An Assessment of the PCAOB's Risk-Based Inspection Program : Are Inspection Findings Generalizable and Do They Improve Audit Quality?

I examine the extent to which the Public Company Accounting Oversight Board's (“PCAOB”) risk-based inspection process produces a generalizable signal of the annually inspected firms' audit quality and improves audit quality. Specifically, I test whether account-specific deficiencies (revenues) are associated with account-specific audit quality (discretionary revenues) and if the association applies to a firm's extended client portfolio or just clients that exhibit a higher likelihood of being selected by the inspection program. To do this, I create a selection model to approximate the PCAOB's risk-based inspection process. Results suggest that inspection findings (at the firm level) can be generalized to the audit quality of those deficient accounts for the clients that exhibit higher levels of selection risk. Further, I find that audit quality increases in the subsequent fiscal year for the deficient accounts for clients with increased selection risk, indicating that the PCAOB risk-based inspection process improves audit quality