The Unintended Consequences of the Frequency of PCAOB Inspection

Paul N. Tanyi · Barri A. Litt

37 citations0/0 files storedJournal of Business Finance &amp Accounting

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Auditing, Earnings Management, Governance Corporate Governance and Financial Management Financial Reporting and XBRL

Abstract

Abstract After more than 50 years of self‐regulation of the US auditing profession, the Sarbanes‐Oxley Act of 2002 (SOX) created the Public Company Accounting Oversight Board (PCAOB) as a quasi‐governmental entity with statutory authority to inspect accounting firms that audit public clients. The frequency of this inspection is annual or triennial, based upon the number of public clients the firm audits. We examine the effects of these two levels of inspection frequency on financial reporting quality and audit fees for clients of small and midsize public accounting firms. Our findings provide evidence of significantly higher audit quality and audit fees for clients of annually inspected firms relative to clients of triennially inspected firms. These findings are robust to auditor‐client alignment analyses, propensity score matching, time‐series analyses, examination of firms that have changed from triennial to annual inspection, and particular examination of firms with inspection deficiencies. Overall, our study suggests that the two‐tier frequency system of PCAOB inspection may have also resulted in two‐tier audit quality and audit fee systems for small and midsize public accounting firms, with more frequent inspection leading to more rigorous and informed auditor decisions. We discuss the implications of our results for the Board and the profession at large.

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References

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Cited by

2020Corporate Governance Determinants of Financial Restatements: A Meta-Analysis 2023The roles and interplay of enforcers and auditors in the context of accounting fraud: a review of the accounting literature 2020PCAOB Inspections and Audit Fees: An Analysis of Inspection Rounds of Small Audit Firms

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