This paper complements and extends the limited extant research on inspection risk by clearly defining the construct and providing empirical evidence consistent with its existence and impact on auditors’ planning decisions. The authors contend that while auditors may perceive that PARs do not influence effort or fees, both PARs likely cause auditors, perhaps unconsciously, to increase effort and fees. 

C. M. Stefaniak, R. W. Houston, and D. B. Brandon. 2017. Investigating Inspection Risk: An Analysis of PCAOB Inspections and Internal Quality Reviews. Auditing: A Journal of Practice and Theory 36 (1): 151 – 168.

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This study shows that Big N auditors are more effective in reducing the cost of debt in countries with strong investor protection. In particular, the authors find that high-quality auditors are perceived by creditors as providing higher-quality audits in strong investor protection countries other than the U.S., including the U.K. and Canada. The study has implications for policy makers because it suggests that auditors (and, perhaps, auditing standards) may not be effective in weak investor regimes. High-quality auditors may be less effective in performing a governance role without the support of a strong investor protection regime. 

Gul, F. A., G. S. Zhou, and X. K. Zhu. 2013. Investor Protection, Firm Informational Problems, Big N Auditors, and Cost of Debt around the World. Auditing: A Journal of Practice & Theory 32 (3): 1-30.

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The authors provide initial empirical evidence that Securities and Exchange Commission (SEC) registrants found GAAP-deficient PCAOB inspection reports to be a useful signal of audit quality for triennially inspected auditors. This evidence indicates that PCAOB inspection reports created heterogeneity in auditor brand name that did not previously exist. Also, this paper is the first to empirically link audit committee characteristics to PCAOB inspection report severity and auditor choice. The authors believe this is an increasingly relevant finding as audit committees have been granted much greater auditor dismissal and hiring authority due to SOX. This study indicates that a PCAOB inspection report may serve as an audit quality signal for auditors of broker-dealers, who were previously exempt from the inspection process. Such a finding has current relevance given the PCAOB has recently sought to expand the inspection program to foreign auditors, such as those based in China whose clients are cross-listed on U.S. security exchanges or are listed due to a reverse merger.

Abbott, L. J., K. A. Gunny, and T. C. Zhang. 2013. When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors. Auditing: A Journal of Practice & Theory 32 (2): 1-31.

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The objective of this study is to determine whether PCAOB inspection reports of triennially inspected auditors are used as audit quality signals. The study was based upon the premise that the reports may serve as a publicly-available proxy of perceived audit quality. Clients were found to react differently to the PCAOB inspection reports contingent upon their severity with GAAP-deficient reports are more likely to trigger an auditor dismissal than a clean or GAAS-deficient report. The results suggest that clients of non-Big 4/non-national auditors are using certain PCAOB inspection reports as a publicly-available signal of audit quality and not as a means of procuring more favorable audit reporting or audit fees. 

Abbott, L., K. A. Gunny, and T. C. Zhang. 2013. When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors. Auditing 32 (2).

Auditors should be interested in the results of this paper because the trends provide information both on emerging issues in accounting, as well as areas that are likely to be flagged by the PCAOB for inspection. For example, issues related to fair value measurement are growing as a percentage of overall issues. This may cause audit firms to examine their fair value accounting practices and training.

For more information on this study, please contact Bryan K. Church.
 

Church, B. K., and Shefchik, L. B. 2012. PCAOB Inspections and Large Accounting Firms. Accounting Horizons 26 (1): 43-63.

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