The PCAOB's Interests in and Use of Auditing Research

Date: Jan. 15, 2016

Speaker: Jeanette M. Franzel, Board Member

Event: American Accounting Association, 2016 Auditing Section Mid-Year Meeting

Location: Scottsdale, AZ

Today I participated in a panel session entitled, "Opportunities for Researchers to Inform the PCAOB," at the Mid-Year Meeting of the Auditing Section of the American Accounting Association (AAA).

The panel discussed opportunities for academics to inform PCAOB policy and decision making through research and other collaborative opportunities with the PCAOB.

Recent initiatives at the Board seek to advance research related to the role of auditing in the capital markets. These initiatives have created new opportunities to enhance PCAOB's collaboration with the academic community in ways that further the public interest in auditing to protect investors.

I am publishing this statement to provide a broader distribution among the academic community of this information about the PCAOB's interests in and use of auditing and related research.

I start by recognizing PCAOB's evolving relationship with academia over the past decade of transformation in audit oversight, which has coincided with some changes in the direction of auditing research within the academic community. I then offer a brief summary of several PCAOB initiatives aimed at promoting relevant research and enhancing our use of research in our audit oversight activities.

As a guide to academics interested in conducting research of interest to the PCAOB, I set out a more detailed description of the operational aspects of PCAOB's role and interests in auditing research. Finally, I suggest some opportunities to further PCAOB's recent initiatives to more efficiently and effectively foster relevant research.

The views expressed are my own, and do not necessarily reflect those of the PCAOB Board, individual Board members, or staff.

PCAOB's Historical Relationship with Academia

The establishment of the PCAOB in 2002 and the commencement of PCAOB operations in 2003 marked a significant change in the environment for academic research related to auditing.

A brief summary of the PCAOB's relationship to academia provides a useful frame of reference for considering the direction of the Board's current initiatives and our mutual interests with the academic community.

There is a rich history of academic and other research on topics related to accounting and auditing practice and theory. As the PCAOB assumed the role of public company audit regulator in the U.S. capital markets, the Board identified a number of areas where research could help us diagnose problems facing the profession and understand the potential relationships among and impacts of different auditing and regulatory practices. The PCAOB established close ties to the academic community, actively exchanging information related to PCAOB's mission and standard-setting activities and related needs for research.

In fact, two prominent academics established PCAOB's standard-setting and research functions. PCAOB's first Chief Auditor, Doug Carmichael, had a long and distinguished career in academe prior to joining the PCAOB in 2003. Another distinguished academic, Gary Holstrum, joined PCAOB in 2003 as Associate Chief Auditor and Director of Research.

The PCAOB held its first annual academic conference in 2004 and worked with the Executive Committee of the Auditing Section of the AAA to establish an unprecedented project — nine teams conducted syntheses of existing research that addressed issues faced by the Board in formulating its auditing standards and other issues brought up by the PCAOB's Standing Advisory Group (SAG). Since then, the PCAOB and the AAA have maintained a working relationship, holding 11 annual academic conferences (coordinated by the PCAOB Office of the Chief Auditor), and undertaking a second project to synthesize existing research on topics relevant to PCAOB standard setting.^[1]

The PCAOB also has continuously appointed academics to its SAG and Investor Advisory Group (IAG) to provide advice and input to the Board on establishing professional standards and on investor protection. In addition, academics have provided input into policy discussions through their participation in PCAOB public meetings and conferences. PCAOB Board members and staff also participate in various AAA and other academic conferences to exchange information about pending policy issues and ongoing research projects.

In December 2009, the PCAOB announced the establishment of an Academic Fellowship Program to assist the Board's Office of Research and Analysis (ORA), which has resulted in three successive academic fellowships involving accounting professors.^[2] The Academic Fellows complemented the staff of accountants, analysts, and researchers in ORA, which evaluates current trends and developments affecting audit firms and their audit clients, monitors academic research on the auditing profession, and analyzes information derived from PCAOB inspections.^[3]

In turn, changes in oversight of the auditing profession and other capital market developments have provided an impetus for new research. A recent archival review of auditing research noted "a surge in research that seeks to better understand the drivers of audit quality."^[4]

Coinciding with PCAOB's establishment of its oversight programs and building of a working relationship with academics, the accounting and auditing profession also has invested significant effort in self-reflection on the approach, quality, and relevance of auditing research, as reflected in the 2008 report of the U.S. Department of the Treasury's Advisory Committee on the Auditing Profession (ACAP).^[5] The ACAP called for more interaction between academia and the profession.

