Public Company Accounting Oversight Board Research Articles

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the PCAOB’s Amendments to PCAOB Auditing Standards Related to a Company’s Noncompliance with Laws and Regulations and Other Related Amendments

SUMMARY On June 6, 2023, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its Amendments to PCAOB Auditing Standards Related to a Company’s Noncompliance with Laws and Regulations and Other Related Amendments (Public Company Accounting Oversight Board (PCAOB) 2023b). This commentary summarizes the participating committee members’ views on the proposal. Based on our consideration of the issues, we do not support the proposal, due to a number of fundamental concerns.

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the PCAOB’s Proposed Amendments Related to Aspects of Designing and Performing Audit Procedures That Involve Technology-Assisted Analysis of Information in Electronic Form

SUMMARY On June 26, 2023, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its Proposed Amendments Related to Aspects of Designing and Performing Audit Procedures That Involve Technology-Assisted Analysis of Information in Electronic Form (Public Company Accounting Oversight Board (PCAOB) 2023a). This commentary summarizes the participating committee members’ views on the proposal. We first provide answers to specific questions posed in the release, viewing the issuance of a new standard as a given. Subsequently, we also examine how well the proposal’s economic analysis establishes a solid foundation for new standard setting.

Critical Audit Matters: Recurring, Nonrecurring, and Intermittent

SYNOPSIS The Public Company Accounting Oversight Board (PCAOB) Auditing Standard (AS) 3101 requires auditor’s reports to include the communication of critical audit matters (CAMs). This study investigates the recurrence of CAM topics following the standard’s implementation to determine which CAM topics could be considered recurring, nonrecurring, and intermittent. We provide descriptive evidence that the average number of CAMs reported by auditors decreased over the first three years and then show occurrence patterns for CAM topics during our sample period (June 2019 to June 2022). Using the occurrence rates and the PCAOB’s descriptions in the CAM implementation guidance, we propose a method for classifying CAM topics as recurring, nonrecurring, and intermittent. Based on our proposed CAM topic recurrence categorization, we find that approximately 68 percent of auditor’s reports include at least one recurring CAM topic. Our findings should help practitioners and other financial reporting stakeholders refine expectations for the recurrence of CAMs. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M42; M48.

PCAOB International Inspections and the Market Value of Cash Holdings

ABSTRACT This study examines whether and how Public Company Accounting Oversight Board (PCAOB) international inspections mitigate the market value discount in cash holdings. We find that shareholders value internal cash holdings more highly for the non-U.S.-listed clients of inspected auditors after the public disclosure of the auditors’ inspection reports. We show that the decreased agency frictions and the increased financial reporting credibility are potential mechanisms. Further, we find that the effect of PCAOB international inspections on the market value of cash holdings is stronger in countries with weaker legal institutions and less sound information environment. Since investors’ valuation of cash mirrors how they expect the cash to be used, our results suggest a unique role of PCAOB oversight in mitigating unresolved agency problems and safeguarding corporate resources, thereby lessening investors’ markdowns of cash assets. Our findings help identify the real economic impacts of PCAOB oversight in enhancing global stock market confidence. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G34; M42; M48.

The First PCAOB Director of Registration and Inspections George Henry Diacont

ABSTRACT George Diacont was the first Director of Registration and Inspections for the Public Company Accounting Oversight Board (PCAOB). Diacont joined the PCAOB in March 2003, shortly after it commenced operations. His approach was to build a team of highly skilled professionals and encourage them to contribute their best ideas. His leadership style was to support his team, listen to their ideas, and make the best decisions possible without concern for praise or recognition. He also worked to instill a “regulatory attitude” in the former auditors who had become inspectors. This paper describes Diacont’s long and distinguished career in government service beginning with his military service in the U.S. Marine Corps. He spent 24 years at the Securities and Exchange Commission and five years in the Listing Investigation group at the NASDAQ stock market. He served nearly eight years at the PCAOB before he retired in 2011. JEL Classifications: M4.

