The Impact of PCAOB Reports Containing Audit Deficiencies on Non-U.S. Audit Firms: Initial Evidence Free

In this study, we examine involuntary dismissals, voluntary resignations, and voluntary deregistration of inspected non-U.S. audit firms after they receive PCAOB inspection reports containing audit deficiencies. Our study is important given the significance of, and the challenges facing, the PCAOB international inspections. We start with background information about PCAOB international inspections and motivations for this study, and then discuss relevant literature and research questions, followed by our research method, results, and conclusions.

International inspections are regarded as one of the PCAOB's top priorities (Carcello 2010; Goelzer 2010). Under Sections 102(a) and 106 of the Sarbanes-Oxley Act (henceforth, SOX) and PCAOB Rule 2100, all non-U.S. audit firms (hereafter referred to as non-U.S. audit firms), as well as U.S. audit firms that audit U.S. issuer clients, must be registered with the PCAOB.¹ These non-U.S. audit firms include the member firms of the international accounting firm network and non-affiliate audit firms that conduct audits in non-U.S. jurisdictions. Under SOX Section 106, Congress permitted the PCAOB, with the approval of the Securities and Exchange Commission (SEC), to exempt non-U.S. audit firms from registration. However, the PCAOB decided not to exempt non-U.S. audit firms from registration, arguing that U.S. investors demand high-quality audits of firms listed in U.S. exchanges, regardless of their location (PCAOB 2007). Therefore, non-U.S. audit firms are subject to the PCAOB's inspections in the same manner as are U.S. auditors. Obviously, the PCAOB regards its inspection process as critical for improving audit quality, no matter where the auditors are located (Carcello, Carver, and Neal 2011a). Moreover, at the end of 2012, 911 (39 percent) of the 2,363 audit firms registered with the PCAOB were located in foreign countries (PCAOB 2012a).

The PCAOB began its inspections of non-U.S. audit firms in 2005 (PCAOB 2009), and as of June 30, 2013, the PCAOB has conducted inspections of non-U.S. audit firms in 41 non-U.S. jurisdictions on a cumulative basis.² However, the PCAOB has faced some challenges in its international inspections (Goelzer 2010). First, PCAOB inspections cannot be conducted in certain European countries and China because of legal conflicts with the home country laws and sovereignty concerns. Thus, the PCAOB is currently prevented from inspecting the U.S.-related audit work of PCAOB-registered non-U.S. audit firms in these jurisdictions (PCAOB 2013a). The PCAOB has recently signed a memorandum of understanding with regulators from China that creates a framework to produce and exchange audit documents relevant to investigations by the PCAOB and regulators from China (PCAOB 2013b). Second, international inspections have been delayed because the PCAOB has had to negotiate principles for cooperative work with foreign audit oversight bodies, and to understand other jurisdictions' audit oversight systems (PCAOB 2009).

As a response to these challenges and in order to reduce duplicate regulatory burdens, the PCAOB has entered into 17 cooperative arrangements with audit regulators in foreign countries as of the end of 2013. Cooperative arrangements provide a framework for conducting joint inspections, and include provisions governing the exchange of confidential information between the PCAOB and foreign audit regulators (PCAOB 2012b).³ Table 1 provides a list of 25 countries in which PCAOB-registered non-U.S. audit firms could not initially be inspected as of the end of 2009, and the status of cooperative arrangements that the PCAOB has made with these countries. Among these 25 countries in which the PCAOB had not conducted inspections by the end of 2009, nine countries (China, Finland, France, Germany, The Netherlands, Norway, Spain, Switzerland, and the United Kingdom) have since made cooperative arrangements with the PCAOB as of the end of 2013.⁴ Also, the PCAOB expects that joint inspections would reduce unnecessary duplicate regulatory burdens and limit its involvement in foreign inspections (PCAOB 2007). In joint inspections, the PCAOB has relied on a “sliding scale approach”; specifically, “the more independent and rigorous the home country oversight system, the greater the PCAOB's reliance on that system” (PCAOB 2007, 3).

