Auditing Section Research Summary Database

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  • The Auditing Section
    Mandatory Audit Partner Rotation, Audit Quality, and Market...6
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation in Auditing Section Research Summaries Space public
    Title:
    Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan and Discussion of “Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan”
    Practical Implications:

    The adoption of mandatory partner rotation in many countries suggests that regulators believe that the benefits of rotation outweigh the costs and thus a policy of mandatory rotation enhances audit quality. The results of this study provide initial evidence of the effects of mandatory partner rotation on audit quality. Contrary to regulators’ beliefs, the findings do not support the assumption that audit partner rotation will lead to audit quality increases. One caveat to these findings is whether the findings will generalize to other countries with different regulatory and legal regimes.

    Citation:

    Chi, W., H. Huang, Y. Liao, and H. Xie. 2009. Mandatory audit partner rotation, audit quality, and market perception: Evidence from Taiwan. Contemporary Accounting Research 26 (2): 359-391. 

    Bamber, E.M., and L.S. Bamber. 2009. Discussion of “Mandatory audit partner rotation, audit quality, and market perception: Evidence from Taiwan”. Contemporary Accounting Research 26 (2): 393-402.

    Keywords:
    audit quality; audit partner rotation
    Purpose of the Study:

    The Sarbanes-Oxley Act of 2002 (SOX) reduced the period that an audit partner is allowed to serve a particular client from seven consecutive years (required by the AICPA since the 1970s) to five years. The assumption behind the mandatory rotation requirement is that rotating the audit partner will improve auditor independence and audit quality. Research on audit firm rotation in the U.S. suggests that longer audit firm tenure with a client increases audit quality.  Although, as Bamber and Bamber point out, the results of audit firm rotation may be different than audit partner rotation because the costs and benefits are quite different.  For example, in rotating audit firms, the new firm brings an entirely new audit team and a new audit methodology. In rotating an audit partner, many factors continue to be the same under the new partner (the team, the overall audit methodology, the firm’s history with the client, etc.). Due to the lack of audit partner data in the U.S., this study utilizes audit partner data from Taiwan to assess the effect of mandatory audit partner rotation on audit quality. More specifically, the authors address two primary issues:

    • The authors examine whether a sample of firms subject to mandatory rotation have higher audit quality as compared to three benchmarks: 1) a sample of firms not subject to mandatory rotation, 2) the mandatory sample in the year prior to adoption, and 3) a sample of firms with voluntary audit partner rotation.
    • The authors examine whether investors perceive higher audit quality for the firms subject to the mandatory rotation requirements relative to the three benchmark samples mentioned above.
    Design/Method/ Approach:

    The authors use data for publicly-listed firms in Taiwan from the 2004 Taiwan Economic Journal database.  Mandatory audit partner rotation became mandatory for firms listed on the two major stock exchanges in 2004.  For the 2004 firms, some companies had partners that were required to rotate off the engagement (firms subject to mandatory rotation in that year) whereas other companies did not have partners required to rotate as they had not been on the engagement long enough yet (a non-rotation sample). 

    Findings:
    • Audit quality is not significantly different when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms not subject to mandatory rotation in 2004.  They also find no significant difference in audit quality when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms whose audit partner voluntarily rotated in years before 2003.  
    • The audit quality provided by new partners for Taiwan firms subject to mandatory rotation in 2004 is lower than the audit quality of those same Taiwan firms one year earlier, when the audit was led by the prior partner.
    • The authors find that perceived audit quality is not significantly different when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms not subject to mandatory rotation in 2004.  They also find no difference in perceived audit quality when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of those same Taiwan firms one year earlier.  They find that perceived audit quality is significantly higher for firms subject to mandatory rotation in 2004 compared to firms where audit partners voluntarily rotated prior to 2003. 
    Category:
    Independence & Ethics, International Matters
    Sub-category:
    Audit Firm Rotation, Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    The Influence of Process Accountability and Accounting...1
    research summary posted October 22, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summaries Space public
    Title:
    The Influence of Process Accountability and Accounting Standard Type on Auditor Usage of a Status Quo Heuristic
    Practical Implications:

    The results of this study are important for both audit firms and regulators to consider as standards change to become more principles-based (or as firms move towards using IFRS). The evidence indicates that auditors will sometimes fixate on the prior year accounting treatment, even if the applicable accounting standard has changed, and/or there are changes in the scenario. However, this bias towards maintaining the status quo can be mitigated by holding auditors accountable for their decision making process, particularly through a partner asking about the auditors’ decision making process.

