We survey public company executives and directors to understand what audit clients want from their auditor in today’s regulated environment. Our results provide at least three important takeaways. First, executives and directors view elements of auditors’ service quality (e.g., timeliness of communications) as at least as important as auditors’ technical competence. Second, we find no evidence that stakeholders’ preferences for service quality replaces their expectation for technical competence. Third, we find that 57

We examine government agencies’ audit firm selections when procuring financial audit services. Using a sample of 2,760 financial audit contracts across 17 European countries and a staggered difference-in-differences design, we find that government agencies are more likely to contract with audit firms that receive PCAOB inspection reports with more deficient audits. This tendency is more pronounced in countries with greater illegal diversion of public funds and weaker accountability mechanisms, but does not vary with budgetary constraints, consistent with results being driven by opportunism rather than cost-savings incentives. In supply-side tests, we do not find evidence consistent with audit firms seeking to replace lost public company audits with government audits. These findings suggest that, in low-accountability environments, government agencies may deliberately select lower-quality auditors to reduce the likelihood of detection and disclosure of illegal or ineffective use of public funds.

We make a collective assessment of the consequences of 110 auditor reputation-damaging events with media coverage (“negative events”) from 2007 to 2019 for the U.S. Big Four. First, we fail to find systematic evidence that investors react negatively to negative events. Second, while auditors experience statistically significant client loss after negative events, the effects are short-lived and economically negligible. Furthermore, we find statistically greater effects in situations where theory suggests economic forces could magnify reputation effects (i.e., higher market competition, more replacement auditors, lower client switching costs, and higher audit office reputational capital). However, the economic impact remains small in all cross sections. Overall, our results suggest that negative events with media coverage have only a very marginal impact on investors’ perceptions of Big Four firms’ audit quality and the ability of these firms to attract and retain clients.

We examine whether auditor scrutiny over the allowance for loan losses (ALL) is associated with bank lending decisions. Using PCAOB inspection findings over the ALL to capture increases in auditor scrutiny, we find that auditor scrutiny is associated with a larger ALL for homogeneous loans (i.e., residential mortgages and consumer loans) but not for heterogeneous loans (i.e., commercial real estate; commercial and industrial loans). We next find that auditor scrutiny is associated with a shift in lending away from homogeneous loans, consistent with auditor scrutiny reducing the relative attractiveness of homogeneous loans. These findings suggest that policymakers and audit regulators can indirectly affect bank lending by exercising their authority in ways that affect auditor scrutiny.

On March 28, 2023, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its Proposed Auditing Standard- General Responsibilities of the Auditor in Conducting an Audit and Proposed Amendments to PCAOB Standards (Public Company Accounting Oversight Board (PCAOB) 2023). This commentary summarizes the participating committee members' views on selected questions.

Public accountants are in high demand by non-accounting firms. While this demand attracts high-quality accountants to public accounting, it can negatively impact audit quality by distracting auditors. We find that the number of metropolitan statistical area-level busy season job postings for public accountants by non-accounting firms is positively associated with misstatements. Results are most pronounced (1) when outside job opportunities are from non-publicly traded companies, which likely provide better work-life balance, and (2) when auditors are under a heavier workload, as captured by higher audit fee-to-auditor ratios and increased job postings by audit offices leading into the busy season. Results also suggest that accounting firms that provide large pay increases before the busy season can mitigate the negative audit-quality effects of busy season job postings for public accountants. These results suggest that accounting firms are not immune to negative effects of auditor distraction from outside job opportunities despite accounting firms knowing that their auditors are highly sought after by non-accounting firms.

We examine whether auditor scrutiny over the allowance for loan losses (ALL) is associated with bank loan portfolio composition. Using PCAOB inspection findings specific to the ALL to capture auditor scrutiny, we find that auditor scrutiny is associated with a larger ALL for homogeneous loans (i.e., mortgages and consumer loans) but not heterogeneous loans (i.e., commercial real estate; commercial and industrial loans). We next find that auditor scrutiny is associated with a shift towards heterogeneous loans, consistent with auditor scrutiny increasing the cost of banks holding homogeneous loans. Additional analyses using data on newly originated loans indicate that auditor scrutiny is associated with a decrease (increase) in risk in the homogeneous (heterogeneous) loan portfolio. These findings suggest that policymakers and audit regulators can indirectly affect bank lending activities by exercising their regulatory authority in ways that affect auditor scrutiny.