Moreover, in order to provide transparency with regard to the PCAOB's international inspection program, the PCAOB has posted three lists on its website since April 2009: (1) jurisdictions that the PCAOB has already inspected; (2) jurisdictions that the PCAOB plans to inspect in the current calendar year; and (3) non-U.S. audit firms that have not yet had their first PCAOB inspection, even though more than four years have passed since the end of the calendar year in which a firm first issued an audit report while registered with the PCAOB.⁵ There are various reasons why inspections have not been conducted during the four years since the non-U.S. audit firm issued the first audit report while registered with the PCAOB. Some firms are included on the list because their inspections were postponed in accordance with PCAOB Rule 4003(f) or Rule 4003(g).⁶ Some other firms are included on this list because access to audit information necessary to conduct inspections has been denied because of legal conflicts with local laws or sovereignty concerns.

Given the importance of, and the challenges facing, the PCAOB international inspections, and the efforts and resources that the PCAOB has devoted to international inspections, research is needed to examine whether and how the PCAOB international inspections influence the audit market and inspected auditors. This study seeks to address these issues. Specifically, we examine the involuntary dismissals, voluntary resignations, and voluntary deregistration of inspected non-U.S. auditors following PCAOB inspections (mainly PCAOB reports including audit deficiencies).

The PCAOB conducts inspections annually for registered audit firms with more than 100 issuer clients (i.e., large firms), and at least once every three years for registered audit firms with 100 or fewer issuers (i.e., small firms; Section 104 of SOX and PCAOB Rule 4003). For each inspection it conducts, the PCAOB publishes an inspection report: a clean report not disclosing any audit deficiencies or quality control criticisms, or a report disclosing audit deficiencies and/or quality control criticisms.⁷ The PCAOB does not attempt to inspect a representative sample of audit engagements; its selection of audit engagements to be inspected is purposely biased. Only certain significant audit deficiencies that are found in the inspections are disclosed in inspection reports. The audit deficiencies disclosed are “of such significance that it appeared to the PCAOB that the firm did not, at the time it issued its audit report, have sufficient evidence to support its opinion on the financial statements” (Center for Audit Quality [CAQ] 2012, 9) or its opinion concerning the client's internal controls over financial reporting. Other systemic quality control criticisms are made public (on the PCAOB webpage) only if the audit firm does not remediate the criticisms in its quality control system within one year of the inspection report date.

Some studies provide descriptive information about PCAOB inspection reports, primarily for U.S. inspections. Hermanson, Houston, and Rice (2007) document that small CPA firms with deficiencies reported in the inspection reports have more issuer clients and grow more rapidly than firms without reported deficiencies. These results suggest that some small CPA firms have overextended themselves by auditing too many public clients. Based on a survey of triennially inspected firms, Daugherty and Tervo (2010) document that medium and larger firms reported positive impacts on their audit practices, whereas smaller firms reported more negative impacts from initial PCAOB inspections.⁸

Two studies provide evidence that PCAOB inspections improve audit quality. Gramling, Krishnan, and Zhang (2011) find that audit firms with publicly reported audit deficiencies during 2004–2006 are more likely to issue a going concern report after the inspection rather than before. In addition, Carcello, Hollingsworth, and Mastrolia (2011b) find a significant decrease in income-increasing abnormal accruals following the initial PCAOB inspections on Big 4 audit firms in 2004.⁹

Bishop, Hermanson, and Houston (2013) were the first study to investigate PCAOB inspections of non-U.S. audit firms. Based on a sample of 175 first-time and 56 second-time inspection reports the PCAOB issued to non-U.S. audit firms through February 4, 2012, they conclude that most of the descriptive results based on inspected non-U.S. auditors are similar to those for U.S. small auditors that have been inspected triennially, while some results are different from those in the U.S. setting. Importantly, Bishop et al. (2013) focus on descriptive evidence, including the frequency and nature of audit deficiencies and quality control criticisms, and non-U.S. audit firms' responses to the PCAOB. They specifically call for research on client losses after the publication of PCAOB reports containing audit deficiencies. Our study examines this issue, and we focus on auditor changes and deregistration from the PCAOB following the publication of PCAOB reports for non-U.S. audit firms.