     

    For more information on this study, please contact Scott Vandervelde.

    Citation:

    Messier, Jr., W. F., L. A. Quick, and S. D. Vandervelde. 2014. The influence of process accountability and accounting standard type on auditor usage of a status quo heuristic. Accounting, Organizations and Society 39 (1): 59-74

    Keywords:
    International Financial Reporting Standards, principles-based standards, status quo bias, accountability, auditor judgment
    Purpose of the Study:

    There has been considerable discussion about the U.S. reporting standards becoming less rules based, similar to International Financial Reporting Standards (IFRS). One proposed advantage of a change to IFRS is increased comparability across multinational and non-U.S. companies. Additionally, some believe that IFRS afford greater flexibility in its principles, thereby enabling firms’ accounting choices to better reflect the true economic nature of any given transaction. With fewer rules, both financial statement preparers and auditors would be expected to adjust to having more options with regards to financial reporting. However, some proposed changes leave the option open to implement IFRS (or other principles-based standards) in ways that still follow rules in U.S. GAAP. This paper investigates whether prior year accounting treatments influence the judgment for current year treatments when one way to implement the standard is to follow the prior year treatment.

    The authors motivate their expectations based on status quo theory and accountability theory. Status quo theory suggests that individuals often choose to maintain a prior decision when faced with a new choice. Accountability theory suggests that when individuals are held accountable for their decision making process, this will reduce the bias towards the status quo. 

    Design/Method/ Approach:

    The research evidence is collected in 2010 through 2013. The authors use an experiment to collect data from auditors, mainly at the senior and manager level, from Big 4 and large national accounting firms in the United States and Norway.

    Findings:
    • The authors find that some auditors fixate on prior year scenarios and judgments, even if the current year scenario and applicable accounting standards are different.
    • The authors find that holding auditors accountable for their decision making process reduces the likelihood of sticking with the prior year treatment, most notably when the prior year standards were U.S. GAAP.
    Category:
    Auditor Judgment, International Matters
    Sub-category:
    IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    An Examination of Partner Perceptions of Partner Rotation:...1
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summaries Space public
    Title:
    An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality
    Practical Implications:

    The findings of this study shed light on the perceived benefits and detriments of the five versus seven year partner rotation requirements.  The results highlight the potential unintended consequences of implementing the accelerated rotation including a reduction in partner quality of life and auditor independence and audit quality. 


    For more information on this study, please contact Brian Daugherty. 
     

    Citation:

    Daugherty, B., D. Dickins, R. Hatfield, and J. Higgs.  2012.  An Examination of Partner Perceptions of Partner Rotation:  Direct and Indirect Consequences to Audit Quality. Auditing: A Journal of Practice & Theory 31 (1): 97-114. 

    Keywords:
    Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life.
    Purpose of the Study:

    This study examines practicing audit partner perceptions regarding the mandatory partner rotation and cooling off periods.  Specifically, the authors investigate how recently enacted and stringent rules might negatively impact auditor quality of life leading to deterioration in audit quality.  As a result of the Sarbanes-Oxley Act of 2002 (SOX), the US moved from a seven-year rotation with a two-year cooling-off period to a five-year rotation and five-year cooling-off period.  This change in standard provides the authors the opportunity to investigate the perceptions of partner that have worked under both standards.

    Design/Method/ Approach:

    The authors conducted in-depth semi-structured interviews with seven practicing audit partners.  Most of these partners were managing partners from various geographic locations.  Based on those interviews, the authors developed a model of the effects of mandatory rotation and created a field survey that was completed by 370 audit partners.  Collection of survey results occurred prior to May 2011. 

    Findings:

    The audit partners in the study believed that rotation generally improved independence which has a positive impact on audit quality.  However, partners also expressed that accelerated rotation reduced client-specific knowledge and had a negative impact on audit quality.  Partners suggested that the accelerated rotation and extended cooling-off period imposed by SOX has increased the need to relocate if the partner wishes to remain in the same industry.  As a result partners often choose to gain new industry experience and stay in the same location, rather than to relocate.  This decision maintains the partner quality of life, but possibly at the expense of industry depth and to the detriment of overall audit quality.  Partners also discussed a two to three-year new-client familiarization process, resulting in an increase in the amount of time that engagements suffer from “start-up efficacy”.  In sum, although the partners view rotation in general as a means to improve independence, they believe the accelerated rotation imposed by SOX may actually result in a reduction in independence and possibly audit quality.

