An Incomplete Audit at the Earnings Announcement: Implications for Financial Reporting Quality and the Market's Response to Earnings

Abstract

There has been a substantial increase, since 2004, in the number of firms that announce annual earnings before audit completion as opposed to after audit completion. In this study, we argue that earnings announced before audit completion are associated with lower financial reporting quality and investor perceptions that earnings are more likely to be overstated. Consistent with this expectation, we document that the market places more (less) weight on good (bad) earnings news for earnings announced after audit completion relative to earnings announced before audit completion. We continue to find this differential market response when we expand the returns window to include the 10‐K filing date, suggesting that the differential response is not driven by investors' temporary concerns about earnings revisions between the earnings announcement and the 10‐K filing date or by differential GAAP disclosures in the earnings announcement, as suggested in prior research. Finally, as a direct test of financial reporting quality, we show that earnings announced with a completed audit are less likely to be restated in the future, are less likely to meet or beat expectations, and are associated with fewer income‐increasing discretionary accruals than those announced with an incomplete audit.

The Effect of Regulation on the Timeliness and Informational Role of Earnings Announcements

“…announcement (e.g., Bronson et al 2011;Schroeder 2016;Marshall et al 2017). My results regarding the change in earnings announcement timing are robust to a series of sensitivity analyses that control for additional GAAP and non-GAAP earnings announcement disclosures, and other audit characteristics.…”

“…Schroeder () also finds that companies releasing their earnings announcements after the financial statement audit is complete include more GAAP disclosures in their announcements. Marshall et al () present evidence that after PCAOB AS 2/3, firms made more earnings announcements before the audit was completed. They also find evidence suggesting that investors place more reliance on earnings announcements with a completed audit.…”

“…Recent studies (Bronson et al 2011;Schroeder 2016;Marshall et al 2017) find that new audit regulations induced audit firms to take longer to issue their audit reports and that the delay in audit reports is greater than the delay in earnings announcements after earnings announcement regulation. As such, the likelihood of a company issuing its year-end earnings announcement prior to the completion of the audit increased after the new audit regulations.…”

“…I find additional evidence that other regulatory changes for auditors are also associated with the timing of management's earnings announcements. Prior studies have identified consequences related to PCAOB regulations regarding the timing of the audit, which is closely associated with the timing of the earnings announcement (e.g., Bronson et al ; Schroeder ; Marshall et al ). My results regarding the change in earnings announcement timing are robust to a series of sensitivity analyses that control for additional GAAP and non‐GAAP earnings announcement disclosures, and other audit characteristics.…”

Corporate reputation and the timeliness of external audit and earnings announcement

“…Furthermore, Marshall et al (2019) find that the market places greater reliance on earnings with a completed audit than those with an incomplete audit. Auditors are significantly less likely to require audit adjustments for aggressive financial reporting when earnings have been announced prior to audit completion (Bhaskar et al, 2019).…”