When the PCAOB talks, Who Listens? Evidence from Stakeholder Reaction to GAAP- Deficient PCAOB Inspection Reports of Small Auditors

55 Pages Posted: 15 Sep 2008 Last revised: 23 Oct 2014

See all articles by Lawrence J. Abbott

Lawrence J. Abbott

University of Memphis

Katherine Gunny

University of Colorado at Denver

Tracey Chunqi Zhang

Singapore Management University - School of Accountancy

Date Written: December 14, 2012

Abstract

Section 104 of the Sarbanes-Oxley Act (SOX) created the Public Company Accounting Oversight Board (PCAOB). The PCAOB conducts inspections of registered public accounting firms that provide audits for publicly traded companies. The results of the inspection process are summarized in publicly available reports at the PCAOB website. Using these reports, we categorize the inspection reports into three levels of increasing severity: clean, GAAS-deficient, and GAAP-deficient. We examine the potential use of GAAP-deficient PCAOB inspection reports as perceived audit quality signals for the clients of GAAP-deficient auditors that are inspected on a triennial basis by the PCAOB. Our investigation is predicated on the notion that audit quality is generally not directly observable. Thus the clients of these auditors may seek to signal their desire for audit quality by dismissing their GAAP-deficient auditors. Our results suggest that the clients of GAAP-deficient, triennially inspected auditors are more likely to dismiss these auditors in favor of triennially inspected auditors that are not GAAP-deficient. In addition, we find that greater agency conflicts, the presence of an independent and expert audit committee, and outside blockholdings magnify this effect. Interestingly, we find no evidence that the clients use GAAP-deficient reports to procure a subsequent year audit fee discount or more favorable going-concern auditor reporting treatment. Our evidence indicates that PCAOB inspection reports created heterogeneity in auditor brand name among a group of non-Big N/non-national auditors that did not previously exist and universally treated by prior research as “other auditors.”

Keywords: PCAOB, agency costs, audit quality

JEL Classification: M49, G34, G38, K22

Suggested Citation

Abbott, Lawrence J. and Gunny, Katherine and Zhang, Tracey Chunqi, When the PCAOB talks, Who Listens? Evidence from Stakeholder Reaction to GAAP- Deficient PCAOB Inspection Reports of Small Auditors (December 14, 2012). Auditing: A Journal of Practice & Theory, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1266950 or http://dx.doi.org/10.2139/ssrn.1266950

Lawrence J. Abbott (Contact Author)

University of Memphis ( email )

Department of Accounting
Memphis, TN 38152
United States
901-678-4576 (Phone)
901-678-2685 (Fax)

Katherine Gunny

University of Colorado at Denver ( email )

Box 173364
1250 14th Street
Denver, CO 80217
United States

Tracey Chunqi Zhang

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

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