Washington is famous for the revolving door – the practice of professionals serving some time in government and then going to work for the industry that they were previously in charge of regulating. But is that a bad thing? A recent academic study presents evidence that former PCAOB employees bring with them expertise that is beneficial for audit quality.
In Does audit firm hiring of former PCAOB personnel improve audit quality?, a paper published in the Review of Accounting Studies, Jagan Krishnan (Temple University), Jayanthi Krishnan (Temple University), and Steven A. Maex (George Mason University) examine whether large audit firm hiring of PCAOB employees firms is associated with subsequent higher audit quality at these firms. They find that adding staff with PCAOB experience reduces the likelihood that the firm will fail to detect material misstatements or will issue an incorrect opinion on internal control over financial reporting:
“[F]inancial restatements and Big R restatements are negatively associated with regulatory audit quality expertise, consistent with the expectation that the revolving door hires can help identify and address audit deficiencies in areas of high misstatement risk. * * * We find that internal control audit quality improves (i.e., internal control audit opinions become more accurate) as regulatory audit quality expertise increases but only for high misstatement-risk clients. * * * Overall our tests suggest that regulatory audit quality expertise benefits both financial statement and internal control audit quality for clients prone to significant misstatement risk.”
The revolving door between accounting firms and the PCAOB has been controversial, not because of doubts about whether it potentially benefits firm audit quality, but because of the possibility that former PCAOB employees could illicitly provide their new firm with confidential information regarding the Board’s inspection program. In 2018, two former PCAOB inspections staff members who had joined KPMG were criminally charged with participation in a scheme to misappropriate and use confidential PCAOB inspection plans to aid KPMG in improving its inspection results.
While the audit committee should certainly take an interest in the professional background of senior members of the engagement team, in practice the presence of PCAOB alumni on an audit firm’s staff is not a basis for differentiating between the major firms, since almost all of them engage in such hiring. According to a table in the study, beginning in 2014, nine of the ten largest U.S. accounting firms had at least one ex-PCAOB employee on their staff (the exception was Marcum). By 2016, the last year included in the study, the six global network firms each had at least seven former PCAOB employees, while one firm (EY) had 19 alums.