Investor response to engagement quality review hours

Abstract

Purpose

This study aims to investigate whether mandated disclosure of engagement quality review hours provides new information that affects investors’ decision-making.

Design/methodology/approach

In 2014, Korean authorities mandated that audit engagement quality review hours must be disclosed in their audit reports. Using this unique field setting in Korea, this study presents empirical evidence of the policy initiative’s effect on earnings reliability by examining both pre- and post-implementation periods.

Findings

Following the initial disclosure of engagement quality review hours in 2014, the authors observe that the capital market’s valuation of quarterly earnings surprises, measured by earnings response coefficients (ERCs), was significantly lower for firms with high levels of abnormal engagement quality review hours than for other firms. This paper also finds that the observed association between engagement quality review hours and ERCs in the postregulation period hinges on the probability of earnings management, proxied by discretionary accruals and just meeting or beating analyst earnings forecast.

Originality/value

This paper suggests that the policy mandating disclosure of engagement quality review hours provides original information that the market considers relevant for appraising the reliability of reported earnings.