ChatGPT, a language-learning model chatbot, has garnered considerable attention for its ability to respond to users' questions. Using data from 14 countries and 186 institutions, we compare ChatGPT and student performance for 28,085 questions from accounting assessments and textbook test banks. As of January 2023, ChatGPT provides correct answers for 56.5 percent of questions and partially correct answers for an additional 9.4 percent of questions. When considering point values for questions, students significantly outperform ChatGPT with a 76.7 percent average on assessments compared to 47.5 percent for ChatGPT if no partial credit is awarded and 56.5 percent if partial credit is awarded. Still, ChatGPT performs better than the student average for 15.8 percent of assessments when we include partial credit. We provide evidence of how ChatGPT performs on different question types, accounting topics, class levels, open/closed assessments, and test bank questions. We also discuss implications for accounting education and research.

ABSTRACT Using a comprehensive database of U.S. internal auditor job postings, we find that firms are about 10 percent more likely to post an internal auditor job after the revelation of accounting and operational failures. Also, the demand for internal auditors is stronger when a failure is more severe. Among firms posting internal auditor jobs, firms demand higher-quality internal auditors in response to a failure compared with when there has not been a recent failure. We find evidence of internal audit demand spillovers through connected directors, which helps mitigate concerns that the primary results are due to replacing internal auditors that recently left or due to endogenous links between hiring internal auditors and failure revelations. Overall, our evidence suggests that firms demand internal auditors to help ensure high-quality financial reporting and effective operations. JEL Classifications: G34, J23, M41, M42.

On November 18, 2022, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its proposed quality control standard, A Firm's System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules, and Forms (Public Company Accounting Oversight Board (PCAOB) 2022). This commentary summarizes the participating committee members' views on (1) the overall standard and selected questions and (2) recent research that we encourage the PCAOB to consider.

ABSTRACTWe examine whether firms with managers that have prior internal audit experience are less likely to manage earnings. This examination is important because the internal audit function (IAF) is uniquely positioned to provide experiences that could influence future managerial behavior, including limiting the potential negative repercussions of earnings management. We find that firms with managers that have internal audit experience are associated with lower real earnings management (REM) but not accruals‐based earnings management. Effects are strongest when managers with internal audit experience have greater power or currently hold financial roles, or when there are a greater number of managers with internal audit experience. The results are robust to including firm fixed effects, using entropy‐balancing and performance‐matching approaches, using a subsample of firm‐years required to have an IAF, using a subsample of firms for which we can measure IAF quality, and measuring internal audit experience at a previous employer. These results point to an important benefit of manager internal audit experience, as research suggests that REM is common, difficult to detect, not always within the scope of financial reporting regulators, and detrimental to future performance.

Using unique disclosures from the insurance industry, we identify instances where auditors plausibly allow clients to opportunistically utilize discretion in accounting estimates to manipulate losses to reported profits (i.e., auditor lenience). Auditing standards and SEC guidance state that auditors should consider whether a misstatement shifts a loss to a profit as a qualitative factor when evaluating the materiality of misstatements. We find that audit office lenience is positively associated with subsequent market share changes. The effect is driven by increases in the likelihood of keeping existing, non-manipulating clients. In generalizability tests, we find similar inferences in the banking industry when using bank-specific disclosures and across all industries when measuring auditor lenience using likelihood of issuing going-concern opinions. These results highlight settings where auditors may be rewarded for lenience, specifically when management values financial reporting discretion and auditors can avoid publicized audit failures.

