How do Risk-Based Inspections Impact Auditor Behavior? Experimental Evidence on the PCAOB's Process

ABSTRACT I provide theory-based causal evidence on the effects of risk-based regulatory inspections, modeled after the PCAOB's, on auditor behavior in a multi-client setting where clients with relatively higher misstatement risk (“higher-risk” clients) have a higher risk of being inspected than clients with relatively lower misstatement risk (“lower-risk” clients). I predict and find that inspections increase auditor effort, but only for higher-risk clients. Inspections also impair auditors' decision performance for lower-risk clients relative to a regime without inspections and relative to higher-risk clients within an inspections regime, ceteris paribus. Theory-based process model results show that inspections increase auditors' perceived inspection risks, which increase auditor effort for higher-risk clients, but also increase auditors' task-related anxiety, resulting in decreased decision performance for lower-risk clients. Notwithstanding the previously identified benefits, this study identifies potential unintended consequences of risk-based regulatory inspections.