During its study, the ACAP also heard concerns regarding the unavailability of data related to auditing practice and the potential for a decline in auditing research and doctoral students specializing in auditing if such data is not available for research and study.^[6]

In response, the AAA, the American Institute of Certified Public Accountants, and the Center for Audit Quality (CAQ) engaged stakeholders in efforts to study these matters and improve auditing research. These efforts included the establishment of the CAQ's Research Advisory Board in 2008 and the Pathways Commission in 2010.

I understand that the academic community has recently examined questions about the approach and focus of archival auditing research. For example, in late 2014, in light of "changes of unprecedented magnitude [that] have fundamentally altered the audit market landscape for both auditors and their clients," several academics engaged in a debate over the nature, quality, and future direction of empirical research into audit quality.^[7]

Some academics have recently sought to stimulate research using a range of methodologies, or re-engaging with underused methodologies, that start their inquiries with expectations from within accepted theoretical frameworks. For example, some have sought to publish an organized collection of research synthesis review papers by "positioning each review within an appropriate theoretical framework," according to relevant auditing themes.^[8] In the view of these academics, such an approach will stimulate researchers to produce "a body of research that is coherent and generalizable and will help to overcome some of the limitations of existing research."^[9]

Also, in a recent Research Forum on Qualitative Studies in Auditing, academic commentators suggested a methodological framework for qualitative research in accounting and auditing, noting, "The practice and problems of auditing are a source of continuous curiosity and fascination to scholars, and necessarily amenable to many different kinds of investigation."^[10]

And on a broader note, the Pathways Commission identified in its 2012 report a number of pressures, institutional biases, and trends faced by academics that could impede innovation in research techniques and inhibit publication of practice-oriented research.^[11]

Needless to say, the PCAOB and the academic community have been working in a challenging environment while building an effective and productive working relationship.

As a new organization, the PCAOB was going through its own growing pains while establishing new regulatory programs that needed the benefit of solid research relevant to audit quality and audit firm oversight. At the same time, the academic community seems to be exploring a need for changes in the approach to auditing research.

In my view, the PCAOB and the academic community have worked remarkably well together during these challenging circumstances. The academic community has provided great value and insights to the PCAOB during the development of our programs and activities to oversee the audits of issuers and broker-dealers.

Academic research in critical areas has contributed to the establishment of PCAOB's standards and oversight activities during the first 12+ years of operations, and will continue to be valuable as we examine the critical issues impacting audit quality in the future and pursue the many items on our standard-setting and oversight agenda.

Recent PCAOB Initiatives to Promote Audit-Related Research

In 2012, the PCAOB articulated near-term priority initiatives that each involved contributions from academia in addition to internal PCAOB research. These included a project to identify measures of audit quality, an investment in improving the analysis of inspection findings to better understand audit quality, and an effort to enhance the effectiveness of PCAOB's framework for standard setting.^[12]

In late 2013, the PCAOB announced the establishment of its Center for Economic Analysis to study the role and relevance of the audit in capital formation and investor protection.^[13]

Details about the Center's mission and operations and how it would interface with the accounting and auditing academic community have taken some time to develop. The Center began operations in 2014 with a staff of economists, accountants, researchers, and economic research fellows. In 2015, the PCAOB transferred all of its other staff economists who provide support for standard setting into the Center.^[14] The Board also approved the mission of the Center, "to study and advise the Board and PCAOB staff on the role of the audit in capital formation and investment protection and how economic theory and analysis can be used and further developed to enhance the effectiveness of PCAOB programs."^[15]

The Center works to integrate economics and rigorous data analysis across the entire range of PCAOB programs, including standard setting, inspections, enforcement, and risk assessment. The Center's activities include:

• Fostering economic research on audit-related topics, including the role and relevance of the audit in capital markets;
• Preparing economic analysis to inform standard setting and other PCAOB rulemaking; and,
• Developing empirical tools for use in PCAOB oversight programs.

