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UBC Theses and Dissertations

Essays on the economics of market and regulatory enforcement in auditing Gu, Ti


Within the framework of classical auditing theory (Simunic, 1980), an auditor is motivated to exert more effort in the presence of greater litigation risk imposed by courts or regulators. A key element underexplored by literature based on the auditing theory is how the detection of audit failure or non-compliance of auditing standards. This dissertation uses two natural experiments to illustrate the importance of auditor misconduct detection. The first essay exploits mergers of brokerage houses in order to examine whether an exogenous loss in analyst coverage affects audit effort. Security analysts, who are considered to be sophisticated users of financial statements, scrutinize auditor-verified financial statements. I predict that a change in perceived analyst scrutiny will cause auditors to change the effort that they expend in achieving high auditing standards. Using the audit fee as the proxy for audit effort, I find that firms which lose an analyst experience a reduction in audit fees, compared to similar firms that do not lose an analyst. Moreover, this effect is stronger for smaller firms. Overall, the results support the hypothesis that analysts contribute to auditor discipline. The second essay of this thesis makes use of an announcement by the PCAOB on May 18, 2010, which indicates that the PCAOB oversight of foreign auditors has been restricted, as an exogenous shock, in order to identify the perceived effectiveness of cross-border enforcement of audit oversight. Analyzing a comprehensive sample of foreign companies registered with and reporting to the SEC, I document that 1) the “inability” announcement had a spillover effect: the stock market reacted negatively not only for companies mentioned in the “inability” list, but also for other U.S. listed foreign companies; 2) the market reactions to the announcement varied with companies’ home country institutional strength and firm-level characteristics; 3) US-listed foreign companies’ bid-ask spreads increased following the announcement and the changes in bid-ask spreads also varied with companies’ home country institutional features. The evidence supports a prediction of the theory developed herein: that the value creation of adherence to a stringent auditing regime should be more pronounced for companies from countries with weaker institutional strength.

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