Do PCAOB Inspection Deficiencies Related to Management Review Controls Affect Financial Reporting Decisions? Evidence From Goodwill Impairments

ABSTRACT

We examine whether PCAOB inspection deficiencies related to management review controls (MRCs) affect financial reporting decisions. Using the goodwill impairment setting, we find that firms are more likely to record goodwill impairments when their auditors have received more PCAOB inspection deficiencies related to goodwill MRCs. The association is stronger when inspection deficiencies are more likely to lead to changes to the design or implementation of an internal control (repeat deficiencies and deficiencies related to MRC precision). We observe some evidence that MRC inspection deficiencies increase the likelihood of goodwill impairment even when unrelated to goodwill, indicating that improving the audit of MRCs can broadly affect financial reporting. Our findings provide evidence that PCAOB inspections affect not only auditor behavior but also the financial reporting behavior of audit clients. Specifically, inspection feedback appears to influence reporting outcomes through changes in the audit and evaluation of MRCs, identifying a channel through which regulatory oversight affects issuers. The results have implications for audit firms seeking to remediate inspection deficiencies, for management and audit committees responsible for overseeing significant estimates and impairment analyses, and for regulators evaluating the broader effectiveness of the PCAOB inspection process.