Two essays on financial reporting quality

Abstract

Essay I: Auditors' Response to Initiation of Compensation Clawback Provisions While firm-initiated compensation recovery (or clawback) provisions are gaining popularity, little is known about their impact on information intermediaries such as auditors. This study shows that auditors view such provisions as useful in reducing audit risk. Specifically, I find that auditors are less likely to report material internal control weaknesses after the firm adopts clawback provisions. In addition, auditors charge those firms lower audit fees and are able to issue audit reports sooner after the adoption. These results imply that auditors consider clawback provisions helpful in enhancing the integrity of financial reporting and thus reduce audit effort. Essay II: Internal Control Weaknesses and Investors' Assessment of Earnings Quality This study examines if the mandated disclosure of firms' internal control quality affects the market's assessment of earnings quality. I find that the earnings response coefficient (ERC) declines after the first disclosure of internal control weaknesses (ICWs) and recovers after the weaknesses are remediated. I further show that the ICW-induced decrease in the ERC is more pronounced when the firm discloses more weaknesses. The decrease is stronger for positive than for negative earnings news. In addition, firms with lower ex ante likelihood of reporting ICWs suffer more decrease in the ERC. Thus, my evidence suggests that mandated ICW disclosure is viewed by investors as relevant in appraising earnings quality. Since internal control over financial reporting is designed to provide reasonable assurance of the reliability of financial reporting (PCAOB, 2004), my findings show that the ICW disclosure is viewed by the market to at least partially achieve PCAOB's intended objective.

Date of Award	2011
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology