The Impact of the PCAOB Individual Engagement Inspection Process Preliminary Evidence

Abstract

This study investigates, mainly for the largest auditors, the impact on auditors’ and client issuers’ activities of the PCAOB individual engagement inspection process. Using a unique dataset of inspected engagements and identified audit deficiencies (Part I Findings), I find that both auditor and client issuer react to the issuance of a Part I Finding on their engagement. The audit firm increases effort on its inspected engagement and also on non-inspected engagements of offices or partners that receive a Part I Finding, suggesting both direct and spillover impact of the PCAOB inspections. The client is also more likely to switch auditors, often to auditors with high perceived quality. However, audit firms reduce their subsequent effort on inspected engagements that did not receive a Part I Finding, perhaps because of a better understanding of where the Part I Finding bar stands, and a lowered deterrence effect of the PCAOB inspection program following a clean inspection. In contrast, clients are less likely to switch auditor following a clean PCAOB inspection. Overall, these results suggest that both audit firms and client issuers care about the PCAOB individual engagement inspection process and gravitate towards the level of the Part I Finding bar.