Do Investors Perceive Improvements in Fair Value Accounting for Investment Assets After PCAOB Inspections?

Abstract

We examine whether fair value (FV) deficiencies highlighted in Public Company Accounting Oversight Board (PCAOB) inspection reports improve perceptions of the reporting quality of FV investment assets. Qualitative studies illustrate that subjective and complex estimates pose unique challenges to audit improvement. Using a market-based measure of financial reporting quality (i.e., implied asset-specific betas), we find a positive association between the intensity of FV-deficient reports and perceived reporting quality of level 2 (but not level 3) FV investment assets and show that the association is stronger when audit office FV expertise is high. Consistent with improvements in disclosures, after a FV-deficient report, we find FV footnotes become relatively more readable and include less cautionary language as level 2 holdings increase. Overall, our evidence suggests investors value PCAOB inspections regarding level 2 FV assets.