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    Did the 2007 PCAOB Disciplinary Order against Deloitte...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control 
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    Title:
    Did the 2007 PCAOB Disciplinary Order against Deloitte Impose Actual Costs on the Firm or Improve Its Audit Quality?
    Practical Implications:

    The results suggest that the PCAOB censure imposed actual costs on Deloitte by adversely affecting its switching risk and lowering audit fees. However, Deloitte’s audit quality appears to be no different from that of the other Big 4 firms during a three-year period either before or after the censure. Thus, the findings suggest that PCAOB censure can inflict actual harm on a Big 4 auditor by adversely impacting audit committee perceptions of the firm’s audit quality, but without an observable improvement in the firm’s audit outcomes as reflected in the audit quality metrics.

    Citation:

    Boone, J. P., Khurana, I. K., & Raman, K. K. 2015. Did the 2007 PCAOB Disciplinary Order against Deloitte Impose Actual Costs on the Firm or Improve Its Audit Quality? Accounting Review 90 (2): 405-441.

    Keywords:
    audit fees, Big 4 audit quality, PCAOB censure, switching risk
    Purpose of the Study:

    The December 2007 disciplinary order of Deloitte was unprecedented for a Big 4 firm, representing the first-ever public censure of a Big 4 firm by the PCAOB. These disciplinary proceedings followed up on a prior-year inspection report by publicly censuring Deloitte for violations of auditing standards in connection with the 2003 audit of Ligand Pharmaceuticals. Notably, the December 2007 censure came about more than three years after Deloitte’s resignation from the Ligand engagement in August 2004, and more than two years after the audit failure became public information in May 2005, when Ligand restated its financial statements for 20032004.

    The authors investigate the nature of the actual costs imposed on Deloitte by the December 2007 disciplinary order issued against the firm by the Public Company Accounting Oversight Board (PCAOB). That is, the authors examine whether Deloitte’s switching risk in terms of the likelihood of losing existing clients to other Big 4 firms or attracting new clients and audit fees changed following the PCAOB censure. They also examine whether the PCAOB censure improved Deloitte’s audit quality relative to that of the other Big 4 firms during the three years following the PCAOB censure.

    Design/Method/ Approach:

    The authors use four samples to test their hypotheses using ordinary least squares regression models. They used Audit Analytics and Compustat data with fiscal years between 2005 and 2010, resulting in a sample of 10,013 firm-year observations. Within this sample the authors derived three smaller samples to run further tests.

    Findings:
    • The 2007 PCAOB disciplinary order against Deloitte imposed significant actual costs on the firm, as measured by a subsequent change in Deloitte’s switching risk in the form of an increase in the firm’s existing client loss rate to other Big 4 firms and a drop in the client gain rate.
    • Deloitte reduced the rate at which they were escalating fees over a three-year period following the censure to stem the tide of client defections to other Big 4 auditors.
    • Deloitte’s audit quality was no different from that of the other Big 4 firms during either the pre-censure (20052007) or the post censure (20082010) time periods.
    • Collectively, these results are consistent with the notion that PCAOB oversight during the 20052010 period of the study was focused more on documentation and substantiation compliance than on a holistic assessment of a Big 4 auditor’s brand name service quality.
    • It is possible that Deloitte’s audit quality improved after the censure, but the authors were unable to detect the improvement based on existing methods.
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of PCAOB