SEO Underpricing and PCAOB Inspection Reports: Do Investors Use PCAOB Inspection Information?

Abstract

We examine the association between Public Company Accounting Oversight Board (PCAOB) inspection reports and a firm’s cost of equity capital, measured using seasoned equity offering (SEO) discounting. SEO discounting occurs when the offer price is lower than the prior day’s market price of the firm’s shares and represents ‘money left on the table’ for issuing firms. SEO discounting is a non-trivial cost to an issuing firm, and its occurrence is increasing in both frequency and magnitude. We document an economically significant, positive association between SEO discounting and the use of an auditor found to be deficient by the PCAOB, and this association is most pronounced for clients of smaller, triennially inspected auditors for which few other signals of quality exist. Cross-sectional evidence suggests that, for clients of triennially inspected auditors, this relation is stronger for timelier inspection reports and smaller auditing firms. In conclusion, our evidence is consistent with PCAOB inspections providing meaningful information about audit quality to market participants, particularly for clients of smaller, triennially inspected auditors.