The PCAOB's new strategic plan articulates eight discrete strategies to support the Board's objective of "[using] the Center to enhance the use of economic analysis, empirical tools and analysis throughout PCAOB programs."^[16] The strategic plan also now includes measures to track some of the activity in these areas.^[17]

The Center has become the primary vehicle through which the PCAOB seeks to enhance its role in and meet its needs for auditing and related research.

PCAOB's Role and Interests in Auditing Research

The PCAOB's interests in high-quality auditing research are manifold. As stated on the Center's public webpage, "High quality, independent academic research on audit-related topics, including the role and relevance of the audit in capital markets, informs the PCAOB in its oversight activities and provides evidence regarding the possible outcomes of policy decisions."

The PCAOB continues to have an interest in a multitude of interdisciplinary issues raised by our standard-setting activities. All of the PCAOB's oversight functions benefit from research that promotes insight and understanding of the impact of PCAOB oversight and rules on auditing, financial reporting, and the broader capital and financial markets.

And cutting across all of these is an interest in a deeper understanding of audit quality, its proxies and measurement, as demonstrated by our Audit Quality Indicators (AQI) project and enhanced analyses of inspections findings.

To realize these interests in research, the PCAOB has undertaken a number of new initiatives involving (to borrow a phrase from the SEC's Chief Economist) both the contribution to and consumption of current research.^[18]

Fostering research

The Board engages with academics and other researchers through its fellowship programs, annual conferences with academics, internal PCAOB seminars, and PCAOB advisory groups and public meetings. Of course, the Board continues to engage with academics through interactions at conferences, such as this one, and other formal and informal meetings.

The Board's initiatives and activities over the years have provided academics with opportunities to explore new research topics and techniques, using newly available information and data from PCAOB oversight activities to study issues related to public company auditing and audit quality. This research, in turn, helps to inform PCAOB policy making.

Fellowship Programs

The Center conducts an Economic Fellowship Program and is authorized to continue the Board's previously established Academic Fellowship Program.

The Center currently has a budget for up to four economic research fellows, with three fellows currently on board. The staff publishes a call for applicants once a year on the PCAOB website (in the mid-fall timeframe), the AAA career web page, as well as the job openings listings from the American Finance Association and the American Economic Association, and various relevant journals of SSRN (Accounting Research Network, Financial Economics Network, Economics Research Network, Legal Studies Network). In addition, PCAOB staff reaches out to members of the AAA Auditing Section via the section's listserv, with the help of the section president (thanks to Chris Hogan on this most recent round).^[19]

The unique benefit of the Economic Fellowship Program is the opportunity to conduct original, publishable research using PCAOB's proprietary data, much of which is subject to statutory confidentiality restrictions.^[20]

The Board continues to consider other ways to make that data available to researchers, and I want to express my appreciation to the AAA leadership for making constructive suggestions.

PCAOB's current call for applicants for the 2016-2017 academic year lists the following 10 topical areas for research interest to the PCAOB:

• the role of the audit in capital formation and economic growth;
• applications of regulatory economics to auditing;
• the market impact of audit regulation and oversight;
• the industrial organization of the audit profession;
• economic and social incentives in the audit profession;
• the role of the audit in promoting access to public markets for small enterprises;
• the effects of audit and financial reporting failures on financial markets;
• the effects of multi-layered principal-agent relationships present in auditing;
• applications of behavioral economics to auditing and financial reporting; and,
• proxies for and indicators of audit quality and their potential usage and impact.

Applicants must submit, among other things, at least one research proposal, although we encourage applicants to submit more than one. The above categories of topics are intentionally broad so that researchers can select specific topics of interest for their research proposals. We've also found that the research fellow's proposals evolve after they have the opportunity to learn more about the PCAOB data available to them.

