Auditing Section Research Summary Database

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  • Jennifer M Mueller-Phillips
    Shareholder Voting on Auditor Selection, Audit Fees, and...
    research summary posted September 12, 2013 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 13.0 Governance, 13.06 Board/Audit Committee Processes in Auditing Section Research Summaries Space public
    Title:
    Shareholder Voting on Auditor Selection, Audit Fees, and Audit Quality
    Practical Implications:

    The U.S. Department of the Treasury’s Advisory Committee on the Auditing Profession (ACAP) recently recommended that all publicly traded companies be required to have shareholder ratification of auditor selection. This study provides evidence of the potential implications of making a shareholder vote on auditor selection mandatory. The results of this study indicate that a shareholder vote on auditor selection is associated with higher audit quality and higher audit fees. These findings should be of interest to policy makers, auditors and public companies that might become subject to this policy change.


    For more information on this study, please contact Mai Dao.
     

    Citation:

    Dao, M., K. Raghunandan, and D. Rama. 2012. Shareholder Voting on Auditor Selection, Audit Fees, and Audit Quality. The Accounting Review 87 (1): 149-171.

    Keywords:
    auditor selection, shareholder voting, audit fees, audit quality.
    Purpose of the Study:

    The U.S. Department of the Treasury’s Advisory Committee on the Auditing Profession (ACAP) recommended in 2008 that all publicly traded companies be required to have shareholder ratification of auditor selection. ACAP justified this recommendation by citing the need for enhanced competition in the auditing industry. While the ACAP did not explicitly state what benefits increased competition may produce the authors espouse that the desired outcome would be reduced prices and increased quality. The authors point out that another potential benefit could come from a governance and accountability standpoint. They say that shareholder involvement may have a positive impact on the incentives of auditors and auditor independence. They argue that with shareholder voting there may be fewer opportunities for auditors to have a cozy relationship with management.
    This study informs this proposed policy choice. The authors look at audit fees and audit quality at firms that voluntarily engage in shareholder ratification of the auditor. By looking at these outcomes they hope to better understand the competitive and governance implications of making a shareholder vote on auditor selection mandatory.

     

    Design/Method/ Approach:

    The authors use data on publicly-traded companies in 2006 and compare audit fees and audit quality for companies that engage in shareholder ratification of auditors to those that do not. The authors also look at firms that switched from not having a shareholder vote on auditor selection in 2005 to having one in 2006 and compare them to firms that had a shareholder vote in 2005 and did not have one in 2006 to see if these firms had changes in audit fees relative to each other.

    Findings:
    • The authors find that within the 2006 sample shareholder involvement in auditor selection is associated with higher audit fees.
    • Additionally, they find that firms that switched from not having a shareholder vote on auditor selection in 2005 to having one in 2006 have, on average, higher audit fees than firms that stopped having a shareholder vote in 2006 but had one in 2005.
    • In their study of audit quality, the authors find that shareholder involvement in auditor selection is associated with a reduced probability of having a restatement that results in a negative effect on financial statements. 
    • Additionally, they document lower abnormal accruals for firms that have shareholder involvement in auditor selection.

    The authors claim that these findings are consistent with shareholder involvement in auditor selection being associated with higher audit quality and higher audit fees. They attribute these results to increased auditor effort requiring increased cost which is passed on to the client in the form of audit fees.

    Category:
    Auditor Selection and Auditor Changes, Governance
    Sub-category:
    Board/Audit Committee Processes
  • Jennifer M Mueller-Phillips
    Agency Conflicts and Auditing in Private Firms
    research summary last edited September 12, 2013 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes in Auditing Section Research Summaries Space public
    Title:
    Agency Conflicts and Auditing in Private Firms
    Practical Implications:

    By understanding the auditor selection decisions and the agency costs faced in many private firms, auditors of private firms can more appropriately gauge risk and better understand their clients.

    For more information on this study, please contact Ole-Kristian Hope.
     

    Citation:

    Hope, O., Langli, J. C., and Thomas, W. B. 2012. Agency Conflicts and Auditing in Private Firms. Accounting, Organizations and Society 37 (7): 500-517.

