PCAOB Inspections and Trade Credit: International Evidence

Description

In 2002, the Public Company Accounting Oversight Board (PCAOB) was launched to oversee both U.S. and foreign auditors of U.S.-listed firms. Prior studies find that the inspections on foreign auditors increase audit quality for their U.S.-listed clients (Lamoreaux, 2016; Krishnan et al., 2017), and the positive effects spillover to non-U.S.-listed clients (Fung et al., 2017). Prior studies further document that the positive consequences of PCAOB inspections extend to global audit and capital markets, as evidenced by growing market shares of inspected foreign auditors (Aobdia and Shroff, 2017), increased capital expenditure of non-U.S.-listed clients of audited auditors (Shroff, 2019), and improved deal quality for global merger and acquisitions (Kim et al., 2020). However, there is little evidence on the role of PCAOB in product market. Hence, this study attempts to investigate the impact of PCAOB international oversight on trade credit between non-U.S.-listed clients and their suppliers.Trade credit is an imperative channel of informal financing. WTO’s report (2018) shows that 80 percent of international trade is backed by trade credit. I predict that PCAOB international inspections have positive consequences on trade credit, for the following reasons. First, previous studies show that financial statements facilitate financing providers to assess the lending risks (Hui et al. 2012; Penman, 2013; García-Teruel et al. 2014). In addition, suppliers rely on credit rating agencies for credit risk assessment (Love, 2015; Cassar et al., 2015; Sutherland, 2018) while the agencies reply on firm’s financial information to make assessment (Kim et al., 2013; Ayers et al., 2010; Florou et al., 2017). Recent studies (Lamoreax, 2016; Krishnan et al., 2017; Fung et al., 2017) suggest that PCAOB inspections improve financial reporting quality, therefore facilitating suppliers to evaluate firms’ credit risks. Second, recent studies suggest that PCAOB inspections reduce information asymmetry between firms and various stakeholders (Shroff, 2019; Kim et al., 2020; Lamoreaux et al., 2020). The improved firms’ information environment helps their suppliers monitor the firms’ investment and operating decisions, and hence increases the suppliers’ willingness to provide trade credit to the firms. Third, as a public auditing regulator, PCAOB can enhance the audit value by certifying that the audit process obeys audit standards (Coates, 2007). A few studies find that PCAOB inspections enhance investors’ confidence in audit work, and increase investors’ assessment of financial reporting reliability and credibility (Aobdia and Shroff, 2017; Krishnan, et al., 2017; Gipper et al., 2020), therefore enhancing suppliers’ trust on firms’ financial statement.