Can Auditor Responses Mitigate Unfavorable PCAOB Inspections?

• In Event: Continental Breakfast - Research and Education Forum
  In Roundtable Session: Table 5: Risk Signals and the Market's Response

Abstract

Prior literature suggests that clients perceive GAAP-deficient PCAOB inspection reports to be a signal of low audit quality. We examine whether certain auditor responses alter the perception of audit quality, thereby mitigating the effects of unfavorable inspection reports. We find that clients are significantly less (more) likely to dismiss GAAP-deficient auditors if the auditor attributes the PCAOB’s criticism to differences in professional judgment (documentation deficiencies). We also find that clients audited by GAAP-deficient auditors experience significant positive abnormal returns around the release of the inspection report when auditors’ responses indicates that the criticisms were the result of differences in professional judgment or that the auditor has addressed the criticism in accordance with professional standards. 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.

Authors

• William L. Buslepp, Texas Tech University

• Matthew Adam Notbohm, University of North Dakota