Costs of Public Auditor Oversight: Real Earnings Management and Innovation Loss

Prior research documents positive effects of PCAOB oversight on reporting and audit quality. However, to have a clear understanding of the net benefits of regulation, it is important to also investigate corresponding costs. To this end, we investigate the relation between PCAOB inspection oversight and real earnings management, a potentially value-destroying activity. We exploit the staggered timing of foreign governments’ allowance of PCAOB inspections in a generalized difference-in-differences design and find that companies engage in greater REM after the introduction of PCAOB inspection oversight. This relation is stronger for companies with a reduced ability to manage earnings via accruals. Lastly, we find a negative association between PCAOB oversight and innovation, particularly for firms making larger discretionary cuts to R&D expenditures. Collectively, our findings document unintended consequences of auditor regulatory oversight. JEL Classifications: G38; M41; M42; M48.