Economic Fellows have an opportunity to publish their research under their own name (disclaimed by the PCAOB). For example, the independent research conducted by PCAOB fellows has generated several working papers that may be submitted by the fellows for publication.^[21] In addition to publication, fellows have access to PCAOB staff and Board members, and the opportunity to gain an understanding of the regulatory process, gain firsthand experience with the PCAOB's emphasis on audit quality and investor protection, and participate in the PCAOB's goal of fostering high-quality research.

Annual Conferences

The PCAOB continues to hold a two-day annual meeting in conjunction with the AAA Auditing Section (previously known as the Academic Conference) to exchange information and ideas on matters of mutual interest. This spring, we plan to hold our 12^th PCAOB/AAA annual meeting in Washington, DC.

And two years ago, our Center began to host an annual, invitation-only Conference on Auditing and Capital Markets, organized in conjunction with the Journal of Accounting Research. The conference, attended by researchers from around the world, promotes academic research that studies the economic impact auditing has on capital markets. The goal is to consider the characteristics of an audit, audit firms and the structure of the audit market in order to help inform the work of regulators.

The PCAOB issues a call for papers in advance of the conference, which includes a list of topical areas of interest.^[22] Papers submitted to the conference are reviewed by a program committee organized by the Center, and those selected for presentation are discussed in a panel format with one or more discussants, typical of academic conferences.

Seminars

In addition, the Center invites various academics to present ongoing or published research to the Board and PCAOB staff at internal seminars. The Center selects topics and research of interest (and availability) to PCAOB programs and activities.

These seminars offer various benefits to all participants, primarily the shared insights and feedback on data sources and limitations, research techniques, and related policy implications.

The Center has conducted 10 seminars since it began this program, including eight in calendar year 2015 that covered topics ranging from behavioral research, including fraud, to corporate governance, auditing research, and the economic effects of regulation in the capital markets.

PCAOB Advisory Groups and Public Meetings

The Board continues to engage with academics in other formal venues, including through its SAG and IAG meetings and periodic public meetings on a range of topics. Academics who serve as members of PCAOB advisory groups contribute in a variety of ways, with all the privileges of full membership in these collegial bodies.

In addition, the Board often calls on academics to present papers or lead discussions in more depth on topics of particular interest. For example, in a November 2014 meeting, the SAG heard two panel discussions of academics on the topic of fraud.^[23] The Board also often invites academics to participate in public meetings on particular topics, such as the presentations by academics at the Board's April 2014 public meeting on the auditor's reporting model[24] and the Board's October 2014 meeting on auditing accounting estimates and fair value measurements.^[25]

Research in Support of PCAOB Economic Analysis and Policy Making

High-quality research is essential to inform PCAOB's economic analysis and policy making, each of which involves discrete processes, tools, and skills. Both activities benefit from the use of original research (and critical surveys and syntheses of such research), both published and internal.

For economic analysis in rulemaking, the PCAOB staff developed and follows guidance modeled on that used by federal agencies.^[26]

As the SEC's Chief Economist noted recently, "The economic analysis of a rule's impact is a specific type of research question — a question to which we should apply the most current tools available.… We routinely draw on the academic literature to provide us with deeper understanding of market issues."^[27]

High-quality academic research can provide valuable input to the four basic elements in standard economic analysis for rulemaking: (1) understanding the nature, extent, and impact of any problems with audit practice (or, to frame the question in economic terms, "market failures"); (2) defining the existing "baseline" of regulation and market or practice conditions; (3) considering reasonable alternatives to solving a stated problem; and (4) evaluating the potential impacts of alternative policy actions.^[28] PCAOB has a dedicated staff of economists (with PhDs in economics, finance, or accounting) to conduct economic analysis that involves analyses of public and nonpublic data and review of the literature on such matters.^[29]

In the area of broader policy-making analysis, the PCAOB draws on a range of approaches to analysis and research, including use of traditional quantitative and statistical analyses, as well as program performance evaluations and other operations assessment tools.^[30]

The staff continues to develop approaches to analyzing PCAOB's oversight programs using such techniques, but, as with formal economic analysis in rulemaking, this also often involves the use of the published research literature. PCAOB staff regularly review the significant body of growing literature on the impact of PCAOB inspections on auditor behavior and the capital markets more broadly and topics that are relevant to our inspections and other oversight activities.

