PCAOB inspection report outcomes: do they reflect audit quality and audit clients' levels of governance and controls?

This study is about the quality of the work of external auditors as part of the broader corporate governance frame. It contributes new evidence to the U.S.’s Public Company Accounting Oversight Board (PCAOB) inspection research literature on the association between the PCAOB inspection outcomes and audit quality, as well as between PCAOB inspection outcomes and client firms’ internal control systems and internal corporate governance. In hypothesising these relationships, agency theory and signalling theory are invoked. This study focuses on two rounds of PCAOB inspections to identify change that have occurred in these inspection outcomes and their practical implications for medium-to-small auditor firms and their business clients’ managers and investors. Three sets of hypotheses are generated in this study. A quantitative research method is applied in this study. The sample in this study consists of 806 inspection reports. They are several findings from this study. First, in relation to the association between the PCAOB inspection outcomes and abnormal audit fees paid to auditors by client firms used to test the first hypothesis, the result suggests if there is an increase in abnormal audit fees then there will be an increased probability of obtaining a deficiency report. In terms of the association between the PCAOB inspection outcomes and client firms’ effective internal controls used to test the second hypothesis, the result suggests if there is an improvement in client firms’ internal controls then auditors will have a decreased chance of obtaining a deficiency report. With regard to the association between the PCAOB inspection outcomes and client firms’ internal corporate governance applied to test the third hypothesis in this study. This result suggests if client firms’ internal corporate governance is stronger thus client firms’ auditors are more likely to have a favourable PCAOB inspection outcome. However, the result is insignificant, while in the hypothesised direction, can not be claimed as supporting the third hypothesis. This study highlights the significant association between the PCAOB inspection outcomes and positive abnormal audit fees paid to auditors by client firms and client firms’ effective internal controls as well. Finally, this study contributes to current PCAOB literature by examining the direct association between the PCAOB inspection outcomes and audit quality, client firms’ internal controls and client firms’ internal corporate governance.