Carcello et al. (2011a) also examine PCAOB international inspections. On August 12, 2009, the PCAOB disclosed the first list of non-U.S. auditors that had not been inspected by the PCAOB because their home countries did not allow them to be inspected. Carcello et al. (2011a) find a significant negative market reaction to the PCAOB's August 12, 2009 disclosure for clients audited by these non-inspected non-U.S. auditors. They also find that companies whose auditors are domiciled in the U.K. experienced a positive market reaction to the PCAOB announcement in January 2011 that a joint inspection agreement was reached with the U.K., in which inspections were blocked previously. The authors conclude that investors value the PCAOB's efforts to gain access to non-U.S. auditor markets that initially deny the PCAOB inspection authority.

Some U.S.-based studies examine the association between auditor dismissals and modified or adverse opinions from peer reviews or PCAOB inspection reports containing audit deficiencies.¹⁰ Based on 1,001 peer reviews issued during 1997–2003, Hilary and Lennox (2005) document that peer-reviewed auditors gain clients after receiving clean opinions and lose clients after receiving modified or adverse opinions. On the contrary, based on 545 inspection reports issued through December 31, 2007, Lennox and Pittman (2010) do not find an association between different measures of weaknesses disclosed in the PCAOB reports and subsequent changes in the inspected auditors' market share. They claim that the legislative restrictions that disallow the PCAOB from disclosing quality control criticisms and evaluative summaries of audit firms' quality control systems explain why clients do not find the inspection reports to have informational value.

However, Daugherty, Dickins, and Tervo (2011) find that triennially inspected auditors with PCAOB reports of audit deficiencies are more likely to be involuntarily dismissed by their clients, and that client firms dismissing these audit firms are more likely to hire triennially inspected audit firms with clean PCAOB reports. In addition, Abbott, Gunny, and Zhang (2013) document that clients of triennially inspected auditors are more likely to dismiss an auditor that receives a PCAOB inspection report containing GAAP deficiencies and then switch to a non-GAAP-deficient auditor.¹¹

Nevertheless, the above studies on auditor dismissals are based on inspections of U.S. auditors. Whether their results apply to non-U.S. auditors inspected by the PCAOB is an empirical question, given the differences between U.S. auditors and non-U.S. auditors in terms of audit markets in which they operate and the audit standards that they have to comply with (Bishop et al. 2013). Therefore, we examine these research questions:

• RQ1: 

  Are client firms likely to dismiss inspected non-U.S. auditors receiving PCAOB reports containing audit deficiencies? If so, are they likely to hire non-U.S. inspected auditors with clean PCAOB reports after the auditor dismissals?

U.S.-based studies also examine the association between PCAOB inspections and auditor resignations, as well as deregistration. DeFond and Lennox (2011) note that there is a fixed component in the costs of complying with auditing standards and, with a small audit fee base, small auditors are less likely to recover these compliance costs. They also argue that costs for staying registered with the PCAOB are higher for low-quality auditors because of possible costly penalties attributable to uncovered misconduct and regulatory attention as a result of the PCAOB registration process.¹² Consistent with these arguments, the authors report that 607 out of 1,233 small auditors with fewer than 100 SEC clients during 2001–2008 exited the audit market following the passage of SOX.¹³ They also find that exiting auditors exhibited lower audit quality than did small non-exiting auditors. In addition, Daugherty et al. (2011) provide evidence that triennially inspected auditors are more likely to resign from their clients and deregister with the PCAOB if they receive a PCAOB report including audit deficiencies.