When considering published literature in its economic analysis and other policy making, PCAOB staff generally looks for a consensus in the literature — a sense that the literature over time, based on various methodologies, sources of data, researchers, etcetera, supports a given proposition.

PCAOB staff use their own expertise to determine whether the methodology is sound, the hypothesis is supported by the methodology, the data are relevant, and the authors are credible.

As those who follow the PCAOB's rulemaking process have undoubtedly observed, the Board's public releases that accompany each rulemaking have increasingly incorporated discussions of economic impacts of the rulemaking and cite relevant academic literature and other internal research.

In addition, the Auditing Standards Committee of the AAA, as well as individual academic researchers, regularly provide comments on PCAOB's standard setting and other rulemaking actions.^[31] Often these letters provide references to relevant research and sometimes include reviews of the literature relevant to particular issues or questions raised by the proposals. This highlights for us potential relevant inferences that may be drawn from the literature.

The PCAOB staff advises academics and others interested in pursuing research topics of interest to PCAOB's standard-setting and other oversight programs to monitor such public developments and periodically survey the PCAOB's website for updates.

I support developing a more structured process for providing information to academic researchers about research questions that would be relevant and useful for informing our oversight programs over time.

Opportunities to Further Advance PCAOB's Initiatives

As the PCAOB's vision and strategy for contributing to and consuming research continue to evolve, there are some additional opportunities to more efficiently and effectively foster research into areas of direct relevance to the PCAOB. I offer five concrete suggestions, and I invite today's conference participants to offer other feedback and other suggestions as well.

The PCAOB's initiatives should foster relevant research without supplanting the role of academics in reviewing the literature and independently developing new and innovative research questions and methods.

• With this in mind, I believe that the Board could engage in a more structured process of reviewing its oversight programs to identify and publish specific topics and questions that may be suitable for research that would help inform standard setting and all other PCAOB oversight programs.
• Because the viability of a research question, and of potential methodologies, depends on the availability of reliable data, the PCAOB should continue to look for ways to share information about the inventory of the categories and structure of its proprietary data that could be used for research purposes.
• As the academic community deliberates over the appropriate framework for understanding the direction of archival auditing research — and as the PCAOB enhances its processes for economic analysis -- PCAOB staff could, like the SEC staff, publish white papers describing relevant economic and auditing theories and the state of the literature on particular topics. Such publications could provide a framework not only for guiding original research, but also could articulate the relationship between original research and the unique discipline of PCAOB economic analysis.
• Likewise, the PCAOB could summarize and synthesize the results of its conferences, seminars, and other deliberations over ongoing research. Dissemination of such information could benefit the academic community, investors, and other regulators around the world as they address their own needs.
• Finally, I'd like to see a regular and predictable mechanism in place for interacting with the academic community and communicating about the above issues, so that we can continue to evolve and develop the productive working relationship between PCAOB and academia to achieve the goals of advancing research to inform regulation that advances audit quality, protects investors, and promotes confidence in the capital markets.

Conclusion

The investments and organizational changes undertaken by the PCAOB in the area of economic analysis and research are substantial. Likewise, the continued focus by academics on innovation and rigor in research on audit quality and investor protection continue to be impressive.

It is now time to build on this strong foundation and on previous successes to form a clear, long-term strategy aimed at meeting our mutual goals of reliable, relevant, and rigorous research to inform regulation that promotes reliable auditing and investor protection, while inspiring the future generations of practitioners and academics in the field of auditing.

By addressing the opportunities I suggested, and possibly others, and by providing more transparency about PCAOB's research needs and activities under such a strategy, we can leverage the power of independent academic research to advance the regulation of auditing in the capital markets.

I will be happy to personally work with the Auditing Section of the AAA and other representatives of academia to help move forward with these goals.

Thanks for all that you do to educate future members of the profession while conducting research to help advance the integrity and reliability of financial reporting and auditing.

I look forward to continuing to work with the academic community as PCAOB continues to advance its mission into the future.