Martin Nienhaus

Do Reviews by External Auditors Improve the Information Content of Interim Financial Statements

Current German security regulations allow listed entities to decide whether they have their quarterly reports reviewed by an external auditor. In light of the trend toward global accounting harmonization, German regulators are considering to require mandatory reviews of interim financial statements. However, there is little empirical evidence on the reasons why some firms voluntarily purchase quarterly reviews and how such reviews affect the quality and information content of quarterly earnings. This study addresses this gap by investigating the economic determinants of the review decision. Management will weigh benefits and costs to decide whether to purchase reviews. We find that the review decision is linked to factors that drive the direct costs of the review and agency costs that impact the demand for additional monitoring. Moreover, after controlling for these fundamental differences and the self-selection issue with propensity score matching we find that reviewed interim financial statements show higher earnings quality and that they yield more decision-useful information for investors compared to un-reviewed reports. These results can be useful for preparers and auditors as well as jurisdictions contemplating changes in review requirements of quarterly reports.In the last decades, regulators around the world have increasingly mandated stricter assurance requirements for interim reporting. In several countries, firms must have their interim financial statements reviewed by an external auditor. However, there is little evidence to indicate whether auditor assurance is desirable for interim financial statements. We address this gap and analyze whether investors care about a review of interim financial statements. By exploiting a setting in which firms can voluntarily decide to buy a review, we find that the publication of reviewed interim financial statements causes more abnormal return volatility as well as abnormal trading volume than the publication of un-reviewed interim financial statements. Additional analyses reveal that the increase in information content is largely driven by a signaling effect of the review rather than by an increase in earnings quality. The findings inform the current political debate of mandating reviews for interim financial statements in several jurisdictions.