Apparent audit failures and value relevance of earnings and book value

Abstract

Purpose The purpose of this paper is to examine the value relevance of accounting information in cases of apparent audit failures. Design/methodology/approach The authors adopt the bootstrapping technique and compare the value relevance of key accounting information across samples of firms experiencing apparent audit failures with matched non‐audit failure firms. Findings Accounting information is found to be less value relevant for firms experiencing apparent audit failures, regardless of auditor reputation. Research limitations/implications This study has limitations due to the ex ante research approach adopted. Future research could address this issue by possibly incorporating an “intervening” factor into the model to indicate how the market can differentiate audit failure firms from other firms. Originality/value The paper gives support to the assertion that the market appears to rely less on accounting numbers when audit failures occur, even though formal allegations of audit failure may not appear until years after their occurrence. In addition to contributing to value‐relevance research by providing empirical evidence for the market phenomenon around the time of material misstatements, the paper demonstrates an innovative application of bootstrapping to test for differences in R2.

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