    Keywords:
    N/A
    Purpose of the Study:

    The purpose of this study is to determine how privately held firms handle agency costs; specifically agency costs related to ownership structures. Also, this study examines how those agency costs affect audit fees and auditor selection criteria.

    Design/Method/ Approach:

    Using data from 2000 to 2002 and 2006 to 2007, which were obtained with special permission from the Norwegian government, the authors test the agency costs associated with familial ties in private settings. Specifically, the authors are interested in effort, as measured by audit fees, and desire to send a strong signal as measured by hiring a big 4 auditor.

    Findings:

    This paper tests several hypotheses but some of the most important findings are:

    • Audit fees decrease as ownership concentration increases and as the proportion of shares held by the second largest shareholder increases
    • As CEO ownership increases audit fees decrease
    • When the CEO is a member of the largest owning family audit fees increase
    • Audit fees decrease as the proportion of board members from the largest owning family decreases
       
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Board/Audit Committee Oversight
  • The Auditing Section
    An Analysis of Forced Auditor Change: The Case of Former...1
    research summary last edited May 25, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 04.0 Independence and Ethics, 04.07 Audit Firm Rotation in Auditing Section Research Summaries Space public
    Title:
    An Analysis of Forced Auditor Change: The Case of Former Arthur Andersen Clients
    Practical Implications:

    The results of this study suggest that the auditor changes resulting from the demise of Andersen did not result in improved financial reporting quality and transparency for the former Andersen clients that parted ways with their former audit practice.  This implies that the mandatory rotation of auditors may not yield an increase in financial statement quality.  This result should be of interest to audit regulators and standard setters, as well as practitioners seeking to comment on proposed mandatory rotation regulations. 

    Additionally, the results indicate that switching costs in non-forced auditor change settings likely outweigh agency benefits of changing auditors in many cases.  This result may be of interest to shareholders, managers, and audit committees in their respective roles related to auditor selection.

    Citation:

    Blouin, J., B. M. Grein, and B. R. Rountree. 2007. An Analysis of Forced Auditor Change: The Case of Former Arthur Andersen Clients. The Accounting Review 82 (3): 621-650.

    Keywords:
    auditor selection, auditor change, mandatory auditor rotation, audit quality, earnings quality, Arthur Andersen
    Purpose of the Study:
    • To investigate the factors that contributed to firms' decisions to either retain their Andersen audit team who migrated to another audit firm, or engage a new auditor, after the collapse of Andersen.
    • To investigate the effect of forced auditor change on client firms' financial statement quality.
    • To examine the costs (switching costs and agency costs) a company faces in switching to a new auditor.
    Design/Method/ Approach:

    The authors use a sample of 407 Andersen clients.  The authors classify companies as retaining their Andersen audit team if the audit report in the year after Andersen's collapse indicates the new auditor within a city acquired the Andersen audit practice in that same city. Companies that did not adhere to this were classified as having switched to a different auditor.  In performing this analysis, the authors examine “Switching costs” (i.e. Andersen industry expertise, auditor tenure, auditee size, auditee complexity, and discretionary accruals) and “Agency Costs” (i.e. auditee size, auditee complexity and transparency, insider ownership, leverage, presence of a blockholder, and audit committee expertise and independence.

    Findings:
    • Companies faced with greater switching costs were more likely to stay with their Andersen audit team.  (Note: Greater switching costs include aggressive accruals, a financial expert on the audit committee, and Andersen industry specialization)
    • Companies with greater agency concerns (higher monitoring costs faced by outside shareholders) were more likely to sever ties with their Andersen audit team and hire a new auditor.
    • Companies in the highest quintile of performance-matched discretionary accruals that followed Andersen curbed their accrual behavior in the year after Andersen’s collapse, while there was no change for those that did not follow Andersen.
    • Overall company governance characteristics were not associated with the decision to retain or switch.
    • Overall, the evidence suggests that switching costs likely often outweigh benefits of changing auditors, which explains why we observe infrequent auditor changes for most companies.
    • Evidence in the study suggests mandatory rotation may not be effective in improving client firms' overall financial statement quality.
    Category:
    Auditor Selection and Auditor Changes, Independence & Ethics
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Audit Firm Rotation, Audit Firm Rotation
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  • The Auditing Section
    The Pricing of National and City-Specific Reputations for...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications in Auditing Section Research Summaries Space public
    Title:
    The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market
    Practical Implications:

    This study has practical audit client portfolio management implications for audit firms seeking to earn audit fee premiums for reputations of industry expertise. For example, auditors’ reputations for industry expertise are neither strictly national nor strictly local.  One interpretation with practical implications for such firms is that national level or city level reputations for industry expertise are not individually sufficient to maximize fee premiums.  Rather, auditors can most effectively earn fee premiums when they establish both city-level and national-level reputations for industry expertise.

