Audit the Auditors: Commitment versus Professional Judgment

Abstract

This paper provides a theoretical framework to evaluate the trade-off between the self-regulated peer review system and independent government inspection (PCAOB) in the auditing profession. We model the peer review system as a Judgment Regime, where a stakeholder utilizes professional expertise, captured as a private signal, to make ex-post decisions on verifying audit failures. In contrast, PCAOB inspection is modeled as a Commitment Regime, where the stakeholder lacks private information but can commit ex-ante to a predetermined level of verification. We find that the Judgment Regime benefits from a resource-allocation effect and a deterrence effect driven by informed verification, whereas the Commitment Regime deters audit failures through the first-mover advantage of ex-ante commitment. Our analysis demonstrates that the stakeholder prefers the peer review system if and only if the private signal is sufficiently informative. Furthermore, comparative statics reveal that higher verification costs or stronger audit incentives shift the stakeholder's preference toward PCAOB inspection.