Does the Threat of a PCAOB Inspection Mitigate U.S. Institutional Investorss Home Bias?

Abstract

We exploit the staggered introduction of the PCAOB’s international inspection program to examine the role that the stringency of public audit oversight plays in shaping US institutional investors’ home bias. Analyzing a sample of foreign firms listed in the United States, we evaluate whether US institutional investors hold larger equity stakes in these firms―a longstanding issue that reflects investor portfolio decisions―if their auditors are exposed to the threat of a PCAOB inspection. In a differences-in-differences framework, we find that US listed foreign firms enjoy an increase in US institutional investors’ equity positions after their auditors become subject to PCAOB inspection access. Cross-sectional analysis implies that the benefit of the PCAOB inspection threat in mitigating US institutional investors’ home bias is concentrated in: foreign countries without a strict local audit oversight system; active US institutional investors that are known to value accounting transparency; and firms from countries that grant PCAOB access later (after the onset of its international inspection program in 2005). Our evidence suggests that foreign firms become better known in the capital markets under the PCAOB inspection program, which induces US institutional investors to acquire larger equity stakes in US listed foreign firms given the lower information asymmetry that ensues under the PCAOB inspection threat.