Do regulator inspections of audit firms discern audit quality? Evidence from Korean regulator inspections

Abstract

During the past decade, many countries have adopted a regulatory inspection program to oversee the auditing profession. In general, the inspection programs consist of two components: evaluation of accounting firms' quality control systems and review of selected audit engagements. This study examines whether quality control system deficiencies and audit engagement deficiencies identified in the inspections reflect the audit quality of accounting firms using the data from Korean regulator inspections. We find that both quality control system deficiencies and audit engagement deficiencies reflect the audit quality of the accounting firms under inspection. Our findings also suggest that quality control system deficiencies discern the audit quality of accounting firms better than audit engagement deficiencies. Our results are robust across audit quality measures and auditor size. This study expands the literature by providing evidence about quality control system deficiencies and providing evidence for more comprehensive measures of audit quality.