TY - JOUR
T1 - A multi-method analysis of the PCAOB's relationship with the audit profession
AU - Ege, Matthew
AU - Knechel, W. Robert
AU - Lamoreaux, Phillip T.
AU - Maksymov, Eldar
N1 - Funding Information:
We thank our editor, Mark Peecher, and two anonymous referees, as well as Andrew Call, Mark DeFond, Dominic Detzen, Yves Gendron, Steve Kachelmeier, Steve Kaplan, Clive Lennox, Sean McCarthy, Mike Mowchan, Mark Nelson, Steve Salterio, Jaime Schmidt, Kecia Smith, Ken Trotman, Kim Westermann, Michael Williamson and workshop participants at Maastricht University, Michigan State University, ESSEC Paris Business School, European Auditing Research Network (EARNET 2017), Lonestar Conference (2016), University of Kansas, University of Southern California, and University of Texas for helpful comments and suggestions on this and previous drafts of this manuscript. We also thank Brandon Barlek, Will Ciconte, Rachel Flam, Patrick Kielty, Daniel Lovland, Mike Mowchan, Elizabeth Tori, Hannah Tucker, Angie Wang, and Devin Williams for research assistance. Matthew Ege, Robert Knechel, Phillip Lamoreaux, and Eldar Maksymov acknowledge research support from Texas A&M University, the Fisher School of Accounting, and Arizona State University, respectively. This paper was previously titled “Reputation incentives of the PCAOB and large audit firms: Preliminary evidence from inspection findings”. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.
Funding Information:
The resulting culture of resentment and resistance among audit partners (Westermann et al., 2019) has likely led the profession to lobby for protection against the PCAOB's punitive regulatory approach. The audit profession is known for its lobbying efforts. Non-profit organizations supported by the profession, such as the Center for Audit Quality and the AICPA, are explicit in embracing lobbying as an important tool of supporting the profession. Thus, it is not surprising that in recent years the PCAOB has come under severe criticism from SEC (Park, 2020), with whom, according to our partner interviews, the profession has had a constructive relationship since before the PCAOB's creation. The SEC's criticism culminated in a complete replacement of the PCAOB's chairman and the board of directors, with two former Big 4 partners appointed to the board for the first time since the PCAOB's creation (SEC, 2017). Future research could explore the role of the audit profession in these significant changes relevant to the public.
Publisher Copyright:
© 2020 Elsevier Ltd
PY - 2020/7
Y1 - 2020/7
N2 - Responsive regulation (RR) theory posits that effective regulators enforce compliance by escalating penalties only if persuasion fails, otherwise risking formation of a culture of resentment. Using RR theory as a lens, we examine the interactions between large audit firms and the PCAOB during the initial years of PCAOB regulation, when annually-inspected auditors utilized negative tone within their inspection response letters to express public disagreement with their inspection reports. Consistent with our expectations, we find that negative tone within response letters is positively associated with (1) future Part I inspection findings that result in a restatement of a client's financial statements and (2) the likelihood that Part II of a future inspection report will be publicly disclosed. We triangulate these results and the underlying theory in semi-structured interviews of eight PCAOB inspectors and six audit partners involved in these early interactions between the largest firms and the PCAOB. Consistent with RR theory, the PCAOB viewed public disagreement as indicators of noncompliance, incorporated public disagreement into subsequent inspections, and escalated penalties for noncompliance. Contrary to RR theory's prescriptions, the PCAOB did not use persuasion as a first reaction to noncompliance. In response, the firms stopped publicly disagreeing, but may have formed a culture of resentment toward the PCAOB.
AB - Responsive regulation (RR) theory posits that effective regulators enforce compliance by escalating penalties only if persuasion fails, otherwise risking formation of a culture of resentment. Using RR theory as a lens, we examine the interactions between large audit firms and the PCAOB during the initial years of PCAOB regulation, when annually-inspected auditors utilized negative tone within their inspection response letters to express public disagreement with their inspection reports. Consistent with our expectations, we find that negative tone within response letters is positively associated with (1) future Part I inspection findings that result in a restatement of a client's financial statements and (2) the likelihood that Part II of a future inspection report will be publicly disclosed. We triangulate these results and the underlying theory in semi-structured interviews of eight PCAOB inspectors and six audit partners involved in these early interactions between the largest firms and the PCAOB. Consistent with RR theory, the PCAOB viewed public disagreement as indicators of noncompliance, incorporated public disagreement into subsequent inspections, and escalated penalties for noncompliance. Contrary to RR theory's prescriptions, the PCAOB did not use persuasion as a first reaction to noncompliance. In response, the firms stopped publicly disagreeing, but may have formed a culture of resentment toward the PCAOB.
KW - Audit regulation
KW - Auditor inspections
KW - PCAOB
KW - Responsive regulation theory
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U2 - 10.1016/j.aos.2020.101131
DO - 10.1016/j.aos.2020.101131
M3 - Article
AN - SCOPUS:85084508747
SN - 0361-3682
VL - 84
JO - Accounting, Organizations and Society
JF - Accounting, Organizations and Society
M1 - 101131
ER -