Quality control system criticism raised by the Public Company Accounting Oversight Board in non‐US jurisdictions and earnings quality of non‐cross‐listed clients

• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/ijau.12123

ORIGINAL ARTICLE

Quality control system criticism raised by the Public Company

Accounting Oversight Board in non‐US jurisdictions and

earnings quality of non‐cross‐listed clients

Christophe Van Linden

1

|Tatiana Mazza

2

1

Jack C. Massey College of Business, Belmont

University, Nashville, TN, USA

2

Free University of Bozen, Bolzano, Italy

Correspondence

Christophe Van Linden, Jack C. Massey

College of Business, Belmont University,

Nashville, TN 37212, USA.

Email: christophe.vanlinden@belmont.edu

Funding information

Limperg Institute; Belmont University; KU

Leuven

This study investigates the association between Public Company Accounting Oversight

Board (PCAOB) inspection‐related criticisms of an accounting firm's system of quality

control and earnings quality of non‐cross‐listed clients in non‐US jurisdictions. We also

assess whether this association is different in subsamples where a local independent

inspection regime is present compared with jurisdictions without such a regime. We

use a difference‐in‐difference design to assess changes in accruals quality in pre‐and

post‐inspection periods. Our sample includes 2006–2011 data on first‐time, interna-

tional PCAOB inspections of Big 4 accounting firms in 19 countries. Our findings indi-

cate that earnings quality improvement of non‐cross‐listed clients after international

PCAOB inspections is higher for inspections with (versus without) PCAOB‐detected

deficiencies of the system of quality control. We also find that this improvement occurs

in countries with independent oversight of the audit profession.

KEYWORDS

Earnings management, public accountingfirms, regulation

1|INTRODUCTION

Since the start of its inspection program in 2005, the Public Company

Accounting Oversight Board (PCAOB) has conducted inspections not

only of accounting firms in the USA but also in more than 40 non‐

US jurisdictions wherein accounting firms audit clients that are

cross‐listed on a stock exchange in the USA (PCAOB, 2013). These

inspections investigate (i) the work performed by the accounting firm

for a sample of Securities and Exchange Commission (SEC)‐registered

clients (part I in the inspection report) and (ii) the effectiveness of the

quality control system (QCS) of the accounting firm (part II in

the inspection report). We examine herein the spillover effect of

QCS‐related criticism associated with first‐time international PCAOB

inspections of QCSs of accounting firms and earnings quality of non‐

cross‐listed clients in non‐US jurisdictions. We also investigate

whether the relation is different in jurisdictions where an independent

domestic inspection regime is in place compared with jurisdictions

without an independent regime.

Prior literature documents a relation between international PCAOB

inspections and earnings quality of cross‐listed clients (e.g., Krishnan,

Krishnan, & Song, 2017) and non‐cross‐listed clients (e.g., Fung, Raman,

& Zhu, 2017; Shroff, 2015). Fung et al. (2017) empirically demonstrate

positive externalities of initial international PCAOB inspections

on audit quality of non‐cross‐listed clients. They investigate the

externality on earnings quality of non‐cross‐listed clients without

taking into account inspection outcomes as reported in inspection

reports. They compare the change in earnings quality of non‐cross‐

listed client portfolios of audit firms inspected by the PCAOB with

the change in earnings quality of a noninspected control group of

non‐cross‐listed clients. Their study concludes that improvements in

earnings quality after initial PCAOB inspections are higher for the

client portfolio of audit firms that were inspected relative to

the noninspected portfolio. We extend this stream of research by

analyzing differences in inspection outcomes of first‐time interna-

tional PCAOB inspections based on inspection reports. In particular,

we investigate whether (i) the remediation of the QCS‐related

deficiencies described herein (i.e., raised by the PCAOB during

international inspections) is associated with earnings quality for non‐

cross‐listed client portfolios and (ii) the presence of a local inspection

regime has an influence thereon.

Received: 10 October 2016 Revised: 26 April 2018 Accepted: 2 May 2018

DOI: 10.1111/ijau.12123

374 © 2018 John Wiley & Sons Ltd Int J Audit. 2018;22:374–384.wileyonlinelibrary.com/journal/ijau