“Market-Based Incentives for Optimal Audit Quality” with Oxford Saïd Bus. Prof. Martin Schmalz

Martin Schmalz is a Professor of Finance, Economics, and Real Estate at the University of Oxford, Saïd Business School. He is currently on leave to serve as the Chief Economist of the Public Company Accounting Oversight Board (PCAOB), as well as the Director of its Office of Economic and Risk Analysis. More on Professor Schmalz

ABSTRACT for "Market-Based Incentives for Optimal Audit Quality"
We examine how equity markets respond to the public release of audit-firm inspection reports by the U.S. regulator. Investors react differently based on the identifiability of the public issuers whose audits are covered in the inspection report. Auditors with identifiable issuer clients show positive abnormal returns for non-deficient reports and negative reactions for deficient ones. In contrast, issuers less easily linked to specific auditor inspections experience muted responses. More timely publication of inspection reports intensifies market reactions, while delays reduce their informativeness.

The findings highlight how regulatory transparency can enable investors to better incorporate audit quality information into equity prices. We discuss implications for market-based incentives for issuers and auditors.