    Category:
    Audit Quality & Quality Control, Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox, Impact of SOX, Industry Experience
  • The Auditing Section
    The Impact of Auditor Rotation on Auditor-client Negotiation1
    research summary posted May 4, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 10.0 Engagement Management, 10.04 Interactions with Client Management, 15.04 Audit Firm Rotation in Auditing Section Research Summaries Space public
    Title:
    The Impact of Auditor Rotation on Auditor-client Negotiation
    Practical Implications:

    The study investigates how mandatory audit firm rotation may affect the process of auditor-client negotiations that produce financial statements observed by the public.  Standard setters should be cognizant of the possible implications of mandating rotation.  Mandatory rotation will likely change the auditors’ and clients’ incentives and auditors and clients will likely change their negotiation strategies.  This may result in less cooperation between auditors and clients and in fewer negotiations that end to the satisfaction of both parties (not only in the final audit year prior to rotation but also in non-final years).

    Citation:

    Wang, K. J. and B. M. Tuttle. 2009. The Impact of Auditor Rotation on Auditor-client Negotiation. Accounting, Organizations, and Society 34 (2): 222-243.

    Keywords:
    Auditor rotation, auditor independence, auditor-client negotiation
    Purpose of the Study:

    This study is motivated by a demand for research on the potential effects of requiring mandatory rotation of audit firms following the Sarbanes-Oxley Act of 2002. While some believe that mandatory audit firm rotation is the only way to ensure auditor independence, most audit firms and their clients do not believe that mandatory audit firm rotation would impact auditor behavior. This study advances this debate by investigating how mandatory rotation may affect the process of auditor-client negotiations that produce financial statements.  Auditor-client negotiation is important to auditing because it is a natural process of reconciling incentive-induced differences in financial reporting.  Below are the objectives that the authors address in their study: 

    • Investigate how mandatory audit firm rotation (hereafter, mandatory rotation) affects auditor-client negotiations.
    • Examine the process differences in auditor-client negotiation with and without mandatory rotation – examine whether these process differences lead to material changes in the financial statements.
    • Examine the negotiation strategies used by both the auditor and the client and relate those strategies to the negotiated outcomes.  
    • Examine the impact on market dynamics as a result of auditor rotation.
    Design/Method/ Approach:

    The authors collected their evidence via a laboratory negotiation experiment using an abstract setting.  The data was collected prior to 2009.  Participants were graduate business students and were randomly assigned the role of manager (i.e., client) or verifier (i.e., auditor).  Participants were paired, one manager and one verifier, and completed a negotiation task.  For half of the negotiation pairs, mandatory rotation was required after three periods and for the other half of the pairs there were no rotation requirements.  Cash incentives were used to model the “real-world” incentives of clients and auditors.  The negotiation process, auditor and verifier strategies, and outcomes were compared between these two groups.

    Findings:
    • Mandatory rotation reduces the auditor’s relative importance of maintaining a relationship with the client. 
    • Auditors are more likely to use an obliging strategy (i.e. cooperating) under no mandatory rotation, as compared to mandatory rotation.
    • Auditors are more likely to use a strategy of inaction (i.e. unwillingness to compromise) under mandatory rotation (7%) compared to no mandatory rotation (1%).
    • Managers are less likely to send contending messages under mandatory rotation (17.6%), compared to no mandatory rotation (22%).
    • Auditors are less cooperative under mandatory rotation than under no mandatory rotation.
    • The agreement rate of negotiations under mandatory rotation is significantly lower than that under no mandatory rotation.
    • When negotiations result in agreement, the asset values under mandatory rotation are significantly lower (consistent with the auditor’s preferences) than those under no mandatory rotation.
    • In summary, under mandatory rotation auditors adopt less cooperative negotiation strategies, produce results that are more in line with the auditor’s preferences than with the client’s preferences, and less negotiations end in agreement.
    Category:
    Independence & Ethics, Auditor Judgment, Engagement Management
    Sub-category:
    Audit Firm Rotation, Prior Dispositions/Biases/Auditor state of mind, Interactions with Client Management, Audit Firm Rotation
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  • The Auditing Section
    Judgment and Decision Making Research in Auditing: A Task,...1
    research summary posted April 13, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 09.10 Prior Dispositions/Biases/Auditor state of mind in Auditing Section Research Summaries Space public
    Title:
    Judgment and Decision Making Research in Auditing: A Task, Person, and Interpersonal Interaction Perspective
    Practical Implications:

