PCAOB Quality Control Inspection Reports and Auditor Reputation

SUMMARY: In 2002, the peer review auditor program was replaced with independent inspections of audit firms by the Public Company Accounting Oversight Board (PCAOB). The PCAOB inspections differ from the peer reviews in several key areas including the independence level of the reviewers, the nature and timing of the reviews, and the content and timing of the findings' disclosures. This study focuses on the informational value of the quality control criticisms disclosure included in Part II of the PCAOB inspection reports. After each inspection, the PCAOB issues inspection reports that include a public portion (Part I) of identified audit deficiencies, and most include a nonpublic portion (Part II) of identified quality control weaknesses. Part II of the report only becomes public if the firm fails to satisfactorily remediate the quality control deficiencies in a 12-month period. This study examines the change in audit firms' market share following the public disclosure of Part II of the inspection report. The results find that audit firms lose a significant amount of market share following the public disclosure of quality control criticisms, and suggest that such a disclosure provides a credible signal of auditor quality to audit clients.