Following a lengthy and contentious standard setting process, the Public Company Accounting Oversight Board (PCAOB), the U.S. regulator overseeing the auditors of publicly traded companies, implemented Rule 3211 in 2017. This rule requires audit firms to disclose the name of the engagement partner responsible for each of their public company audits on a public filing with the PCAOB known as Form AP.
The rule’s advocates argued that public disclosure of the audit partner’s identity would make the partner more accountable and allow investors to more easily judge the partner’s track record for providing quality audits. Opponents, though, contended that the additional disclosure would not affect audit quality, noting that audit partners were already subject to robust internal quality control and external oversight. Soon after the rule’s implementation, academics cast doubt on the effectiveness and informativeness of these disclosures in the United States, as studies failed to find significant changes in audit quality (Cunningham, Li, Stein, and Wright 2019) or significant market reactions to Form AP filings when released on the PCAOB website (Doxey, Lawson, Lopez, and Swanquist 2021). In a new study, we revisit Form AP disclosure and examine whether investors find these disclosures informative.
We investigate the informativeness of audit partner disclosures by using them in combination with accounting restatements, which correct errors in previously issued financial statements. We examine the stock price reaction of the non-restating clients within a partner’s portfolio to the announcement of an accounting restatement by another one of the partner’s clients. This is a powerful setting to examine this question because the negative shock to a partner’s track record for providing quality audits (i.e., an accounting restatement) is a strong signal about whether an auditor has met his or her primary responsibility of providing reasonable assurance that the client’s financial statements are free of material misstatement. Prior academic literature also finds that stock markets react negatively to the announcement of restatements for other companies in the same industry or for those companies that share the same audit firm as the restating company (e.g., Francis and Michas 2013; Gleason, Jenkins, and Johnson 2008; Ji, Kumar, Pei, and Xue 2019; Weber, Willenborg, and Zhang 2008), ultimately providing us with a strong empirical setting to investigate whether investors find the disclosure of audit partners’ identities informative.
We expect that if investors value an audit partner’s track record for providing quality audits, they will react negatively to the announcement of a restatement of the partner’s other clients, resulting in a drop in the value of the stock of the partner’s non-restating clients. However, investors may view audit-partner identities as uninformative, even when a restatement occurs, as audit firms have implemented robust quality controls over the years, and the majority of the audit work is delegated to middle managers, which leaves a more limited role for the lead audit partners. Further, to the extent investors recognize that audits provide reasonable, not absolute, assurance that financial statements are free of material misstatement, they likely understand that, even when a partner conducts a high-quality audit the financials may nonetheless contain a misstatement. Overall, it remains an open question whether investors value audit partner disclosure.
In our main analyses, we find, consistent with our predictions, that the stock price of an audit partner’s non-restating clients drops significantly in the days surrounding the announcement of another client’s restatement. On average, we find non-restating clients experience abnormal stock returns around the restatement that are 0.86 percentage points lower than those of other companies affected by the restatement. We ensure these returns are not subsumed by other previously identified negative effects of an accounting restatement. In subsequent analyses, we find that the market reaction is greater for more severe restatements, present for all types of auditors (i.e., both Big Four and non-Big Four audit partners), and more salient for less profitable, smaller, and riskier clients.
Overall, our findings are consistent with investors’ use of audit partner disclosures to monitor audit partner’s track records, leading them to revise their expectations about the reliability of the non-restating clients’ financials. By finding direct evidence that investors use such disclosures together with accounting restatements to form a signal of audit quality, our study informs the debate on the usefulness of the disclosures in the United States and their value to investors.
Our study also suggests it may be unproductive for academic researchers to focus on the immediate effects of new rules or regulations, whose value often arises over time and not initially. This is especially true for new disclosure rules, whose benefits are largely seen only as information accumulates or as the market learns about those benefits, as with audit partner disclosures.
This post comes to us from Daniel Aobdia, an associate professor at The Pennsylvania State University’s Smeal College of Business, Vincent Castellani, a PhD candidate at The Pennsylvania State University’s Smeal College of Business and an incoming assistant professor at the University at Buffalo, SUNY, and Paul Richardson, a PhD candidate at The Pennsylvania State University’s Smeal College of Business and an incoming assistant professor at the University of Texas at Arlington. It is based on their recent paper, “Do Investors Care Who led the Audit in the U.S.? Evidence from the Announcement of Accounting Restatements,” available here. Daniel Aobdia was a senior economic research fellow in the Center of Economic Analysis at the PCAOB between September 2014 and September 2016. He currently advises the PCAOB on questions related to the economics of auditing. The views expressed above and in the paper are the the authors’ and do not necessarily reflect the views of the board, individual board members, or staff of the PCAOB.