Costs and Benefits of a Risk-Based PCAOB Inspection RegimeMerage Fit Consultations

Area: Accounting

Host: Assistant Professor Chenqi Zhu

Speaker: “Brant Christensen, Associate Professor of Accounting, Glen McLaughlin Chair in Business Ethics, University of Oklahoma, Price College of Business”

Description: This study investigates how auditors respond to engagement-level PCAOB inspection risk. Using an inspection selection model developed from proprietary data, we find that auditors are more conservative when auditing clients with elevated inspection risk. Specifically, we observe an increased propensity to report material weaknesses, a decreased propensity to assert that previous material weaknesses have been remediated, increased audit effort, a decreased likelihood of subsequent restatement, and an increased likelihood of resignation from the client. Importantly, several tests provide evidence that auditors’ response to inspection risk is distinct from and incremental to their response to misstatement risk. Further, auditors’ response to inspection risk facilitates more accurate evaluations of internal controls and tends to be stronger when the inspection threat is more salient. We also find, however, that auditors’ anticipation of PCAOB inspection may have negative spillover effects for clients with low inspection risk when auditor resources are most constrained. Overall, our findings suggest that there are potential benefits and potential costs associated with the PCAOB’s risk-based selection approach.