    Citation:

    Francis, J. R., K. Reichelt, and D. Wang.  2005.  The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market.  The Accounting Review 80 (1): 113-136.

    Keywords:
    Auditor industry expertise, Big 5 accounting firms, audit fees
    Purpose of the Study:

    The purpose of this study is to examine the pricing of Big 5 industry expertise in the United States based on national and city level reputations for industry expertise.  

    Industry knowledge and expertise help auditors build reputations that auditors can use to negotiate fee premiums.  Prior research suggests that industry knowledge and expertise is developed by investments in accounting professionals and their experiences in serving clients out of city-based practice offices.  However, auditors can build national reputations for industry expertise that may enable them to negotiate audit fee premiums as well.  The authors argue that the central issue in the “national” vs. “city” perspective on industry expertise is the degree to which office-specific expertise is transferrable throughout a firm. Specifically, the national perspective assumes accounting firms capture the industry expertise of its office-based professionals and distribute it throughout the entire firm.  Conversely, the city perspective assumes that auditor expertise is indelibly tied to individual professionals and cannot be distributed throughout the firm.  This study examines industry specialization audit fee premiums at the city level and national level to analyze how auditor reputations for industry expertise are viewed.  Specifically, the authors use U.S. fee disclosures to investigate audit pricing in the U.S.  audit market in order to determine: 

    • whether there is evidence that Big 5 auditor industry expertise is priced in the U.S. audit market 
    • whether the market for audit fees prices a Big 5 firm’s national (firm-wide) reputation or city-specific (local-office) reputations for industry expertise
    Design/Method/ Approach:

    The study uses data on U.S. non-financial publicly-traded companies with Big 5 auditors during the fiscal years 2000 and 2001.  The authors investigate audit fee premiums resulting from:

    • National specialization only,
    • City specialization only, and
    • Combined city and national specialization.
    Findings:
    • There is evidence of a fee premium of 19% on engagements where Big 5 auditors are both the nationally top-ranked auditor and the city-level industry leader in the city where the client is headquartered. The authors argue this indicates that national and city-specific industry leadership jointly impact auditor reputation and pricing. 
    • The magnitude of the premium for joint national-city leadership is bigger for larger clients (22 percent) than for smaller clients (7 percent).  
    • There is evidence of a fee premium of 8% on engagements where Big 5 auditors are the city-specific industry leader but not the national industry leader.  The authors argue this may indicate that auditor industry expertise is tied to individual professionals. However, the result is sensitive to test methods so the evidence is inconclusive on this point. 
    • There is no evidence of a fee premium for auditors that are national industry leaders alone without also being city-specific industry leaders.  The authors argue this indicates that national leadership alone does not result in a premium. 

    The authors argue these findings suggest that an auditor’s reputation is priced into audit fees as if both firm-wide (national) and city-specific (local) reputations are jointly relevant.

    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Audit fee decisions, Auditor Qualifications (e.g. size - industry expertise)
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  • The Auditing Section
    Financial Restatements and Shareholder Ratifications of the...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 13.0 Governance, 13.05 Board/Audit Committee Oversight in Auditing Section Research Summaries Space public
    Title:
    Financial Restatements and Shareholder Ratifications of the Auditor
    Practical Implications:

    The authors’ results show that restatements are viewed by investors as audit failures and restatements reflect negatively on investor perceptions of the external auditor. The study also suggests that audit committees’ decisions to change auditors are not influenced by shareholder ratification voting.  The authors state that the results support “efforts to require SEC registrants to submit auditor selection for a shareholder ratification vote.”

    Citation:

    Liu, L., K. Raghunandan, and D. Rama. 2009. Financial Restatements and Shareholder Ratifications of the Auditor. Auditing: A Journal of Practice & Theory 28 (1): 225-240.

