The Audit Market Effects of Disputing a GAAP-Deficient PCAOB Inspection Report

As part of its charter, the Public Company Accounting Oversight Board (PCAOB) has the authority to inspect and review the workpapers of all accounting firms that provide auditing services to publicly-traded companies. The PCAOB summarizes their findings in publicly-available inspection reports available on its website. Prior research suggests that the accessibility, variation and source creditability of the inspection reports creates a publicly-available audit quality signal that is used by various auditor choice stakeholders. This is particularly true for triennially-inspected auditors that receive a GAAP-deficient report. In a GAAP-deficient inspection report, the PCAOB alleges that the auditor failed to identify departures from generally accepted accounting principles (GAAP) in the clients' financial statements. In this paper, we investigate whether and to what extent the auditor's response – which is also encapsulated in the inspection report – impacts the reaction to GAAP-deficient inspection reports. Using a sample of 59 GAAP-deficient auditors and their 466 audit clients, we find auditors that dispute the PCAOB findings are less likely to be dismissed by their audit clients and that this effect is magnified when a client has a CPA on its audit committee. Collectively, our results indicate that auditor choice stakeholders weigh both the PCAOB- and auditor-assessments of auditor performance