European Market Reaction to Audit Reforms

Abstract

On October 13, 2010, the European Commission initiated an extensive consultation with the launch of the ‘Green Paper on Audit Policy: Lessons from the Crisis’, which included a set of proposals, intended to reform the European audit market. We identify 15 events between 2010 and 2014 that increase or decrease the probability of adoption of the proposed audit reforms. Overall we find that investors reacted positively to the proposals, suggesting that investors in European firms perceived net benefits associated with the reforms. We also find that investors’ reactions are dependent on the firms’ prior audit regulation, audit quality and audit cost characteristics. For instance, the market reaction is less positive for firms that prior to the proposals, were already under, or had been under, an audit firm rotation regime (or a joint-audit regime), and whose audit firms already had a ban on non-audit services - consistent with investors expecting less of a net benefit from these EU audit reforms. We also find a positive reaction to the adoption events for firms whose audit firm has a lengthy tenure, receives higher audit fees, or who is in a country with high audit firm concentration, all consistent with investors expecting net benefits from the audit reform proposals. Finally, our results indicate that this regulatory change has implication for US firms whose subsidiaries are listed in Europe.