Working Paper: The Role of Engagement Characteristics in Internal Quality Reviews and PCAOB Inspections of Component Auditor Work for US Issuers

Paper Authors:  Denise Downey, Colleen Boland, and Jean Bedard

Abstract: This study uses proprietary data from the Public Company Accounting Oversight Board (PCAOB) to investigate quality of the audit process in component audits of US issuer engagements performed by non-U.S. network firms. Our process quality measures are derived from the firms’ Internal Quality Reviews (IQRs) and PCAOB international inspections, which both monitor compliance with professional standards. We study engagement characteristics influencing inspection selection and outcomes (deficiency), using Heckman models to control for selection bias in the outcome models. Results show that IQR selection is more likely for component audit engagements with more non-US labor, more US-specific procedures, and lower profitability; and among non-US firms with fewer US issuer clients, fewer professionals, and more dispersed offices. These findings imply that IQR inspectors perceive resource constraints as key inhibitors of audit quality in US-referred work. Similarly, IQR outcome models show that deficiencies are more likely in engagements with more non-US labor, lower profitability, and in firms with fewer professionals. In contrast, PCAOB Part I deficiencies are more likely in engagements with higher profitability and longer tenure, suggesting influence of commercial incentives rather than resource constraints. Our findings contribute to understanding of factors influencing the quality of the audit process as viewed by internal and regulatory inspections in an important but under-researched sector of the audit market. The observed variation in determinants across programs contributes to the literature on drivers of audit quality and should be useful to both firms and regulators in calibrating their inspection programs and interpreting their findings.

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