Real Effects of Financial Reporting Quality and Credibility: Evidence from the PCAOB Regulatory Regime

I examine whether financial reporting quality and credibility affect firm financing and investment decisions. I use PCAOB inspections of non-U.S. auditors as exogenous shocks to the reporting quality of non-U.S. firms audited by PCAOB inspected auditors. I then use the subsequent public revelation of the inspection as exogenous shocks to the reporting credibility of non-U.S. firms that employ PCAOB inspected auditors. Using a difference-in-differences design, I find that although PCAOB inspections improve accrual quality for non-U.S. firms audited by the inspected auditors, there is no evidence that these improvements in accrual quality lead to changes in investment, investment efficiency or debt financing. However, I find that when PCAOB inspection reports are subsequently made public, non-U.S. firms audited by PCAOB inspected auditors increase their long-term debt (investment) by 11.5% (10.9%) and become more responsive to their investment opportunities. These effects are stronger for financially constrained firms and firms with non-big four auditors. Overall, the evidence in this paper suggests that regulatory oversight of the auditor helps improve reporting credibility, which in turn facilitates corporate investment by increasing firms’ external financing capacity. I thank Daniel Aobdia, Michelle Hanlon, Becky Lester, and seminar participants at the PCAOB Center for Economic Analysis for many helpful comments and suggestions. I thank Niketa Shroff for help with data collection. I gratefully acknowledge financial support from the MIT Junior Faculty Research Assistance Program. All errors are my own.