    Keywords:
    restatements; shareholder voting; auditor ratification
    Purpose of the Study:

    The purpose of this study is to examine the impact that client restatements have on shareholder ratification votes for the external auditor.  Restatements have been widely recognized as an indicator of low audit quality and as such may influence shareholder perceptions of the external auditor.  Shareholder ratification of the external auditor is not required by state or federal laws; however, many firms maintain the practice as a measure of good governance.  This ratification vote is the only opportunity shareholders have to comment on their approval/disapproval of the audit firm and/or audit quality.  Furthermore, some investor advocate groups (e.g., CalPERS) have withheld votes against audit committee directors of firms that did not offer shareholders an opportunity to vote on auditor ratification.                                                                                                                           

    The authors expect that firms will have a higher proportion of shareholders not voting for the appointment of the auditor following a restatement.

    Design/Method/ Approach:

    The authors collect data on firms that restate 2004 or 2005 financial statements and compare shareholder ratification votes for the restating firms to shareholder ratification votes for a control sample of firms that did not restate their 2004 or 2005 financial statements.

    Findings:
    • The authors find that shareholders are more likely to vote against auditor ratification after a client restatement relative to firms that do not restate their financial statements and relative to shareholder voting prior to the restatement.
    • There were 19 of 97 restatement firms that had more than 5 percent of shareholder votes not in favor of ratifying the auditor; only 2 of these 19 firms subsequently changed auditors the following year.
    Category:
    Auditor Selection and Auditor Changes, Governance
    Sub-category:
    Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Board/Audit Committee Oversight
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  • The Auditing Section
    Forced Audit Firm Change, Continued Partner-Client...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.04 Predecessor Auditor Factors, 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers in Auditing Section Research Summaries Space public
    Title:
    Forced Audit Firm Change, Continued Partner-Client Relationship, and Financial Reporting Quality
    Practical Implications:

    The results of this study are important for regulators to consider when scrutinizing auditor changes and former audit partners. The evidence indicates that former audit partners may adopt a strategic approach to auditing follower clients by being more conservative in their audits in the first post-switch year when the level of scrutiny is high, but allowing more aggressive earnings management after the first post-switch year.

    Citation:

    Chen, C. J. P., X. Su, and X. Wu. 2009. Forced Audit Firm Change, Continued Partner-Client Relationship, and Financial Reporting Quality.  Auditing: A Journal of Practice and Theory 28 (2): 227-246. 

    Keywords:
    Forced audit firm change, former audit partner, financial reporting quality, auditor selection and auditor change, audit partner/audit firm switching.
    Purpose of the Study:

    The authors use a setting of forced auditor changes (e.g. the forced demise of Andersen resulting in partners and staff going to work for other firms) to examine whether clients follow their former audit partner, and the implications for earnings management.  Forced auditor changes following an audit failure scandal raise the level of perceived and/or actual regulatory risk to both former audit partners and the new audit firms that take on such partners. However, regulatory scrutiny of the new audit firm in subsequent years may not be as strong as in the first year following the partner switch to the new audit firm. This study investigates the financial reporting quality of Chinese listed firms following forced partner/audit firm changes. The main objectives of the study are to  determine whether: 

    • Former audit partners tend to be more conservative in the first post-switch year.
    • Former audit partners become less conservative after the first post-switch year.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies in the Chinese stock market which faced forced partner/audit firm changes in 2001 to examine the financial reporting quality associated with audits performed by these audit partners with their new audit firm in the post-switch years.

    Findings:
    • The authors document that firms with greater earnings management activities are more likely to follow their former audit partners to a new audit firm.  
    • Follower clients with aggressive earnings management behavior who are audited by former partners do not report abnormally high earnings management in the first post-switch year. 
    • While new audit firms are more likely to assign brand new audit partners to follower clients in the first post-switch year, a large number of former audit partners return to their clients in subsequent years. 
    • The authors find that the financial reporting of aggressive follower clients audited by former partners becomes significantly more aggressive in the second and third post-switch years.
    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Impact of SEC Actions, Predecessor Auditor Factors, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc
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  • The Auditing Section
    Auditor Switches in the Pre- and Post-Enron Eras: Risk or...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.06 Resignation Decisions, 03.0 Auditor Selection and Auditor Changes in Auditing Section Research Summaries Space public
    Title:
    Auditor Switches in the Pre- and Post-Enron Eras: Risk or Realignment?
    Practical Implications:

    This study provides a more complete analysis (compared to the GAO 2006 study) of how Big 4 firms responded to the supply and demand shocks to the audit market by Andersen and SOX Section 404, which is useful for audit firms and regulators to consider.