Similar to U.S. small auditors, all non-U.S. auditors registered with the PCAOB are triennially inspected auditors with small SEC-registered client bases as of the end of 2012 (PCAOB 2012a; Bishop et al. 2013); consequently, their compliance costs for PCAOB inspections may outweigh the benefits of auditing U.S. SEC-registered companies.¹⁴ Therefore, non-U.S. auditors with PCAOB reports including audit deficiencies may resign from U.S. SEC-registered clients or cease to be registered with the PCAOB. Hence, given the unique nature of PCAOB international inspections, we also examine the following research question:

• RQ2: 

  Are inspected non-U.S. auditors with PCAOB reports containing audit deficiencies likely to resign from U.S. SEC-registered clients or cease to be registered with the PCAOB?

We start with 243 inspection reports of non-U.S. auditors, published between January 2006 and December 2011, for inspections completed by the PCAOB between January 2005 and February 2011. These inspection reports include 178 first-time reports, 61 second-time reports, and four other reports for KPMG Canada, which was the only non-U.S. auditor annually inspected for the sample period, for its third to sixth inspections. Part I of the inspection reports describes audit deficiencies where the PCAOB identified that the auditor failed to gather sufficient audit evidence to support its opinion on the financial statements or the client's internal control over financial reporting (PCAOB 2012c). On the other hand, Part II of the inspection reports describes deficiencies in the audit firm's overall quality control system, but only if these criticisms are not remediated within one year after the publication of inspection reports, where the PCAOB doubts reasonable assurance that professional standards related to quality controls are met (PCAOB 2012c). Among the 243 reports, 139 reports (57 percent) disclosed audit deficiencies. All of these 139 reports, except one, also identified quality control criticisms. Twenty-nine (12 percent) of the 243 reports contain only quality control criticisms, with no audit deficiencies. The other 75 (31 percent) of the 243 reports are clean, not indicating any audit deficiencies or quality control criticisms. From each inspection report, we obtain data such as the report date, the inspection start and end dates, the presence of disclosed audit deficiencies and quality control criticisms, number of offices, number of partners, number of professional staff, and number of audit clients.

Moreover, from the Auditor Change data set in the Audit Analytics database, we retrieve all auditor dismissal and resignation cases within 12 months following the publication of the PCAOB reports (up to the end of 2012). We use the 12-month window because auditor appointment decisions are typically made on an annual basis (Lennox and Pittman 2010), and it is difficult to capture direct inspection effects over one year after the publication of inspection reports because of other potential confounding factors. In addition, we gather detailed explanations for auditor dismissals and resignations from 8-K filings of U.S. issuers and 20-F filings of foreign private issuers on the SEC website.¹⁵ Finally, from the “Firms Filings” section of the PCAOB webpage, we collect foreign auditor deregistration cases up to the end of 2012 following the PCAOB inspections.¹⁶

Table 2 reports the results of auditor dismissals, resignations, and deregistration. As indicated earlier, we identify auditor dismissals within one year of the issuance of PCAOB reports. Among the 1,494 clients of the 139 non-U.S. audit firms that received PCAOB reports indicating audit deficiencies, only 23 dismissed their auditors, a rate of 1.5 percent, which is much lower than the 44.3 percent dismissal rate for the GAAP-deficient triennially inspected audit firms and the 20.5 percent dismissal rate for the GAAS-deficient triennially inspected audit firms in Abbott et al. (2013).¹⁷ These 23 clients include seven U.S. issuers and 16 foreign issuers.

Also, from the 110 clients of the 29 non-U.S. audit firms that received PCAOB reports indicating quality control criticisms only, only one auditor dismissal case was identified. Finally, we find only one auditor dismissal case among the 350 clients of the 75 non-U.S. audit firms that received clean PCAOB reports, a rate of 0.3 percent, much lower than the 17.9 percent dismissal rate for the clean PCAOB inspection report sample in Abbott et al. (2013).¹⁸

