The Economic Consequences of Audit Firms’ Quality Control System Deficiencies

This study investigates the association between the largest audit firms’ internal organization and audit quality and efficiency. Using a unique dataset of firm-wide deficiencies in the quality control (QC) systems identified by the PCAOB during its inspections of audit firms, I find a negative association between firm-level QC deficiencies and audit quality. Furthermore, audits conducted by audit firms with more organization-level deficiencies are less efficient, as evidenced by more hours worked on the engagements, despite audit fees remaining unchanged. These results appear to be partly driven by deficiencies in the tone at the top (a proxy for culture) and the audit methodology. In contrast, audit firms with more deficiencies of a practical nature (audit performance issues) do not appear to spend enough effort on their audit, consistent with a “shirking” hypothesis. Overall, these results suggest that while both practical-level and organization-level deficiencies negatively influence audit quality, their root causes are different. In particular, audit firms may have the possibility to improve their profits once they remediate the organization-level deficiencies identified by the PCAOB.