Does PCAOB regulatory enforcement deter low quality audits?

Abstract

Regulatory economics suggests that one benefit of public enforcement is the deterrence of improper conduct. Using a difference-in-differences design, we investigate whether a deterrence effect follows the revelation of PCAOB enforcement. We find that large audit firm offices improve audit quality following enforcement naming another office within their firm while small firm offices improve following enforcement of local small firm competitors, with these responses varying by enforcement type. To understand potential mechanisms for the geographic deterrence effect, we examine the first occurrence of a revoked PCAOB registration within a market and find that results are stronger if there is greater news coverage or if non-sanctioned firms are in closer proximity to the sanctioned auditor. Supplemental tests reveal that results are stronger when non-sanctioned auditor clients are similar to the sanctioned firm’s clientele. Our findings suggest a positive, but varied deterrence effect following PCAOB enforcement.

Keywords: PCAOB enforcement, audit quality, regulation, restatements, sanctions

JEL Classification: G38, M42, M48