Triennially Inspected Audit Firms that Fail to Address PCAOB Quality Control Criticisms Satisfactorily: Do Quality Control Criticisms Really Matter?

Abstract:     
We examine whether Part II of the PCAOB inspection report (quality control criticisms) provides valuable information in addition Part I of the report (audit deficiencies). Using a sample of triennially inspected audit firms whose quality control criticisms were publicly released by the PCAOB (QCC audit firms) and a matched sample of audit firms that successfully remediated their quality control criticisms and thus were not publicly released (remediate audit firms), we find that QCC audit firms are more likely to issue a going concern (GC) report in the period before the release of Part I of the PCAOB inspection report but not after the release. This finding remains after controlling for information in Part I of the PCAOB inspection report and disciplinary actions taken by the PCAOB. Further, the finding cannot be attributed to a difference in the bankruptcy rate for companies in the QCC sample relative to companies in the remediate sample. These results suggest that GC reports were used as a form of legal protection by QCC audit firms before the PCAOB inspection and that the inspection process improved the quality control systems of QCC reporting firms. Lastly, we find that clients are less likely to dismiss a QCC audit firm after the release of the quality control criticisms, which is likely because QCC audit firms are less expensive. Our study suggests that the PCAOB inspection process improves the quality of audits performed by QCC firms. Further, the clients of QCC audit firms are more concerned about affordability rather than actual and perceived audit quality.

Number of Pages in PDF File: 52

Keywords: PCAOB, quality control criticisms, audit quality, going concern, auditor switching

JEL Classification: M42

working papers series