    Citation:

    Landsman, W. R., K. K. Nelson, and B. R. Rountree. 2009. Auditor switches in the pre- and post-Enron eras: Risk or realignment?  The Accounting Review 84 (2):  531-558. 

    Keywords:
    Auditor switching, client risk, client misalignment, Sarbanes-Oxley Act, auditor appointment
    Purpose of the Study:

    The major accounting scandals of the early 2000s affected the market for audit services in two ways: the demise of Andersen resulted in an increase in the number of clients available to other accounting firms, and Section 404 of the Sarbanes Oxley Act (SOX) increased demand for audit services by accelerated filers.  These events resulted in temporary capacity constraints resulting in Big 4 firms rebalancing their public client portfolios.  Big 4 firms issued press releases during this time period indicating that they responded to these market forces by dismissing a number of clients that exposed their public client portfolios to unacceptable levels of risk.  The General Accounting Office issued a 2006 report further suggesting that the Big 4 firms have become more selective regarding risky clients.  This study investigates Big 4 auditor switch decisions during the pre-Enron (1993-2001) and post Enron (2002-2005) time periods to determine whether: 

    • Big 4 firms increased their sensitivity to client risk during the post-Enron period and dismissed clients that presented increased risk to their public client portfolios.  OR
    • Big 4 firms were faced with a capacity constraint due to Section 404 demand and elected to dismiss smaller clients that were misaligned with their overall portfolio strategy of serving larger clients.  The authors define auditor/client misalignment as occurring when a client is predicted to engage a non-Big 4 audit firm but actually engages a Big 4 audit firm.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies and compare measures of client financial risk, audit risk, and auditor/client misalignment pre-Enron (1993-2001) to post-Enron (2002-2005) for three categories of Big 4 clients (as well as comparing resignations versus dismissals): (1) Big 4 clients that continue with their auditor, (2) new clients that switch laterally or upward to a Big 4 audit firm, and (3) Big 4 clients that switch to a national, regional or local audit firm.

    Findings:
    • The frequency of clients switching from Big 4 audit firms to the non-Big 4 audit firms more than doubled during the post-Enron time period relative to the pre-Enron period. 
    • Clients switching from Big 4 audit firms to non-Big 4 audit firms were more likely to be “misaligned” (as defined in the study) with a Big 4 audit firm during the post-Enron time period; however, demonstrated less risk during the post-Enron time period.  Lateral/upward switches during the post-Enron period demonstrated less client financial and audit risk and were less likely to be “misaligned” with a Big 4 audit firm.
    • Big 4-initiated resignations present greater risk compared to client-initiated dismissals, but there is no change in the sensitivities of resignations or dismissals to client risk or auditor/client “misalignment” during the post-Enron time period.           

    The authors claim their findings suggest that realignment decisions of Big 4 firms post-Enron were mostly due to auditor/client misalignment that resulted from the capacity constraints caused by the increase in supply of former Andersen clients and increased demand for audit services resulting from SOX Section 404, and not a change in the Big 4 firms’ sensitivity to client risk. 

    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Resignation Decisions
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  • The Auditing Section
    Auditor Specialization, Auditor Dominance, and Audit Fees:...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications in Auditing Section Research Summaries Space public
    Title:
    Auditor Specialization, Auditor Dominance, and Audit Fees: The Role of Investment Opportunities
    Practical Implications:

    The results may be useful to practitioners in developing a client portfolio and in determining bids for audit fees, as they provide empirical evidence on the consequences of investing in industry expertise under certain conditions.  For example, these results show that high industry IOS and high IOS homogeneity are associated with higher audit fees, which implies that auditors can benefit from investments to develop industry expertise in industries with such conditions.  However, these results also imply that it is more difficult to dominate industries with high IOS homogeneity, since companies in these industries have high incentives to protect proprietary information from other auditor clients. 