Thinking Like an Auditor: Evaluating Information to Arrive at Evidence-Based Conclusions

SYNOPSIS The sources of information today are quite varied and often conflicting, leading to claims of fake news, conspiracy theories, outright lies, and censorship. In such an environment, how do you work toward evidence-based conclusions, or truth when possible? In this paper, we discuss the Auditing Standards Board (ASB)’s Audit Evidence Framework (AEF) and recent Public Company Accounting Oversight Board evidence-related guidance as valuable tools to help auditors and others evaluate the information they might use to arrive at evidence-based conclusions. We encourage others to “think like an auditor” when evaluating information. Our fundamental message is that information is not automatically evidence that should be used to support conclusions. Instead, information needs to be carefully evaluated before it rises to the level of evidence to support a conclusion.

Is expanded auditor reporting meaningful? UK evidence

In 2013, the United Kingdom (UK) Financial Reporting Council (FRC) mandated independent auditors to provide an expanded audit report to disclose the risks of material misstatement and application of materiality. This paper examines the information content and economic consequences of the expanded auditor’s report and offers three main results. We first investigate the usefulness of auditor reporting regime change and find evidence that the new reporting regime has some influence on market indicators. Second, we document that firms receiving an expanded audit report with a higher level of disclosure on risks of material misstatement (materiality) exhibit significantly higher (lower) idiosyncratic risk, beta, and cost of equity. That is, the expanded auditor’s disclosure meaningfully affects firms’ risk fundamentals. Third, we find that information conveyed by the expanded auditor’s report impacts bid-ask spread, trading volume, volatility of market returns, and analyst forecast dispersion. Collectively, our analyses suggest that auditors provide information that meaningfully reflects the risks that the audited companies face. Furthermore, this information is associated with significant economic consequences for capital market participants, implying that it is not generic. This firm-specific and useful disclosure supports the FRC (followed by International Auditing and Assurance Standard Board (IAASB) and Public Company Accounting Oversight Board (PCAOB)) decision mandating the expanded audit report and provides evidence-based insights to major recent structural reforms aiming at proposing remedies to audit and capital market problems in the UK, and beyond.

Impact of Audit Tenure, Fee and Auditor Specialist on Audit Quality

ABSTRACTProblems related to low audit quality are significant problems and require careful consideration, because they can hinder the preparation of accurate audit reports. This concern is not only limited to Public Accounting Firms but also extends to Public Accounting Firms that have high credibility, such as the Big Four. Several examples of low audit quality within the Big Four were highlighted in recent announcements by the PCAOB (Public Company Accounting Oversight Board) in 2016 and 2017, which resulted in sanctions against several of these companies. This situation requires research to assess the impact of auditor specialization, audit tenure and audit fees on audit quality in manufacturing companies audited by the Big Four Public Accounting Firms. This research used purposive sampling to obtain a total sample of 172 companies. The data analysis technique used in this research is multiple regression analysis using SPSS 23. The research results show that audit tenure, audit fees and auditor specialization influence audit quality.

The Regulatory Approach of James R. Doty: PCAOB Chair 2011–2018

James R. Doty was the chair of the US Public Company Accounting Oversight Board (PCAOB) from February 2011 to January 2018. Extant research investigates the outcomes of the PCAOB's regulatory approach without examining what that approach is. This article examines two approaches to regulation: merit and disclosure. For example, the PCAOB inspection process, which focuses on remediation of deficiencies, is a form of merit regulation. A disclosure approach to regulation would focus instead on more timely disclosure of inspection findings to audit committees, investors, and other users of financial statements. The article explores the impact of Doty's regulatory approach on the direction of the PCAOB during his tenure. Under Doty, the PCAOB's approach shifted towards a more disclosure based regulatory approach and away from a merit based regulatory approach. The article is based on extensive documentary evidence as well as interviews with James Doty.