    The last 25 years has been an exciting and very productive period for judgment and decision making research in auditing.  The author of the discussion believes this review study will help stimulate important audit judgment and decision making research.  This line of
    research is important because it has potential to make important contributis to the audit practice.

    Citation:

    Nelson, M.W. and H. Tan. 2005. Judgment and Decision Making Research in Auditing: A Task, Person, and Interpersonal Perspective. Auditing: A Journal of Practice & Theory 24 (Supplement): 41-71.

    Trotman, K. T. 2005. Discussion of Judgment and Decision Making Research in Auditing: A Task, Person, and Interpersonal Perspective. Auditing: A Journal of Practice & Theory 24 (Supplement): 73-87.

    Keywords:
    Auditing, Judgment and decision making, Literature review
    Purpose of the Study:

    The purpose of the study is to review and discuss research in auditing specifically related to auditor judgment and decision making.  This line of research uses a psychological lens to understand, evaluate, and improve auditors’ judgments and decisions.  The authors
    classify the research into three broad areas: (1) the audit task, (2) the auditor and his/her attributes, and (3) the interaction between auditor and other stakeholders in task performance.  The authors synthesize the prior research and identify gaps and opportunities for future research. 

    The objective of the discussion paper is to build on the study by providing additional insights into areas of productive future research for judgment and decision making in auditing. 

    Design/Method/ Approach:

    The authors review judgment and decision making research in auditing conducted over the past 25 years.  Much of the research uses the laboratory experimental approach, but they also include some survey and field study approaches.  The review primarily considers papers published in major accounting journals such as The Accounting Review; Journal of Accounting Research; Contemporary Accounting Research; Accounting, Organization and Society; and Auditing: A Journal of Practice & Theory, as well as some selected working papers. 

    Findings:

    The Audit Task:  

    • The authors of the study find that much of the research related to audit tasks is grounded by the practice and professional standards.  The audit tasks most recently studied include (1) risk assessments, including the audit-risk model and related audit planning decisions, (2) analytical procedures and evidence evaluation, (3) auditors’ correction decisions regarding whether to require clients to book proposed adjustments, and (4) going concern judgments.  The authors stress the need for more research examining how auditing tasks are adapting to the current post-SOX reporting and regulatory environments. 
    • The author of the discussion feels there has been a lack of attention to audit task effects in prior research.  Prior research has not allowed us to make many general statements about the state of knowledge for each of the audit tasks.  The author
      stresses the importance of researchers to place more emphasis on audit tasks and to consider how specific audit tasks are different from the generic judgment and decision making (i.e., psychology-based) tasks.  

    Auditor Attributes: 

    • The authors of the study explain how auditors’ individual characteristics such as knowledge, ability, and personality, as well as their cognitive limitations, leave them susceptible to biases in audit judgments.  The authors focus their review of the related literature on four topics: (1) auditor knowledge and expertise, (2) other individual characteristics including aspects of personality, (3) cognitive limitations, and (4) decision aids designed to improve auditor judgments.  The authors stress the need for more research to examine how auditors’ affect or emotions also influence audit performance. 
    • The author of the discussion encourages future research to examine “why” biases in judgment occur in order to identify remedies for reducing the biases.

