Spillover of Regulatory Enforcement Against Small Audit Firms.

• In Event: Effects of Audit Regulation

Abstract

One of the PCAOB’s primary regulatory mechanisms is its ability to enforce audit firms’ compliance with PCAOB and SEC rules. Once settled, PCAOB enforcement activities are publicized with the intent to serve a deterrence function for other auditors. However, the effect of public enforcement on competing audit firms has not been empirically investigated. We hypothesize that when an audit firm is publicly sanctioned by the PCAOB, there is a spillover effect on competing audit firms in the local market such that these competing firms will increase their audit quality. Importantly, none of these competing audit firms were subjected to PCAOB enforcement. Thus, PCAOB enforcement against an audit firm is exogenous to the competing treatment audit firms in our study. We find that non-sanctioned audit firms with audit clients in the same MSA as a sanctioned firm, improve their audit quality post-enforcement as captured by a lower incidence of client misstatement and a higher incidence of reported internal control deficiencies. We also find that these non-sanctioned auditors charge higher audit fees post-enforcement relative to pre-enforcement revelation. These results have implications for the PCAOB’s intent to made disciplinary proceedings public prior to settlement.

Authors

• Phillip T Lamoreaux, Arizona State University - Tempe

• Michael J Mowchan, American University

• Wei Zhang, Arizona State University - Tempe