When the PCAOB Talks, Who Listens? Evidence from Client Firm Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors

Lawrence J. Abbott, University of Wisconsin - Milwaukee
Katherine A. Gunny, University of Colorado at Boulder
Tracey Chunqi Zhang, Singapore Management University


The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB). The PCAOB conducts inspections of registered public accounting firms that provide audits for publicly traded companies. Inspection results are summarized in publicly available reports at the PCAOB website. We categorize the inspection reports into three levels of increasing severity: clean, GAAS-deficient, and GAAP-deficient. We examine the potential use of GAAP-deficient PCAOB inspection reports as audit quality signals for the clients of GAAP-deficient auditors that are inspected on a triennial basis. We posit that clients of these auditors may seek to signal their desire for audit quality by dismissing their GAAP-deficient auditors. We find the clients of GAAP-deficient, triennially inspected auditors are more likely to dismiss these auditors in favor of triennially inspected auditors that are not GAAP-deficient. We also find that greater agency conflicts, the presence of an independent and expert audit committee, and outside blockholdings magnify this effect. We find no evidence that the clients use GAAP-deficient reports to procure a subsequent year audit fee discount or more favorable going-concern auditor reporting treatment. Our evidence indicates that PCAOB inspection reports created heterogeneity in auditor brand name among a group of non-Big N/non-national auditors that did not previously exist.