Dismissed auditors composition by country is as follows: Argentina (4 percent), Brazil (13 percent), Canada (71 percent), Greece (4 percent), and Israel (8 percent). Also, our data analysis suggests that six of the 24 clients seem to dismiss non-U.S. audit firms for reasons unrelated to PCAOB reports containing audit deficiencies. Two Brazilian clients (Energy Co. of Parana and Ultrapar Holdings, Inc.) dismissed their auditors because of a mandatory auditor rotation law in Brazil.¹⁹ One U.S. client (Gryphon Gold Corp.), one Canadian client (TransAtlantic Petroleum Ltd.), and one Israeli client (magicJack VocalTec Ltd.) reported that their auditor had rendered a going concern audit report. These three clients may have been dissatisfied with the going concern audit report and, therefore, were shopping for a more favorable audit report. One Canadian client (Revett Minerals Inc.) reported that it appointed its new auditor because it adopted U.S. GAAP. The remaining 18 clients may have dismissed their auditors as a consequence of the disclosure of PCAOB reports containing audit deficiencies. However, these clients' auditor change disclosures do not include detailed explanations for dismissals; therefore, it is possible that auditors might have been dismissed for reasons other than PCAOB reports.

In order to examine whether clients dismissing non-U.S. inspected audit firms with PCAOB reports containing audit deficiencies are likely to hire non-U.S. inspected audit firms with clean PCAOB reports, we examine whether successor auditors of the above 24 clients had previously received clean inspection reports. Only four clients (Mercadolibre, Inc., JBI, Inc., Paragon Shipping, Inc., and Ultrapar Holdings, Inc.), whose predecessor auditors received PCAOB reports containing audit deficiencies, appointed successor auditors with clean PCAOB reports. Among the remaining 20 clients, ten inspection reports for successor auditors indicate audit deficiencies and/or quality control criticisms, and the other ten inspection reports for successor auditors were not available at the engagement date. Hence, it does not appear that PCAOB reports containing audit deficiencies make much of a difference in clients' decisions to dismiss non-U.S. audit firms that received such reports.

One explanation for the low auditor dismissal rate and the low rate of switching to an auditor with a clean PCAOB report in our sample is that clients of non-U.S. audit firms may not care about PCAOB reports that contain audit deficiencies. Non-U.S. audit firms may explain to their clients that audit deficiencies identified during the inspection process are merely caused by differences in auditing standards or professional judgment. Also, clients may regard inspection reports containing audit deficiencies as a tool for improving audit quality.

Another potential explanation is related to the difficulties that clients of non-U.S. audit firms may have in finding an appropriate new auditor if the current auditor is dismissed. When considering a new auditor to replace the dismissed auditor, compared to U.S. clients, U.S. SEC-registered non-U.S. clients may have fewer alternatives, both in numbers of audit firms and also in terms of audit firms that also do not have deficiencies.²⁰ Theoretically, when a non-U.S. audit firm is dismissed, the client can switch to one of the U.S. or local auditors registered with the PCAOB. However, realistically, only large local auditors, such as Big 4-affiliated auditors and U.S. auditors with global expertise, may be able to provide audit services to U.S. SEC-registered non-U.S. clients and U.S. clients whose principal business is conducted in foreign countries. For example, in our sample, 75 (31 percent) out of 243 international inspection reports have no audit deficiencies or quality control criticisms. However, these 75 clean inspection reports were not available for some years to the public because the publication of international inspection reports had been delayed.

Table 2 shows that among the 139 audit firms (with 1,494 clients) that received PCAOB reports indicating audit deficiencies, Deloitte & Touche has resigned from three clients (MFC Industrial Ltd., Points International Ltd., and Turquoise Hill Resources Ltd., all in Canada) and KPMG has resigned from one client (Canarc Resource Corp., in Canada), all within one year after receiving a PCAOB report containing audit deficiencies. These clients' 8-K or 20-F filings did not disclose detailed explanations for the auditor resignations. Therefore, the auditor resignations followed the PCAOB reports containing audit deficiencies, but we could not find evidence that they were caused by the PCAOB reports. No auditor resignation case was identified from the 29 auditors that received PCAOB reports identifying only quality control criticisms or the 75 clean PCAOB reports.²¹ The overall resignation rate among the 1,954 clients of all auditors is 0.2 percent, lower than the 4 percent reported in Daugherty et al. (2011), which, in contrast to our study, identifies auditor resignations within only six months of receiving a deficient report.²² Non-U.S. audit firms, especially the small ones, may prefer deregistration to resignation after considering the high compliance costs of being registered; this may explain the low resignation rate in our sample.