    The results of this study may also be relevant for company managers and audit committees in that they provide evidence on the determinants of audit fees and the possible within-industry transfer of proprietary knowledge to competitor firms through the firms' auditor.

    Citation:

    Cahan, S. F., J. M. Godfrey, J. Hamilton, and D. C. Jeter. 2008. Auditor Specialization, Auditor Dominance, and Audit Fees: The Role of Investment Opportunities. The Accounting Review 83 (6): 1393-1423.

    Keywords:
    auditor selection, auditor changes, auditor dominance, audit fees, investment opportunities, auditor concentration
    Purpose of the Study:

    The authors note that the GAO has expressed concerns related to audit firm competition in certain industries.  Namely, certain industries are dominated by few audit firms, resulting in reduced competition.  The authors investigate whether industry “investment opportunity set” (i.e., levels of growth options) explains why auditors choose to specialize in certain industries.  The authors suggest that when an industry investment opportunity set (IOS) is high, audit firms are willing to make costly investments in industry-specific knowledge.  In addition, when IOS is relatively homogeneous across clients in an industry, then auditors can easily transfer the knowledge they invested in across clients.  Below are three objectives that the authors address in their study: 

    • To investigate the impact of the investment opportunity set (IOS) in an industry on auditor industry specialization.
    • To investigate the effect of different levels of homogeneity of industry IOS on auditor industry specialization.
    • To investigate the effect of the industry IOS on audit fees.
    Design/Method/ Approach:

    The authors use a sample that includes 3,443 industry-years of data to determine whether auditor industry specialization is associated with audit clients’ Investment Opportunity Set (IOS) and/or the homogeneity of the IOS within an industry (HIOS).  The authors measure IOS for each industry using four firm-level variables: investment intensity (prior 2 years), growth in the market value of assets (prior 2 years), ratio of market value of assets to book value of assets, and the ratio of R&D expenditures to book value of assets. Further, the authors measure IOS homogeneity (HIOS) as the within-industry standard deviation of the IOS for all firms.  Finally, the authors measure auditor  industry specialization as the market share of client assets audited by the two largest auditors in an industry (defined using 3-digit SIC codes). 

    Findings:
    • Overall, industry IOS affects the structure of industry audit markets and the fees charged by auditors in these markets.
    • Auditors invest more in industry-specific specialization when the within-industry IOS is higher (to create barriers to entry for other auditors) and the IOS is more homogeneous (as auditors are able to transfer the expertise across client firms within the industry more easily).
    • However, auditor dominance (i.e. having one auditor dominate the industry) is negatively associated with IOS homogeneity as client firms will not want proprietary information to be transferred by the auditor to other client firms in the industry.
    • Industry IOS level and homogeneity are both positively associated with audit fees, either as payment for the investment in the IOS or as a premium for hiring the industry expert auditor.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
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  • The Auditing Section
    Auditor Change and Auditor Choice in Nonprofit Organizations
    research summary last edited May 25, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications in Auditing Section Research Summaries Space public
    Title:
    Auditor Change and Auditor Choice in Nonprofit Organizations
    Practical Implications:

    The results of this study confirm the importance of management reputation issues in auditor change decisions, while also extending our understanding of nonprofit organizations.  For nonprofits, a change in auditor is more likely when the organization’s operational structure changes.  As the organization grows and becomes more reliant on federal funding, the likelihood of changing auditors, particularly to bigger audit firms, increases.

    Citation:

    Tate, S. L., 2007. Auditor changes and auditor choice in nonprofit organizations.  Auditing:  A Journal of Practice & Theory 26 (1): 47-70.

    Keywords:
    Auditor switching, auditor choice, nonprofit organizations
    Purpose of the Study:

    Accounting frauds of the early 2000’s coupled with the passage of the Sarbanes-Oxley Act of 2002 (“SOX”) resulted in increased focus on the role of the independent auditor in monitoring public companies.  Although the new SOX rules were not directed at nonprofit organizations, the public support of these organizations suggests that adequate levels of monitoring are also important in this sector.  This study specifically evaluates the auditor choice decisions of nonprofit organizations.