The Spillover of U.S. Regulatory Oversight to Foreign Markets: Evidence from the Effect of PCAOB International Inspections on Executive Compensations

We examine the spillover effect of the Public Company Accounting Oversight Board (PCAOB) international inspection program on improving the contracting role of accounting numbers in executive compensations in an international setting. For a sample of non-U.S.-listed foreign public firms with PCAOB-inspected foreign auditors, we find a significant increase in the sensitivity of their executive cash compensations to earnings after the release of the first inspection reports on their auditors by the PCAOB, relative to those without PCAOB-inspected foreign auditors. Such a result suggests that the compensation committees of firms with PCAOB-inspected auditors infer that the quality of earnings as a performance measure for determining executive compensations improves due to the PCAOB’s inspections of their auditors. We also find that a clean inspection report issued to the firm’s auditor has an incremental effect on increasing earnings pay-for-performance sensitivity. Our findings provide novel evidence on the effectiveness of U.S. regulatory oversight in foreign markets and should interest the PCAOB and local audit regulators around the world.

Comments by the Ad Hoc Task Force of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the Proposed Auditing Standard, the Auditor’s Use of Confirmation, and Other Proposed Amendments to PCAOB Standards

SUMMARY On December 20, 2022, the Public Company Accounting Oversight Board (PCAOB) issued a request for comment on its proposed auditing standard, The Auditor’s Use of Confirmation, and Other Proposed Amendments to PCAOB Standards. The proposed auditing standard describes principles-based requirements that apply to paper-based and electronic confirmations, improves integration with risk assessment standards, requires confirmation for cash held by third parties, and carries over existing requirements regarding confirming accounts receivable. Further, it considers additional audit procedures when using negative confirmation requests and clarifies certain activities where the auditor should not use an internal auditor to provide direct assistance. The proposed standard is important, as the audit confirmation process touches nearly every audit. The comment period ended on February 20, 2023. This commentary summarizes the participating members’ views on the questions posed by the PCAOB. Data Availability: Proposed Auditing Standard—The Auditor’s Use of Confirmation, and Other Proposed Amendments to PCAOB Standards, including questions for respondents, is available at PCAOB Proposes New Standard for the Auditor’s Use of Confirmation | PCAOB (https://pcaobus.org/).

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the PCAOB’s A Firm’s System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules, and Forms

SUMMARY On November 18, 2022, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its proposed quality control standard, A Firm’s System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules, and Forms (Public Company Accounting Oversight Board (PCAOB) 2022). This commentary summarizes the participating committee members’ views on (1) the overall standard and selected questions and (2) recent research that we encourage the PCAOB to consider.

Does Auditor Tenure Disclosure Affect Shareholder Ratification Voting?

SUMMARY The Public Company Accounting Oversight Board requires audit reports to include information about auditor tenure for fiscal years ending on or after December 15, 2017. Tanyi, Rama, and Raghunandan (2021) examine the impact of this requirement on shareholder ratification voting of auditors. Consistent with shareholders sharing the oft-expressed views of legislators and regulators that long auditor tenure may impair auditor independence and audit quality, they find that shareholder opposition to auditor ratification increases (decreases) for long-tenured (short-tenured) auditors after the tenure disclosure. Thus, the very act of public disclosure in the audit report appears to have impacted investors’ voting decisions. The results suggest that auditors should respond to the increased scrutiny of auditor tenure by proactively engaging with the audit committees of their long-tenured clients. The results are also relevant in the context of the Securities and Exchange Commission’s efforts to have such tenure-disclosure requirements in registrants’ proxy statements.