    Interpersonal Interactions: 

    • The authors of the study stress that because auditors do not work in isolation it is imperative to understand how people, tasks, and the environment that auditors interact with influence auditors’ performance.  The authors specifically examine interpersonal interactions between (1) auditors and other auditors, (2) auditors and their clients, and (3) auditors and other participants in the financial reporting process (e.g., jurors, judges, investors, analysts, etc.).  The authors call for more
      research related to interactions between auditors and audit committees as well as to strategic interactions between auditors and important stakeholders.  
    • The author of the discussion provides several insightful areas for future research, such as interactions between auditors and other auditors, auditors and clients, and auditors and users of audit reports. 
    Category:
    Auditor Judgment
    Sub-category:
    Audit Scope & Materiality Judgements, Prior Dispositions/Biases/Auditor state of mind, Materiality & Scope Decisions
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  • The Auditing Section
    An Analysis of Forced Auditor Change: The Case of Former...1
    research summary posted May 7, 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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  • Jennifer M Mueller-Phillips
    Professionalism and Performance Incentives in Accounting...
    research summary posted July 24, 2017 by Jennifer M Mueller-Phillips, tagged 11.13 Partner incentive schemes in Auditing Section Research Summaries Space public
    Title:
    Professionalism and Performance Incentives in Accounting Firms
    Practical Implications:

    The authors of the study state that it will be vital for accounting firms to ensure that partner incentive schemes align incentives with values of the accounting profession.  This issue gains greater importance as mid-tier firms adopt such performance-based profit sharing models in their attempts to stay competitive with Big 4 firms because the new incentives they face represent a risk to their culture and values.  Although the current models appear to measure and weigh both commercial success and professional values, these models represent a significant change from the past when mid-tier firms used lock-step approaches that incentivized partners to follow professional values.  These findings are of interest to accounting firms and regulators as they consider the impact of partner incentive schemes on audit quality.

    Citation:

    Coram, P. J., and M. J. Robinson. 2017. Professionalism and Performance Incentives in Accounting Firms. Accounting Horizons 30 (4): 103-123.

    Keywords:
    accounting firms; profit sharing; performance incentives
    Purpose of the Study:

    In recent years, accounting regulators across the globe (United States, European Union, and United Kingdom) have pushed for greater transparency from accounting firms.  In the required “Transparency Reports,” firms conceptually discuss partner compensation.  This study examines the actual profit-sharing frameworks in place at accounting firms of various sizes in order to understand partner remuneration in the Big 4 and mid-tier accounting firms in Australia.  Particularly, this study addresses the relationship of firm performance to partner remuneration and the commercialism/professionalism trade-off inherent in accounting firms.  This study aims to increase our understanding of the two-decade change in how accounting firms design their partner remuneration framework.  While traditional profit-sharing schemes consisted of equal shares of profit made to partners, accounting firms are currently utilizing partner performance information in determining profit splits.  This trend has given rise to criticism that suggests accounting firms are becoming too commercial—perhaps failing to accomplish their mission in the public’s best interest.

    Design/Method/ Approach:

    The study interviews nine partners of Big 4 and mid-tier firms in Australia.  The mean time spent as a partner was 17.6 years—ranging from 5 years of experience to 27 years.  Six partners interviewed had audit experience or were practicing auditors; the remaining three served in “Financial Advisory” or “Private Clients” capacities.  Each interview occupied one hour, took place at the respective firm of the interviewee across eight firms, in a one-month period in 2012.  Due care was exercised for interviewers to not express opinions that may bias responses given by partners.    

    Findings:
    • Each Big 4 firm has adopted the means to set individual performance expectations and reward performance that exceeds expectations. 
    • Mid-tier firms have, also, adopted elements of performance-based methods to calculate partner profit shares.  However, mid-tier firms continue to embody traditional, lock-step approaches.   
    • A few partners expressed concerns regarding performance-based remuneration—particularly due to firm’s inadequate ability to track each partner’s contributions.
    • When compared to previous literature (2013 and 1998) regarding partner remuneration, results from this study showed an increase in the variation of partner compensation.  The increase corresponds to the stronger influence performance plays in partner compensation.
    • All Big 4 firms utilize the same types of measures to evaluate partner performance.  Partner reviews consist of two steps: ranking (no profit units distributed) and scrutinizing.
    • Big 4 firms appear to be using a balanced scorecard approach, and mid-tier firms have adopted the balanced scorecard to evaluate partner performance.  This model captures partners’ financial and nonfinancial contributions to the firm.
    • Accounting firms are increasingly aware of the “erosion” of professionalism for commercialism.  Firms are counteracting the erosion by introducing metrics on values, quality, and staff development.  However, the study illustrates that performance measures are not equally weighted.  Often, weighting is dependent on the firm’s goals, current economic climate, and partner’s role in the firm.
    • Mid-tier firms—aspiring to grow—are reengineering their remuneration frameworks to take on performance-based elements, with hopes of attracting new talent. 
    • Consistent with previous research, this study finds that accountants working in mid-tier firms identify more strongly with core professional values than their Big 4 counterparts.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Partner incentive schemes
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  • Jennifer M Mueller-Phillips
    Auditor Choice and Audit Fees in Family Firms:Evidence from...
    research summary posted July 20, 2017 by Jennifer M Mueller-Phillips, tagged 04.02 Impact of Fees on Decisions by Auditors & Management in Auditing Section Research Summaries Space public
    Title:
    Auditor Choice and Audit Fees in Family Firms:Evidence from the S&P 1500
    Practical Implications:

