The Economic Consequences of Audit Firms’ Quality Control System Deficiencies

Abstract

This study seeks to determine the role of audit firms’ quality control (QC) system deficiencies, as measured by the Public Company Accounting Oversight Board (PCAOB) inspection program, on audit quality and profitability. Using a unique data set of firmwide QC deficiencies identified by the PCAOB during its inspections of audit firms, I find a negative association between QC deficiencies, mainly performance related, and audit quality. Furthermore, audits conducted by larger audit firms with more organization-level deficiencies appear less profitable, evidenced by more hours worked on the engagements, leading to lower fees per hour. These results appear to be partly explained by deficiencies in the tone at the top (a proxy for culture) and the audit methodology. Further evidence suggests that a lack of remediation of QC system deficiencies has a negative influence on audit quality. This paper was accepted by Suraj Srinivasan, accounting.