Also, from the PCAOB webpage, we identify non-U.S. audit firms' deregistration with the PCAOB following the publication of PCAOB reports. Following Daugherty et al. (2011), we do not set an arbitrary period (e.g., one year) to collect deregistration data, because the wind-down of foreign audit operations may take several years. In addition, we do not exclude the possibility that our data-collection approach potentially includes some auditors that may have closed all operations, including their businesses in local countries (Daugherty et al. 2011). We also recognize the possibility that non-U.S. audit firms may cease auditing non-U.S. clients, but may continue to maintain PCAOB registration to signal strong audit quality (Daugherty et al. 2011). Our results indicate that by the end of 2012, 19 non-U.S. audit firms voluntarily ceased to be registered with the PCAOB after they received PCAOB reports containing audit deficiencies. Although the reasons for deregistration are not disclosed on the PCAOB webpage, deregistered non-U.S. audit firms may have compared the benefits of keeping SEC-registered clients with the costs associated with PCAOB registration. In addition, three non-U.S. audit firms voluntarily deregistered with the PCAOB after inspections began, even before the inspection reports were published. These three non-U.S. audit firms ultimately received PCAOB reports containing audit deficiencies. They may have received negative feedback from the PCAOB inspectors regarding their audit practices during the inspection process and could, as a result, have decided to deregister with the PCAOB after considering both the benefits and costs of registration. We do not find any deregistration cases for the auditors with clean reports or the auditors with quality control criticisms only. Hence, 22 out of 178 unique auditors (with 243 reports) deregistered, a rate of 12 percent, slightly lower than the deregistration rate of 15 percent reported in Daugherty et al. (2011).²³ The composition by country of the 22 deregistered foreign auditors is as follows: Australia (10 percent), Brazil (4 percent), Canada (64 percent), Hong Kong (14 percent), India (4 percent), and Israel (4 percent).

Our sample includes a total of 122 unique auditors that received PCAOB reports containing audit deficiencies—100 remain registered and 22 are deregistered.²⁴ In Table 3, we compare the characteristics of these two groups of auditors. The t-test and Wilcoxon test are used to test for statistical differences in the mean and median for each category of the characteristics. We find that deregistered non-U.S. audit firms have smaller offices, fewer partners, fewer professional staff, and fewer total professionals. However, there are no significant differences in the number of audit clients or total clients between these two groups of auditors. Therefore, the results suggest that deregistered non-U.S. audit firms have fewer resources relative to the number of clients. This observation also is supported by the higher ratio of total partners to total professionals, the lower ratio of total partners to total clients, and the lower ratio of total professionals to total clients (only the medians are statistically different) for the deregistered group.

Therefore, because of the scarce resources discussed above, it may be more difficult for deregistered non-U.S. audit firms than for registered non-U.S. audit firms to bear the compliance costs associated with registration with the PCAOB. On the other hand, large non-U.S. audit firms, including Big 4-affiliated auditors, seem to benefit from keeping SEC-registered clients while bearing the compliance costs of PCAOB inspections and, thus, choose to remain as PCAOB-registered auditors. For instance, by remaining registered with the PCAOB, registered non-U.S. audit firms may keep their reputations as global high-quality auditors in local audit service markets and, thus, attract potential global and local audit clients. In addition, Big 4 global audit firms may require their non-U.S. affiliates to remain registered with the PCAOB as a condition of remaining affiliated.²⁵