    This study provides policy-makers and practitioners with critical insight into differences in auditor selection criteria between family and non-family firms and differences in the severity of their agency conflicts between shareholders and managers and also between family owners and minority shareholders.

    Our empirical evidence also sheds light on how family firms view and value the external audit and whether they are selecting auditors on price or quality, or some combination of these factors. In addition, given the current downward trend in audit revenues as a percentage of total revenues, our findings could lead accounting firms to re-examine how they market audit services to family firms.

    Citation:

    Ho, J.L., and F.Kang. 2013.Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500.Auditing: A Journal of Practice and Theory32(4): 71-93

    Keywords:
    Auditor choice; audit fees; family firms; agency problems
    Purpose of the Study:

    The authors study auditor choice and audit fees in family firms, which have a special ownership structure and different types of agency problems. Family firms are both prevalent and important in the U.S. About one-third of the S&P 500 are family-controlled companies in which the founding families on average own 11 percent of the cash flow rights and 18 percent of the voting rights.

    The unique class of family shareholders may influence firms’ auditor choice in two competing ways. On one hand, compared to non-family firms, family owners can more directly and closely monitor managers and therefore have less severe agency conflicts with managers. This may result in a lower demand for high-quality auditors. On the other hand, due to the agency problems between family owners and minority shareholders, family firms may have incentives to hire high-quality auditors as a signal of credible financial reporting in exchange for better contracting terms (e.g., lower cost of capital). Similarly, the different types of agency problems in family firms may also affect the level of audit fees. Family owners’ active monitoring reduces the inherent risk of material misstatements in financial reporting and results in a lower demand for audit effort, and therefore audit fees. However, the severe agency problems between family owners and minority shareholders suggest that family firms may incur higher audit fees due to higher audit risk and greater audit effort. Therefore, the effect of family firm characteristics on auditor choice and audit fees warrants empirical investigation.

    Design/Method/ Approach:

    The empirical analysis is performed on firms listed on the S&P 1500 index from 2000 through 2008. We define family firms as those in which founders or their family members (by either blood or marriage) are key executives, directors, or block holders and update the classification every year. We hand collected the ownership of the founding family and test our hypotheses on family firms’ auditor choice and audit fees using regressions.

    Findings:
    • The authors find that, on average, family firms are less likely to appoint top-tier accounting firms and incur lower audit fees than non-family firms.
    • The authors observe that the tendency not to hire top-tier accounting firms and to pay lower audit fees is more significant for firms in which family owners are the largest shareholders.
    • The authors find that, compared to family firms without dual-class shares, family firms with dual-class shares tend to mitigate their more severe agency problems between family owners and minority shareholders by hiring top-tier accounting firms to signal their earnings quality and they incur higher audit fees.
    • The authors also find that active family control (i.e., family members as CEOs or on the board) is associated with a lower tendency to hire top-tier accounting firms and lower audit fees.
    Category:
    Independence & Ethics
    Sub-category:
    Impact of Fees on Decisions by Auditors & Management
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  • Jennifer M Mueller-Phillips
    U.S. Audit Partner Rotations
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 05.03 Partner Rotation in Auditing Section Research Summaries Space public
    Title:
    U.S. Audit Partner Rotations
    Practical Implications:

    This study helps to inform about the effects of audit partner rotations. The evidence suggests that partner rotation does add a fresh look at U.S. audit engagements. The results can also be applied to the U.S. debate over audit firm rotation. It demonstrates that firm rotation is not the only way to add a fresh look to audit engagements and that the current system of audit partner rotation already has a measurable effect.

    Citation:

    Laurion, Henry, A. Lawrence, and J. Ryans. 2017. “U.S. Audit Partner Rotations”. The Accounting Review. 92.3 (2017): 209. 

