Investor and client responses to the first PCAOB sanction and Part II disclosure of a Big N Auditor

I examine investor and client responses to the first PCAOB sanction and the first release of “Part II – Issues Related to Quality Controls” of a Big N auditor. I examine the following: the stock market reaction to the Part II disclosure, investors’ perceptions of earnings quality after both events using the earnings response coefficient (ERC), and client dismissals after the sanction. I find that December year-end clients that operate in highly litigated industries or those with auditor tenure greater than three years are more likely to dismiss Deloitte in the post-sanction period. For the sample of U.S. highly litigated clients, the odds of Deloitte being dismissed after the PCOAB sanction are 180% higher than the odds of other Big N auditors being dismissed, after controlling for differences across time. For the sample of U.S. clients with auditor tenure greater than three years, the odds of Deloitte being dismissed after the PCOAB sanction are 107% higher than the odds of other Big N auditors being dismissed, after controlling for differences across time. Unlike Dee et al. (2011) who find that Deloitte clients experienced a negative market reaction to the PCAOB sanction announcement, I find limited evidence that the market reacted to the release of the first Big N Part II PCAOB inspection report. I also do not find strong evidence of a decrease in investors’ perceptions of earning quality after the PCAOB sanction or after the public release of Part II. I contribute to the literature by providing evidence on whether these first time PCAOB disclosures are informative to clients and investors. This is particularly relevant given the perception that information regarding audit firm quality is currently insufficient, that prior research regarding the content of PCAOB inspection reports has been mixed and mostly generalizable to smaller auditors, and that the Big N audit 98% of the total market capitalization of U.S. based issuers.