The Audit Market Effects of Disputing a GAAP-Deficient PCAOB Inspection Report

Abstract

Prior literature suggests that clients perceive GAAP-deficient PCAOB inspection reports to be a signal of low audit quality (Daugherty, Dickins and Tervo, 2011 and Abbott, Gunny and Zhang, 2013). We examine whether certain auditor responses to PCAOB inspection reports alter the perception of audit quality, thereby mitigating the effect of unfavorable inspection reports. We find that clients are significantly less likely to dismiss GAAP-deficient auditors if the auditor attributes the PCAOB’s criticism to differences in professional judgment. We also find that clients audited by GAAP-deficient auditors providing responses are no more or less likely to have restated their financial statements, suggesting that the auditor dismissal is not related to the severity of inspection-identified misstatements. Our findings suggest that auditors can limit the consequences of unfavorable PCAOB inspections by making assertions that create uncertainty or confusion in the reader’s mind.