Do Investors Value Higher Financial Reporting Quality, and Can Expanded Audit Reports Unlock This Value?

Abstract

We present new theory and experimental findings indicating that investors ascribe value to firms that use higher financial reporting quality (FRQ), controlling for the influence of higher FRQ on their estimates of these firms' fundamental value. To guide our investigation, we draw on the cooperation literature in accounting, finance, and psychology. We identify expanded audit reports, particularly auditor commentary, as a mechanism that credibly communicates whether a firm uses higher FRQ. Auditor commentary increases investors' willingness to pay (WTP) more for shares of a firm using higher FRQ than a competing firm using lower FRQ. We also provide process evidence that investors perceive higher FRQ as cooperative behavior by measuring their affective responses and cognitive beliefs, which mediate the influence of audit commentary on investors' increased WTP for higher FRQ. A second experiment bolsters the link between investors' affective and cognitive responses to a firm's FRQ and perceived cooperative behavior.

The Effect of Quality and Timeliness of Limited Review Report on Perceived Interim Financial Reporting Quality during COVID-19 Pandemic Crisis: Evidence from Egypt

“…KAM paragraph is concise and straight forward and it is expected that it will draw the attention of investors and other stakeholders more than the disclosures in the financial statement footnotes, as this paragraph is presented by an independent auditor (Christensen et al, 2014). Expanded audit reports (after adding KAM paragraph) are expected to affect investors' behavior significantly (Sutthipan, 2020) and will increase investors' willingness to pay and buy the firms' shares when they disclose information about the firms' higher financial reporting quality (Elliott et al, 2020).…”

The Effect of Financial Reporting Quality on the Cost of Equity Financing: Evidence from PIPE Offerings.

“…For example, Francis et al (2005) are among the first to test the relation between accrual quality and cost of capital and find that higher accrual quality is associated with lower cost of equity capital and cost of debt capital. The experimental findings of Elliott et al (2020) show that investors are willing to pay more for firm shares when the firm's financial reporting quality is higher. Lee and Masulis (2009) examine the relation between reporting quality cost of capital under a more specific setting: Seasoned equity offering.…”

Profitability, Audit Quality, and Firm Value: Case on Indonesian Manufacturing Companies

“…The stock market gives a positive reaction to companies that use public accountants' services with high audit quality. Elliott et al (2020) state that the firm value estimate influences investors' willingness to buy company shares. Investors may have different interpretations of the information available in the financial statements, but the quality of the financial statements has been theorized to be a factor affecting firm value.…”

“…Investors may have different interpretations of the information available in the financial statements, but the quality of the financial statements has been theorized to be a factor affecting firm value. According to Elliott et al (2020), the effect of the quality of financial statements on firm value will be strengthened by the quality of the audit process. The quality audit can be seen through the existence of an effective communication mechanism between auditors and company management through auditor comments written in independent audit reports.…”