Does Audit Transparency Improve Audit Quality and Investment Efficiency?
Social Science Research Network
We examine e¤ects of disclosing precisions of audit opinions (i.e., enhancing audit transparency) on auditor quality and investment e¢ ciency in a setting where the usefulness of an audited ...nancial report is jointly determined by the quality of the underlying ...nancial reporting (i.e., a mapping from a ...rm's fundamentals into an unobservable true accounting signal), misreporting of the true signal by the ...rm's manager, and audit quality (i.e., the precision with which audit evidence
... audit evidence collected by the auditor correctly captures the underlying true accounting signal and hence uncovers managerial misreporting). In our model, the auditor exerts an unobservable e¤ort to in ‡uence audit quality and is motivated by liability in the event of an audit failure. We show that while higher transparency enhances the information decision usefulness of audited ...nancial reports for investors, it can also adversely a¤ect the auditor's incentives and consequently lower the expected audit quality and investment e¢ ciency. We show that the underlying quality of ...nancial reporting is an important determinant for this Preliminary and comments welcome. We bene...t from discussions with Morris Mitler, Brian Mittendorf, Doug Prawitt, Katherine Schipper, and Dae-Hee Yoon. We thank participants at the 2014 Chicago Accounting Theory Conference for their helpful comments. Chen (firstname.lastname@example.org) and Xu (email@example.com) are from the Fuqua School of Business at Duke University. Zhang (firstname.lastname@example.org) is from George Washington University School of Business. Electronic copy available at: http://ssrn.com/abstract=2538076 tradeo¤, and the case for audit transparency is weaker when the underlying ...nancial reporting quality is high. Our ...ndings also imply that the underlying ...nancial reporting quality and auditing regulations are two interconnected elements. That is, whether increasing the underlying ...nancial reporting quality has a favorable e¤ect on audit e¤ort and investment e¢ ciency depends on the auditor's disclosure requirement, and whether expanding the scope of auditors'communication is desirable depends on the underlying reporting quality.