An Examination of the Effects of PCAOB Inspection Selection Method and Disclosure of Audit Strengths on Investor Judgments

Abstract

In its inspection process, the PCAOB has historically focused on reporting audit deficiencies and used a risk-weighted selection method. In two experiments (focusing on a “micro” and a “macro” investment), we take a “what if” exploratory public policy perspective of evaluating the potential effects on investors’ audit quality judgments and investment decisions of two evolving PCAOB inspection practices: disclosure of audit strengths as well as deficiencies; and the use of a random inspection selection method. In both experiments, we manipulate: inspection reporting (only deficiencies under the historical PCAOB inspection reporting; only deficiencies under a “balanced” PCAOB reporting; or a report where strengths are present but outnumbered by deficiencies), and inspection selection method (risk-weighted or random). We find that inspection strengths are highly relevant to investment decisions, through influencing investors’ audit quality assessments and confidence in financial reporting, and that investors consider inspection selection method in macro-level, but not micro-level judgments.