Do Fair Value Deficiencies in PCAOB Inspection Reports Reduce the Association of Information Uncertainty with Complex Estimates?

Abstract

This study examines the role of PCAOB inspection reports as a regulatory and monitoring mechanism. Specifically, I examine whether the issuance of PCAOB inspection reports with fair value deficiencies results in increased auditor scrutiny of fair value estimates and ultimately reduce the information uncertainty associated with level 2 and level 3 fair value estimates. Using models derived from Fields, Fraser and Wilkins (2004) and Riedl and Serafeim (2011), I predict and find evidence that corroborates a positive and significant audit effort (as proxied by audit fees) associated with level 3 fair value estimates after the issuance of a fair value inspection report. I also find a reduction in the information uncertainty associated with level 2 and level 3 fair value estimates (as proxied by implied asset-specific betas). Upon further subsample analysis, I find these results are driven by issuer clients that engage annually inspected audit firms versus those that engage triennially inspected audit firms.