Information intermediaries – auditors and financial analysts: cases of decreased effectiveness
Creators: name: Calabrese, Kristyn
Publisher: name: No Publisher Supplied
Year: 2019

description: Auditors and financial analysts serve to reduce information asymmetries in capital markets. The role of the independent auditor is to obtain reasonable assurance on whether a client’s financial statements are free of material misstatement and to express an appropriate opinion (PCAOB, AS1001). The role of the sell-side analyst is to obtain and analyze financial information and provide this information to investors in the form of research reports. This dissertation consists of three essays that examine settings where these parties may fall short in their roles as information intermediaries. The first essay investigates whether time pressure on the audit increases the cost and/or reduces the quality of professional audit services. I examine this question in the context of the accelerated filing regulation passed by the Securities and Exchange Commission in 2002. I identify client engagements that may experience audit time pressure given their audit report dates in the years prior to regulatory implementation. I analyze audit fees as an input cost to measure changes in audit effort and/or perceived audit risk. I then investigate the relationship between audit fees and restatements, an output measure of audit quality. I find time-pressure engagements are associated with significantly lower audit fee increases during implementation years when compared to other engagements. Initially, lower fee changes are associated with higher audit quality; however, this benefit is lost during further deadline reductions. Findings suggest changes in audit effort to meet the shortened deadlines with mixed implications for quality. This study may be of interest to both academics and regulators concerned with potential unintended consequences of audit time pressure. The second essay investigates a possible unintended consequence of audit workload and time pressures, the shifting of auditor effort. I investigate this in the context of the accelerated filing regulation and Section 404(b) of the Sarbanes Oxley Act, implemented during the years 2003-2004. These regulations shortened the filing deadlines and increased audit production requirements for accelerated filers, imposing time and resource pressures on auditors. Given non-accelerated filers were not subject to these regulations, auditors may reallocate effort (resources) away from this group and toward their accelerated filer clients. Results show a significant increase in the audit report lags of non-accelerated filers during this period. The increase is more pronounced for clients whose audit firms and offices have a greater proportion of accelerated filers in their portfolio (high-pressure auditors), clients with greater reporting slack (resource availability), and clients of audit offices with neighbor offices in proximity (resource transferability). Overall, high-pressure auditors at the firm level maintain higher audit quality on non-accelerated engagements; however, high-pressure auditors at the office level are associated with greater absolute changes in discretionary accruals. Furthermore, resource availability and resource transferability play a role in reducing negative quality effects. Findings are suggestive of audit resource reallocations with a downside of reduced audit timeliness and quality. The third essay investigates the overlooked subset of analyst recommendation revisions for which investors react in the opposite direction. In a sample from 2000-2016, I find approximately 32% of all recommendation downgrades (upgrades) are associated with a positive (negative) market reaction for which I use the term “conflicting reaction.” I investigate the determinants of a conflicting reaction and whether revisions with conflicting reactions are related to future earnings surprises. Results indicate that low firm-relevant news media attention or opposing news media sentiment are positively associated with a conflicting reaction. Investor inattention, changes in investor sentiment, information redundancy, information leakage, and weak analyst signals are also positively associated with a conflicting reaction. Further, revisions for stocks with larger analyst following, higher volatility, and greater analyst disagreement are positively associated with a conflicting reaction. Finally, revisions made by less experienced/reputable analysts and smaller brokerages are positively associated with a conflicting reaction. Looking at future earnings surprise, results suggest that analyst recommendations are equally helpful in identifying earnings surprises in the conflicting and non-conflicting subsamples. Trading portfolios that take advantage of the contradictory reaction earn approximately 7% to 14% per annum, providing evidence of price reversals. Findings suggest that revisions with conflicting reactions have important information that is initially overlooked by investors.