The Effect of Audit Quality and Pre-Audit Financial Reporting Quality on Investor Decision-Making

This study examines how nonprofessional equity investors value variations in audit quality at different levels of audit clients’ pre-audit financial reporting quality. Using source credibility theory, we predict that nonprofessional investors will value the greater reduction in information uncertainty from high audit quality versus low audit quality when the client’s pre-audit financial reporting quality is high. However, when pre-audit financial reporting quality is low, we predict that the level of audit quality will have less of an effect on investor decision-making. To test our predictions, we conduct a between-participants experiment in which participants assume the role of an equity investor contemplating stock acquisition in a U.S. public company representing different combinations of pre-audit financial reporting quality and audit quality. Results are consistent with our predictions. This study clarifies the debate surrounding investors’ audit quality preferences by showing that companies’ perceived pre-audit financial reporting quality moderates these preferences