    Design/Method/ Approach:

    The author uses publicly available data for the years 1998 through 2002 to examine the effects of operational structure, management reputation and contracting, and audit fees on a nonprofit organization’s choice of auditor and decision to change auditors.

    Findings:
    • Consistent with prior research from other sectors, the author finds that management reputation and audit fees are important in the decision to change auditors. 
    • The author finds that changes to the organization’s operational structure, including revenue sources and resource uses, are important factors in the decision to change auditors.
    • The author also finds that organization size is an important factor in selecting a large audit firm over another smaller audit firm.  Changes in revenue sources, resource uses, leverage, and management contracting as well as management reputation may also be factors in the selection of the auditor.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
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  • The Auditing Section
    Are the Reputations of the Large Accounting Firms Really...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk in Auditing Section Research Summaries Space public
    Title:
    Are the Reputations of the Large Accounting Firms Really International?
    Practical Implications:

    This study provides an important implication for audit firms in maintaining their worldwide brand name reputation. The results suggest that, for global audit firms, the damage to auditor reputation in one country may spill over and cause concern among investors about the quality of their services in other countries. Further, the damage to reputation is greater where the demand for auditing and assurance is higher.

    Citation:

    Cahan, S. F., D. Emanuel, and J. Sun. 2009. Are the Reputations of the Large Accounting Firms Really International? Evidence from the Andersen-Enron Affair.  Auditing: A Journal of Practice and Theory 28 (2):  199-226. 

    Keywords:
    Auditor reputation, international audit markets, Arthur Andersen, Enron, auditor selection and auditor changes
    Purpose of the Study:

    The Big 4 accounting firms market themselves as global firms that deliver a uniform level of service across countries. While such a global reputation helps build worldwide demand for high-quality audits, it also creates risks if service quality becomes questionable in one of the countries in which a firm operates. Questionable audit practices in one of the countries, especially in the home jurisdiction, may  raise doubts as to whether sub-standard audits also occur in other countries. 

    This study examines whether the damage to the name brand of Arthur Andersen following the Andersen-Enron scandal in the U.S. spilled over into other countries. The study focuses on two key event dates leading up to Andersen’s demise: (1) January 10, 2002, when Andersen announced it had shredded documents related to the Enron audit, and (2) February 4, 2002, when Enron’s board released the Powers report that was critical of Andersen and when Andersen announced the establishment of an Independent Oversight Board (IOB) to investigate the firm’s audit policies and procedures. This study investigates the market reaction to Andersen’s clientele base around these two dates to determine whether: 

    • the events caused investors to reassess the reputation of Andersen’s non-U.S. audit units. 
    • investors’ reevaluation of Andersen’s reputation is more pronounced in cases where there is a higher demand for audit quality or credible financial statements. 
    • the effect is due to the perceived assurance or insurance value of an audit. The assurance value relates to an auditor’s ability to communicate with investors about the overall quality of client financial statements, while the insurance value relates to an auditor’s legal and financial liability for an audit failure.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies audited by Arthur Andersen in 2001 to examine whether there is a negative market reaction to Andersen’s non-U.S. clients around the two event dates discussed above.

    Findings:
    • The authors document that an adverse market reaction to Andersen’s clients exists in non-U.S. countries, which suggests that the damage to Andersen’s reputation and audit quality in the U.S. spilled over to other countries.  
    • The market reaction is more negative in countries where there is a greater demand for high-quality auditing and credible financial reporting. More specifically, more-pronounced adverse market reactions are observed in common law (compared to code law) countries where investor protection is higher, ownership is more dispersed, and conflicts of interest between owners and managers are more likely to occur. 
    • The authors find that the market reaction for the shredding event is more negative for Andersen’s non-U.S., cross-listed clients than for Andersen’s non-U.S., non-cross-listed clients. This suggests that the shredding event may have been anticipated by the U.S. market as triggering lawsuits against Andersen and reducing its ability to pay for possible legal claims. 
    • The authors also report a similar market reaction for Andersen’s non-U.S., cross-listed clients and Andersen’s U.S. clients, suggesting similar levels of perceived audit quality across Andersen as a whole.
    Category:
    Auditor Selection and Auditor Changes, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Litigation Risk
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