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

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 to own 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. Overall, we contribute to the accounting literature by motivating a reinterpretation of studies on value relevance and mispricing. We also provide theory and evidence that there is greater value in expanded audit reports than previously understood, and this value likely has standard-setting and audit-pricing implications