The Influence of PCAOB Inspections on Audit Committee Members' Judgments

ABSTRACT

This paper experimentally examines whether the likelihood of a Public Company Accounting Oversight Board (PCAOB) audit engagement inspection can moderate the negative incentives created by short-term stock option compensation on audit committee members' decisions. Prior research suggests that short-term option compensation may weaken audit committee member objectivity and oversight quality (Archambeault et al. 2008; Magilke et al. 2009; Keune and Johnstone 2010); however, holding individuals accountable for their actions has been shown to result in less self-serving decisions (Rus et al. 2012). Ninety-two Executive M.B.A.s, serving the role of audit committee members, evaluate a hypothetical audit case that involves a dispute between management and the external auditors, with likelihood of PCAOB inspection and type of compensation manipulated between participants. Results confirm prior research on option compensation, finding that participants show less support for recording a proposed income-reducing audit adjustment when compensated primarily with short-term options rather than cash. In addition, a significant interaction reveals that PCAOB inspection likelihood moderates the effect of compensation form, such that option compensation only causes audit committee members to not recommend recording the proposed adjustment when PCAOB inspection likelihood is low. These results allow stakeholders to gain valuable insights into ways in which loyalties that have been potentially misaligned may be realigned by regulatory requirements aimed at improving the corporate governance process.

Keywords:  audit committees, PCAOB inspection, audit committee compensation, proposed audit adjustments, corporate governance

Source : Julie S. Persellin (2013) The Influence of PCAOB Inspections on Audit Committee Members' Judgments. Behavioral Research in Accounting: Fall, Vol. 25, No. 2, pp. 97-114.