Auditing Standards and Boards’ Decisions about CEO Risk-Taking Incentives: Evidence from the PCAOB’s Proposed Amendment to Auditing Standard No. 12

Abstract

We exploit a proposed amendment by the Public Company Accounting Oversight Board (PCAOB) to Auditing Standard No. 12 (AS12) to examine its effect on CEOs’ risk-taking incentives. Using a difference-in-differences design, we find that clients with an overlapping director on both the compensation and audit committees, which facilitates greater information sharing, decrease risk-taking incentives relative to control clients following the proposal. We argue that the shared information involves the increased salience of risk-taking incentives to audit committees, who convey a corresponding concern regarding financial reporting consequences to the compensation committee. In additional analysis, we fail to find statistically or economically significant evidence that auditors react to the proposed modification of AS12. Overall, our results are consistent with an unintended consequence of PCAOB standard setting. That is, although the PCAOB asserted that the modification should not impact the design of compensation arrangements, we find evidence that it did. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M12; M42.