This paper investigates whether capital market participants assign informational value to the engagement partner (EP) identity disclosure requirement by the PCAOB. It also investigates whether and how restatement announcements that result in a downward revision of earnings for the restating firm affect the stock prices of peer firms not restating (contagion firms) but audited by a common EP as the restating firm.
Using restatements as a proxy for low audit quality, the study examines the market reaction to a contagion firm’s stock price following the restating firm’s announcement. The study employs a short-window event study with the event date as the restating firm’s announcement date. Additional regression analyses are conducted to confirm the results.
We find that the cumulative abnormal returns of contagion firms are, on average, 1.61%lower than those of non-contagion firms in the three days surrounding the announcement. Overall, our results are consistent with a contagion stock price effect of restatements through shared EPs.
This study has important policy implications. The results suggest that capital markets attribute or assign informational value to EP identity disclosures. The broader implication of the results is that by realizing the implication of associating with low-quality auditors, firms will demand higher-quality EP’s, thereby enhancing audit quality in general. Thus, the PCAOB’s objective of enhancing audit quality and auditor accountability can be met.
This study extends the conversation about audit quality at the individual level by examining the investor perception perspective. The results of this study should be of interest to stakeholders such as audit committees, regulators, investors and creditors, as it provides an indicator for assessing the quality of audits.
