Market Reaction to the PCAOB's Inability to Conduct Foreign Inspections

Abstract

This paper investigates the potential costs to investors of the Public Company Accounting Oversight Board’s (PCAOB’s) inability to conduct inspections of foreign audit firms. Specifically, we examine the stock market reaction of companies audited by non-inspected foreign audit firms to a series of disclosures by the PCAOB relating to its difficulties in conducting foreign inspections in European Union countries, Switzerland, China, and Hong Kong. We find a significant negative stock market reaction, in both the univariate and multivariate settings, to the PCAOB’s initial disclosure in August 2009 of the names of foreign auditors that had not been inspected by the PCAOB. These results are driven by companies with a China-based auditor. Further, we find univariate and multivariate evidence of a significant negative market reaction to the Board’s February 2010 disclosure of additional audit firm names (i.e., not named in the August 2009 disclosure) that had not been inspected by the PCAOB. In addition, we find univariate, but not multivariate, evidence of a significant negative market reaction to the Board’s May 2010 disclosure of company names whose auditor is located in a country that does not permit PCAOB inspections. Finally, in both the univariate and multivariate settings, we find evidence of a significant positive market reaction to the PCAOB’s January 2011 disclosure that registered U.K. audit firms would now be subject to inspection. Together, the negative market reactions to the Board’s disclosure of its inability to inspect audit firms located in certain foreign countries and the positive market reaction to the Board’s subsequent disclosure that inspections would now be permitted in a country (U.K) that previously blocked inspections provide evidence that the significant resources devoted by the PCAOB to its inspection program are valued by market participants.