While it’s well documented that Public Company Accounting Oversight Board (PCAOB) inspections improve audit quality for the inspected audit firms, it remains unclear whether the positive effect of PCAOB inspections extends to the non-inspected audit firms. This paper examines whether there is an increase in audit quality for the non-inspected member audit firms in non-Big 4 international accounting associations and networks (AANs) following the initial PCAOB inspection of the first member firm within the same AAN.

Using a difference-in-differences research design, I find that client companies audited by the non-inspected member firms exhibit an improvement in audit quality after the first member firm within the same AAN undergoes the initial PCAOB inspection. This improvement is more pronounced for client companies in the same industries as those of the first inspected member firm and in AANs in which the average distance between the first inspected member firm and other member firms is shorter, supporting the knowledge transfer mechanism. An additional analysis reveals that subsequently inspected member firms receive fewer deficiencies in their inspection reports than the first inspected member firm within the same AAN, suggesting that knowledge sharing by the first inspected member firm results in more favorable inspection outcomes for subsequently inspected member firms within the same AAN.

Furthermore, I find evidence supporting the notion that audit clients perceive the non-inspected member firms to benefit from knowledge sharing by the first inspected member firm within the same AAN. Specifically, I find that the non-inspected member firms experience an increase in auditor market share after the first member firm within the same AAN undergoes the initial PCAOB inspection. The increase is larger for the non-inspected member firms with similar client industry profiles as the first inspected member firm in the same AAN and in AANs in which other member firms are geographically closer to the first inspected member firm.

Cross-sectional analyses indicate that the improvement in audit quality for the non-inspected member firms is larger (1) when the non-inspected member firms have stronger incentives to improve audit quality, (2) when the first inspected member firms are more influential in the AANs, and (3) when the first inspected member firms experience larger improvement in audit quality following PCAOB inspections. I also show that the effect of PCAOB inspections on increasing audit quality for the non-inspected member firms holds across various settings, including both PCAOB-registered and non-registered audit firms, and is robust to a battery of robustness checks.

Overall, this paper uncovers a novel positive externality of PCAOB inspections on the non-inspected audit firms affiliated with the same AANs as the inspected audit firms and provides stronger evidence on the knowledge transfer within AANs.