The importance of independent audit and ethics in prevention of risk in businesses

Purpose- Regarding risks that express the possibility of loss of financial, physical, human and intellectual resources of businesses, not only due to their effects on the existence of the relevant businesses; At the same time, due to its devastating effects extending to international economies, it has become necessary to make institutional and legal regulations at national and international levels. Since the focus of the regulations is on "independent auditing and ethical rules", examining this issue constitutes the purpose of the study. Methodology- The method of the study is to consider the audit institutions and concepts developed for the prevention of risk in the historical development process, to reveal the importance of independent auditing and ethical principles in terms of stakeholders and the social environment, and to evaluate the subject in a whole, based on the literature. Findings- In preventing risks; It has been determined that audit activities are carried out under three headings: public audit, internal audit and independent audit. In independent auditing, which provides assurance regarding the reliability of financial data and statements, ethical principles are a prerequisite for ensuring the public interest. When we look at the historical roots of the concept of independent auditing and ethical principles; The emergence of financial reporting and auditing scandals behind the sudden bankruptcies of international companies such as Enron, World Com, Xerox, Lucent in the USA and Parmalat in the EU has shaken the trust in capital markets, company management, financial reports, independent audit companies and auditors. The need to re-establish public confidence in the markets and to introduce regulations regarding the transparency, honesty and financial information disclosure responsibility of public companies necessitated institutional structuring and regulations. In this context, the Treadway commission, established in 1985 in the USA, prepared the Sarbanes-Oxley Act (SOX) in 2002, and based on this law, the Public Company Accounting Oversight Board (PCAOB) was established to monitor the accounting sector in order to protect the interests of public company investors. International Supreme Audit Institutions have published the Code of Ethics Standard (ISSAI 30). In parallel, the Public Oversight Institution (KGK) and Capital Markets Board (SPK) in Turkey published the "Corporate Governance Principles". Conclusion- In order to prevent risks, independent auditing based on ethical principles, on the one hand, ensures the protection of stakeholders and public interest; On the other hand, it will contribute to the successful continuation of the activities of the related enterprises. The trust and transparency to be provided in the investment environment will be the guarantee of the development of national and international economies in general and the increase of social welfare and the dynamic of development. Keywords: : Risk, audit, ethics JEL Codes: M12, G10

The two sides of corporate social responsibility and the quality of internal control audit opinions

Although corporate social responsibility (CSR) activities provide a strong signal of management integrity, the involvement of the client in irresponsible CSR should alert the auditor to the risk of material misstatement. Framing management integrity assessments by relying on responsible CSR activities can lead to auditors' unintended alignment with their clients' preferred outcomes. Motivated by the increasing frequency of clean internal control opinions (ICOPs) regarding clients that subsequently misstate, we explore whether auditors' overreliance on responsible CSR influences the quality of ICOPs. We find that clients' CSR involvement is associated with fewer adverse ICOPs, but this CSR effect is asymmetric because it is only explained by responsible CSR activities and not by irresponsible CSR activities. Importantly, the ‘good side of CSR’ is associated with fewer adverse opinions being issued to misstated clients. Additional analyses show that only irresponsible CSR activities increase the risk of financial misstatements. Our findings provide support for the Public Company Accounting Oversight Board's warning that certain conditions inherent in the audit environment, such as the assessment of management integrity, can lead to auditors unconsciously favouring confirming evidence (represented by responsible CSR activities) instead of relying on disconfirming evidence (represented by irresponsible CSR activities) that could raise issues about management's integrity and ethical commitment.

Critical Audit Matters: Possible Market Misinterpretation

SUMMARY The Public Company Accounting Oversight Board recently expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. We study the first wave of CAM disclosers from July 2019 through May 2020, which included large accelerated filers reporting on their 2019 fiscal year results. We examine whether market participants erroneously perceive firms with more extensive CAM disclosures to be riskier than firms with less extensive CAM disclosures. Consistent with possible market misinterpretation, we find that firms with more extensive CAM disclosures are associated with increased perceived uncertainty: Stock prices of these firms are significantly more volatile and analyst forecasts are significantly more dispersed than those of firms with less extensive CAM disclosures. Data Availability: Data used in this study are available from public sources identified in the study. JEL Classifications: G12; G14; M41.

