Abstract
I investigate the effects of the issuance of the PCAOB Part II report on audit fees and audit quality. The PCAOB replaced the peer review auditor program with an independent inspection of audit firms. Upon completion of each inspection, the PCAOB issues inspection reports that include a public portion (Part I) of identified audit deficiencies, and most include a nonpublic portion (Part II) of identified quality control weaknesses which is not disclosed publicly unless the audit firm does not sufficiently complete remediation during the next 12 months. Upon issuance of the Part II report, I find that audit firms experience reputational damage resulting in a decrease in audit fees. I also find that though audit fees decrease, audit quality increases as the audit firms increase their efforts to remediate the quality control issues identified in the Part II report in an effort to comply with the expectations of the PCAOB. In summary, my results indicate that there is an associated cost to audit firms when they are unable to remediate their control deficiencies within the 12 month remediation period as well as an associated benefit for the audit clients who decide to remain with the audit firm after the issuance of the Part II report, as they not only are able to negotiate lower audit fees but also receive higher audit quality for those lower fees.