Investigating the Demand for Low Audit Quality: An Investigation of Companies that Hire Triennial Auditors with a Part II Report

• In Event: Audit Quality, Opinions and Specialization

Abstract

Quality audits are a mechanism to reduce information risk in the capital markets. As financial statement users are not able to observe the audit process, they must rely on other available information, such as auditor reputation. Public Company Accounting Oversight Board (PCAOB) inspection reports, especially Part II findings that relate to systematic quality control issues, can impact auditor reputation. Nagy (2014) provides evidence that companies generally switch from auditors that receive a Part II inspection report; however, auditors with quality control criticisms also attract new clients subsequent to the report. We examine why companies would be interested in hiring auditors identified by the PCAOB to be providers of poor quality audits. Results indicate that companies that switch to triennial Part II report auditors are associated with lower audit quality as compared to companies that switch to auditors without Part II reports. Further analyses demonstrate that companies that switch to Part II auditors are not able to negotiate lower fees. Our findings suggest that there may be unintended consequences of the Part II inspection reports, auditors with quality control issues may be attracting clients that prefer a low quality audit.

Authors

• Jared A Eutsler, University of North Texas

• Darin Kip Holderness, West Virginia University

• Megan Marie Jones, West Virginia University