Auditors’ Use of In‐House Specialists

ABSTRACTUsing Public Company Accounting Oversight Board (PCAOB) inspection data from 2006 to 2018, we examine the use of auditor‐employed specialists in audit engagements. First, we find that the use of specialists is increasingly prevalent and related to clients’ size and complex accounting estimates. Second, the use of specialists is positively associated with the incidence of audit process deficiencies (identified by PCAOB inspections) but is not associated with output‐based audit‐quality proxies (restatements or absolute discretionary accruals). Hence, although process deficiencies are more likely to occur in engagements with higher use of specialists, financial reporting quality is not negatively impacted. Third, the use of specialists is positively associated with the likelihood of goodwill impairments and negatively associated with engagement profitability. Finally, cross‐sectional tests suggest that board accounting expertise is a salient condition for more effective use of specialists. Collectively, our findings align with concerns noted by the PCAOB and prior experimental and survey studies. Although specialists assist auditors with the audit of complex estimates, engagements with comparatively high specialist use entail an incremental risk of audit process deficiencies.

Does Public Company Accounting Oversight Board Regulatory Enforcement Deter Low-Quality Audits?

ABSTRACT Regulatory economics suggests that one benefit of public enforcement is the deterrence of improper conduct. Using a difference-in-differences (DiD) design, we investigate whether a deterrence effect follows the revelation of Public Company Accounting Oversight Board (PCAOB) enforcement. We find that large audit firm offices improve audit quality following enforcement naming another office within their firm while small firm offices improve following enforcement of local small firm competitors, with these responses varying by enforcement type. To understand potential mechanisms for the geographic deterrence effect, we examine the first occurrence of a revoked PCAOB registration within a market and find that results are stronger if there is greater news coverage or if nonsanctioned firms are in closer proximity to the sanctioned auditor. Supplemental tests reveal that results are stronger when nonsanctioned auditor clients are similar to the sanctioned firm’s clientele. Our findings suggest a positive but varied deterrence effect following PCAOB enforcement. JEL Classifications: G38; M42; M48.

The Association between PCAOB Inspection Reports and Seasoned Equity Offering Discounting

SUMMARY We examine the association between Public Company Accounting Oversight Board (PCAOB) inspection reports and a firm’s cost of equity capital, measured using seasoned equity offering (SEO) discounting. SEO discounting occurs when the offer price is lower than the prior day’s market price of the firm’s shares and represents “money left on the table” for issuing firms. We document an economically significant, positive association between SEO discounting and the use of an auditor found to be deficient by the PCAOB for clients of triennially inspected auditors. Cross-sectional evidence suggests that this relation is stronger for clients with lower analyst following and disclosed material weaknesses in financial reporting controls, and weaker if the auditor issues a going concern modification. Our evidence is consistent with PCAOB inspections providing meaningful information about audit quality to market participants, particularly for clients of smaller, triennially inspected auditors. Data Availability: All data are from publicly available sources. JEL Classifications: M42.

Is Audit Partner Identification Useful? Evidence from the KPMG “Steal the Exam” Scandal

SUMMARY On April 11, 2017, the Securities and Exchange Commission charged KPMG with using confidential information relating to the Public Company Accounting Oversight Board’s planned inspections of KPMG. The incident was colloquially labeled the KPMG “steal the exam scandal.” We use this setting to investigate whether the market finds information concerning individual partner identity useful. Since KPMG withheld the names of the audit partners involved in the scandal, the market was unable to distinguish between rotation-induced audit partner turnover and regulatory-related audit partner terminations. Following information economics models of nondisclosure, we predict the market would use information about KPMG audit partner turnover as evidence of regulatory-related audit partner terminations and impose costs on KPMG audit clients who experienced audit partner turnover. The results are consistent with our prediction as KPMG’s overall reputation was not damaged, whereas audit engagements involving audit partners that were potentially involved in the scandal were. Data Availability: All data was obtained from publicly available sources. JEL Classifications: M42; M48.