Social hierarchy theory predicts that the power and status of an organizational function have a first-order effect on the function's ability to influence outcomes. We find that the rank of the title of the top tax executive is positively associated with tax planning after controlling for treatment effects. Our inferences remain when (1) using changes in the size of the c-suite as a shock to the relative power and status of the tax function, and (2) examining promotions and demotions in title rank. Point estimates suggest that tax function power and status are up to 2.6 times as important as tax planning resources, up to 4.0 times as important as tax function-specific expertise, and, more often than not, more important than manager fixed effects. Overall, results suggest that the power and status of the tax function is often what matters most in determining tax outcomes.

ABSTRACTThis study investigates whether PCAOB inspections of foreign auditors affect global financial reporting comparability. Foreign auditors may adjust audit methodologies to address PCAOB inspection findings, which could affect financial reporting of local clients. Exploiting both within‐ and cross‐country variation in PCAOB inspections, we predict and find that non‐US‐listed foreign companies' financial reporting becomes more comparable to their US and non‐US industry peers after their auditors undergo an initial inspection. However, there is a decrease in comparability compared to local peers whose auditors have not been inspected. Subsample tests suggest that the improvement in comparability is driven by (i) auditors that satisfactorily address deficiencies and (ii) auditors that do not publicly push back against deficiencies. The effects are dampened after local audit regulators begin inspection programs. Overall, our evidence suggests that the PCAOB international inspection program affects audit methodologies of inspected auditors in a consistent way, improving comparability across jurisdictions. The improved comparability implies that the PCAOB international inspection program may unintentionally help meet accounting regulators' goals of cross‐country financial reporting convergence, which potentially promotes efficient cross‐country capital allocation.

SUMMARY We commend the International Auditing and Assurance Standards Board (the Board) on its efforts to determine “whether the auditing standards related to fraud and going concern need to be updated to reflect the rapidly evolving external reporting landscape.” We especially commend the Board on the timeliness of the call for input into these issues in that there is sufficient time to conduct research to further inform questions raised in the Discussion Paper and the questions that will inevitably arise as deliberations continue and progress is made on the project. We note below insights from the extant research literature as they relate to the questions posed in the Discussion Paper, but there remain many unanswered questions. We believe that many members of the Auditing Section of the American Accounting Association stand ready to work with the Board and other stakeholders to inform deliberations in this area. Data Availability: Information about and access to the Discussion Paper are available at: https://www.iaasb.org/publications/fraud-and-going-concern-audit-financial-statements.

Using a sample of bank-years from 2005 to 2017, we examine the effect of internal control quality on future risk-taking and performance. We find that banks that disclose a material weakness in internal controls have higher risk-taking and worse performance in the future, including having a higher (lower) likelihood of experiencing large losses (gains). These findings suggest that weak controls increase (reduce) downside (upside) risk-taking or conversely that strong controls increase (reduce) upside (downside) risk-taking. Path analyses suggest that 22.3 to 43.7 percent of the effect of internal control quality on future performance is through risk-taking. Additionally, material weaknesses are negatively associated with total asset, loan, interest income, and non-interest income growth, suggesting that internal control quality affects both core and non-core activities of banks. Overall, results suggest that strong internal controls improve bank risk-taking, in part through asymmetrically reducing downside risk-taking while facilitating upside risk-taking, ultimately improving bank performance.

The Big 4 have acquired numerous consulting firms since the late 2000s, and regulators are concerned that a focus on consulting practices could negatively affect audit quality through audit firm culture. Audit firms counter by arguing that expertise gained through consulting can improve knowledge brought to audits. Using a difference-in-differences design, restatements as an audit quality proxy, and enterprise resource planning- (non-enterprise resource planning-) related acquisitions as a proxy for audit- (non-audit-) related acquisitions, we find nuanced support for both positions, depending on acquisition type. Audit quality increases (decreases) at the local office level after the acquisition of consulting firms that provide services that relate (do not relate) to the audit. Semi-structured interviews of 17 highly-experienced audit practitioners suggest that consulting firm acquisitions positively (negatively) affect audit quality through expertise transfer (shifting the culture towards commercialism) when acquisitions are (are not) audit-related. Thus, the effect of consulting firm acquisitions on audit quality appears to depend on how closely the acquired services are related to the audit.