    Keywords:
    U.S. audit partner rotations; fresh look; restatements; valuation allowances and reserves; write-downs; special items
    Purpose of the Study:

    Currently, the SEC requires that lead partners rotate off an audit engagement after five years and then sit out another five years before returning to the audit engagement. The audit partner rotation requirement was put into place to add renewed professional skepticism and a fresh insight into the audit. Previous studies in the United States generally indicate that partner rotation decreases audit quality due to a loss of client-specific knowledge and expertise. This paper adds to the discussion by examining the incidence of restatements, write-downs, and special items, as well as changes in valuation allowances and reserves surrounding partner rotation.

     

    Design/Method/ Approach:

    The authors identified audit partner rotations by using SEC comment letter correspondences for issuers who have received comment letter reviews in two consecutive years that copy different audit partners for each of those years. The information was gathered using the Audit Analytics Comment Letter database and comprised of 205 U.S. partner rotations at 189 SEC public companies from 2006 to 2014. A difference-in-differences model was used to compare the before and after results against a non-rotating firm control group. 

    Findings:

    The authors find the following:

    • There is no change in the frequency of misstatements after a partner rotation.
    • However, restatement discoveries and restatement announcements display relative increases of 5.9% and 5.1% respectively after there is a new lead partner. This suggests that the audit partner rotation requirement does in fact increase audit quality.
    • Additionally, there is some evidence of decreases in positive special items.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Independence & Ethics
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  • Jennifer M Mueller-Phillips
    Auditor Changes and the Cost of Bank Debt
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes in Auditing Section Research Summaries Space public
    Title:
    Auditor Changes and the Cost of Bank Debt
    Practical Implications:

    Currently, bank loans account for more than half of the total debt financing in the United States. The results from this study indicate that there is an increase in loan costs for companies within the following year of an auditor change. This is a factor companies should consider when applying for loans after a switch. 

    Citation:

    Francis, Bill B., D. M. Hunter, D. M. Robinson, Michael N. Robinson, and X. Yuan. 2017. “Auditor Changes and the Cost of Bank Debt”. The Accounting Review. 92.3 (2017): 155.

    Keywords:
    auditor change; information risk; financial reporting quality; information signaling; loan contracting; cost of bank debt; loan spreads; private credit market
    Purpose of the Study:

    Companies change auditors for various reasons, however due to the costs associated with switching, it is often an indication of potential problems between the auditor and company. This study examines the effects that an auditor change has on bank loan contracting. Specifically, whether companies that switch auditors incur increased costs and more stringent nonprice terms on loans. The authors address two potential reasons of why an auditor change would lead to information risk, and subsequently higher costs on loans. The first is if creditors perceive that the auditor change is opportunistic, such as management trying to find a more compliant auditor. The second information risk is related to the new auditor’s lack of client-specific knowledge. Both of these risks would cause for audit quality to decrease and, therefore loan costs would increase. The authors also consider the type of switch and its effect on loan costs. The three types examined are from (Non)Big 4 to (Non)Big 4, Big 4 to Non-Big 4, and Non-Big 4 to Big 4.

    Design/Method/ Approach:

    The sample includes 312 pairs of auditor change companies and non-audit change companies from 1998-2014. The audit change information was gathered using Audit Analytics and the bank loan data was from DealScan. Additionally, the authors excluded all audit switches due to the collapse of Arthur Andersen in 2002. The authors utilize a difference-in-differences (DID) research design comparing loan spreads between auditor change companies (before and after switch) and non-audit change companies.

    Findings:

    Overall, the authors find that when companies initiate a loan within a year of changing auditors there is a 22% increase in loan costs.           

    Specifically, the authors find the following:

    • There is no significant difference in the incremental loan spread between the three types of auditor switches. This evidence suggests creditors place a stronger emphasis on the two information risks instead of the potential differences between Big 4 and Non-Big 4 audit quality.
    • There is still a substantial increase in information risk following the change regardless of whether the company initiates the auditor switch (dismissal) or the auditor resigns
    • There is a 13.65% increase in the probability that banks add collateral requirements following an auditor change. The upfront and annual fees also increase by an average of about 53% and 25% respectively.
    Category:
    Auditor Selection and Auditor Changes
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