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SubscribeWorking Paper: Exploring the Auditor's Role in Internal Control Misreporting: Evidence from PCAOB Data
Paper Author: Daniel Aobdia, Preeti Choudhary, and Gil Sadka
Abstract: Prior research finds that companies and their auditors often fail to report existing internal control weaknesses. While other studies document reasons for the company’s internal control misreporting, we investigate the auditor’s role in such misreporting. Understanding why auditors fail to report material weaknesses can help audit regulators enact more effective interventions to improve internal control audits. To understand the auditor’s role, we analyze Public Company Accounting Oversight Board (PCAOB) proprietary data on audit clients’ internal control deficiencies (both material weaknesses and less-severe deficiencies) and deficiencies in the audits of internal controls documented by PCAOB inspectors. We find a significant yet overlooked explanation for unreported material weaknesses – auditors fail to detect relevant controls. Additional analyses suggest auditor incentives and lack of expertise in auditing internal controls contribute to the auditor’s detection failure. Collectively, our results suggest audits can be improved by requiring that internal controls are audited by more experienced and better incentivized auditors.
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The economic research fellows and staff economists generate high-quality working papers that inform the oversight activities of the PCAOB and are disseminated to stimulate discussion and critical comment to the benefit of the public. Working papers are preliminary materials that have not been approved by the Board and reflect only the views of the author(s).
The research topics of economic research fellows, including a description of any nonpublic data sets required for research, are presented to the Board for approval and research papers are reviewed to confirm that the topic of the paper is consistent with the researcher's proposal. That review does not, however, encompass an evaluation of the conclusions reached by researchers.