We examine whether involuntary dismissals, voluntary resignations, and voluntary deregistration of inspected non-U.S. audit firms follow negative PCAOB international inspection reports. Based on 243 PCAOB inspection reports of non-U.S. audit firms, published between January 2006 and December 2011, we find that 24 out of 1,604 clients of non-U.S. audit firms have dismissed their auditors within one year following the disclosure of audit deficiencies in PCAOB reports, and only four of these 24 clients appointed successor auditors with clean PCAOB reports. One possible explanation for these results is that, different from clients of U.S. auditors, clients of non-U.S. audit firms may not care about PCAOB reports that contain audit deficiencies. Alternatively, compared to clients of U.S. auditors, clients of non-U.S. audit firms may have more difficulties in finding an appropriate successor auditor that fits their needs if the current auditor is dismissed.

Also, we find only four resignation cases from the 1,604 clients of non-U.S. audit firms within one year after they received a PCAOB report containing audit deficiencies. Finally, 22 non-U.S. audit firms voluntarily ceased to be registered with the PCAOB either during the inspection process or after they received PCAOB reports containing audit deficiencies. Non-U.S. audit firms, especially the small non-U.S. audit firms, might prefer deregistration to resignation after considering the high compliance costs of being registered. Our results also suggest that, relative to the number of clients, the level of resources available to deregistered non-U.S. audit firms is lower than that for registered non-U.S. audit firms. Hence, the deregistration decision may have been related to the difficulties in bearing compliance costs, as a result of fewer resources.

This paper contributes to our understanding of how the audit market and inspected auditors are affected by the PCAOB international inspections. Overall, our findings suggest that the impact of PCAOB reports containing audit deficiencies on non-U.S. audit firms seems to be limited mainly to the deregistration decision of small non-U.S. audit firms with relatively scarce resources. Carcello et al. (2011a) find that investors value the PCAOB's efforts to gain access to non-U.S. auditor markets that initially deny the PCAOB inspection authority. However, our results seem to indicate that the impact of PCAOB reports containing audit deficiencies on non-U.S. audit firm changes is not significant at this point. The findings of this study provide regulators, non-U.S. audit firms, companies, and investors with insights regarding several aspects of the outcomes of PCAOB international inspections. These insights are especially important as the PCAOB is considering ways to overcome the challenges it is facing and devoting substantial resources to gain access to non-U.S. auditor markets.

Previous academic studies that examine auditor changes in the U.S. after the publication of peer review or inspection reports seem to assume random occurrence as the reason for auditor dismissals or resignations (Daugherty et al. 2011). This paper shares this limitation of research on auditor changes. Many U.S. and non-U.S. SEC registrants still have not disclosed detailed explanations for auditor dismissals and resignations (Grothe and Weirich 2007). Hence, we are not able to find evidence to support the causality between the PCAOB inspections and the subsequent auditor changes (and deregistration) in our sample. If the SEC revises its rules to require detailed disclosures of the reasons for auditor changes, the public may have a better understanding of auditor changes.

We encourage more research in PCAOB international inspections. First, our results suggest that PCAOB reports containing audit deficiencies do not seem to make much of a difference in non-U.S. auditor dismissals and resignations. As the PCAOB strengthens its regulations on international inspections in the future, PCAOB reports containing audit deficiencies may have a greater impact. Researchers can use multivariate analysis to reexamine our research questions with a larger sample of inspection reports available in the future. Second, this study only examines the auditor changes of clients that are U.S. SEC registrants. Research is needed to examine how the PCAOB reports containing audit deficiencies affect the auditor changes of local clients that are not SEC registrants. Third, we encourage researchers to examine other outcomes of international inspections, such as perceptions of financial analysts and shareholders regarding PCAOB reports containing audit deficiencies. Finally, Carcello (2010) suggests that the PCAOB focus its efforts on inspecting not only non-U.S. audit firms of U.S. issuer clients, but also non-U.S. audit firms that play a substantial role in auditing U.S. multinational companies. Multinational companies with foreign subsidiaries where non-U.S. audit firms play a substantial role in audits will be another interesting setting to examine the impact of PCAOB international inspections.