What are the Benefits of Audited Disclosures to Equity Market Participants?

Abstract

This study documents that the market places more reliance on earnings announcements with a completed audit than on earnings announcements with an incomplete audit. The PCAOB’s Auditing Standards No. 2 and 3 (AS2/3) resulted in the majority of firms issuing annual earnings announcements prior to audit completion. Prior research documents an increase in earnings revisions around the implementation of AS2/3, a negative market reaction to earnings revisions, and lower investor reliance on earnings announcements that foreshadow an impending earnings revision. We argue that the issuance of earnings announcements with a completed versus an incomplete audit has a more fundamental impact on the market. Specifically, earnings announcements with an incomplete audit lead investors to perceive lower financial reporting quality and to place less reliance on the earnings announcement even in the absence of an impending or ex post earnings revision. Using both difference-in-difference and cross-sectional analyses, we find that earnings announcements with a completed audit are associated with a larger market reaction than earnings announcements with an incomplete audit. This differential market reliance on earnings announcements with a completed versus an incomplete audit persists after the implementation of AS2/3 into a more steady-state regulatory environment from 2007 through 2013.