Deconstructing the PCAOB: Using organizational economics to assess the state of a regulator

Using the principles of organizational economics in this study we assess the quality of the organizational architecture of the Public Companies Accounting Oversight Board (PCAOB). In particular, we use the Four Pillar Framework developed in Brickley et al. (2000) to understand why—according to the SEC’s Chairman Gensler and other stakeholders—the PCAOB may not have entirely realized its mission of investor protection. Our analysis is enabled by the transcripts of the 2019 criminal trial U.S. vs. Middendorf and Wada (i.e., PCAOB-KPMG “steal the inspection data” scandal), which for the first time exposed the inner workings of the PCAOB. Our analysis of the transcripts is augmented by other publicly available documents. Our primary conclusion is that the functioning of the PCAOB has been significantly hampered by misalignment of its tasks (in particular in relation to the SEC), sub-optimally designed performance measurement and employee compensation, and weaknesses in the PCAOB’s organizational culture. These misalignments created an environment susceptible to PCAOB employee criminal misconduct which enabled the PCAOB-KPMG “steal the inspection data” scandal and other Board governance and leadership challenges

Economic Consequences of Auditor Reputation Loss: Evidence from the Auditor Inspection Scandal

We examine whether the 2017 audit inspection scandal affected KPMG's client relationships and audit quality. Using the trial transcripts, we construct a novel dataset of KPMG clients whose audit engagements were compromised by information leakage from the PCAOB (Transcript Sample). We then examine KPMG's response to this regulatory data theft scandal. Our findings suggest an increased departure rate following the public revelation of the scandal of clients in the Transcript Sample but not in the broad portfolio of KPMG clients. While KPMG's audit fees do not appear to have changed, we find a reduction of KPMG's non-audit fees, which is concentrated in the Transcript Sample clients. Finally, we find that the quality of loan loss provisions of banking clients in the Transcript Sample decreased after the scandal. Overall, our results suggest the audit inspection scandal has imposed costs on both KPMG and its PCAOB-inspected clients whose identities were exposed