Do PCAOB Inspections Improve the Quality of Internal Control Audits

Abstract

We test whether PCAOB inspections help remediate auditors’ deficiencies in detecting and reporting material internal control weaknesses. After PCAOB inspectors report higher rates of internal control audit deficiencies, we find that auditors respond by increasing their issuance of adverse internal control audit opinions. We also find that the increased adverse internal control opinions are issued to clients that genuinely warrant such opinions, and are not simply the result of auditors becoming more conservative in their reporting practices. Finally, we find that higher inspection deficiency rates also lead to higher audit fees. Taken together, our results are consistent with critical inspection reports prompting auditors to perform more rigorous tests and evaluations of their clients’ internal controls. Overall, our findings suggest that PCAOB inspections improve the quality of internal control audits through their ability to remediate deficiencies in auditors’ internal control audit procedures.