigation is significantly greater for firms with material weakness disclosures regardless of when the material weakness was disclosed (i.e., during the misstated time period or following the restatement announcement). In fact, we find that over 75 percent of lawsuits allege that management falsely certified internal controls regardless of whether the material weakness was disclosed during or after the misstated time period. While we do not find evidence that internal control-related arguments are associated with the resolution of litigation, our results generally indicate that SOX-mandated internal control certifications are increasing litigation costs without providing management with an incentive to disclose material weaknesses on a timely basis.

SUMMARY This paper investigates the effect of human resource investment in internal control over financial reporting on the disclosure of internal control weaknesses at both the firm and the individual department level. Using a unique reporting requirement for Korean-listed firms, this study uses the ratio of the number of employees involved with the implementation of internal controls (hereafter, IC personnel) to the total number of employees of the firm as a proxy for a firm's human resource investment in internal control. We find that the proportion of IC personnel and the change of the proportion within the firm and several key departments are negatively associated with the disclosure of internal control weaknesses. We also find that a change in IC personnel is positively associated with the likelihood of remediation of the internal control weaknesses. These findings provide valuable insights into the role of human resource investment in determining the strength of a firm's internal controls over financial reporting.

Although the Sarbanes-Oxley Act of 2002 imposes internal control disclosure and certification requirements on management, regulators are concerned that companies are not disclosing material internal control weaknesses on a timely basis. This study investigates whether litigation risk could act as a mechanism to incentivize timely material weakness disclosure. Examining material weakness and restatement disclosures from 2003 – 2011, we find that restatement-related litigation is significantly greater for firms with material weakness disclosures regardless of when the material weakness was disclosed (i.e., during the misstated time period or following the restatement announcement). In fact, we find that over 75 percent of lawsuits allege that management falsely certified internal controls regardless of whether the material weakness was disclosed during or after the misstated time period. While we do not find evidence that internal control-related arguments are associated with the resolution of litigation, our results generally indicate that SOX-mandated internal control certifications are increasing litigation costs without providing management with an incentive to disclose material weaknesses on a timely basis.

ABSTRACT We test the relationship between the change in a firm's cost of debt and the disclosure of a material weakness in an initial Section 404 report. We find that, on average, a firm's credit spread on its publicly traded debt marginally increases if it discloses a material weakness. We also examine the impact of monitoring by credit rating agencies and/or banks on this result and find that the result is more pronounced for firms that are not monitored. Additional analysis indicates that the effect of bank monitoring appears to be the primary driver of these monitoring results. This finding is consistent with the argument that banks are effective delegated monitors for the debt market. The results of this study suggest the need for future research, particularly to test the differential effects of monitoring on the cost of debt compared to the cost of equity.

Implementation of Public Company Accounting Oversight Board Auditing Standards No. 2 on internal control and No. 3 on documentation has delayed audit completion. However, due to market demand for timely disclosures, most firms maintain the same preliminary earnings release date even though the audit may not be complete as of that date. Results indicate revisions to preliminary announcements when filing the 10-K report would have been 35% lower during 2005 if the historical frequency of issuing earnings releases after the audit report date had not changed. Additionally, stock market reaction to impending revisions suggests lower reliability of preliminary earnings.

The market for audit services has been affected in recent years by significant changes like the demise of Andersen and the implementation of the Sarbanes-Oxley Act of 2002. One impact of these market changes has been an increase in the frequency of auditor switches, and in particular, the frequency of clients switching from Big 4 auditors to smaller audit firms. We examine whether this switching activity has resulted in changes in the risk characteristics of publicly traded clients of Second Tier audit firms. This analysis is important as regulators are concerned about audit market concentration and would like to see the Second Tier audit firms expand their share of the publicly traded client market. Results indicate that Second Tier firms are accepting clients with potentially increased audit and client business risk characteristics relative to their existing client base, but they also appear to be "shedding" clients that have increased audit and client business risk characteristics relative to their existing client base. Some of the differences in risk characteristics for those departing clients are more pronounced in the period after 2000, when we expect the most significant changes in the audit market occurred. Second Tier auditors are increasingly exposed to more business risk as they accept larger clients coming from Big 4 predecessor auditors, which may increase their exposure to litigation.

In this study, we investigate how audit firms respond to deficiencies in internal control systems. More specifically, we test whether auditors increase audit fees for firms with internal control deficiencies. Our study is motivated by the lack of support in prior research for the existence of a relationship between control risk and audit fees. We believe that changes in the audit environment following the recent accounting scandals, the demise of Arthur Andersen, and the passage of the Sarbanes-Oxley Act - combined with the recent availability of detailed disclosures on internal control deficiencies - provide an excellent opportunity to reexamine the relationship between control risk and audit fees. Our results show that audit fees are significantly higher for firms with internal control deficiencies after controlling for size, risk, and profitability, and appear to be increasing in the severity of the underlying control problems as well. We therefore conclude that; at least in the current audit and regulatory environment, audit firms do respond to higher levels of control risk by increasing audit fees.