In first-year audits, lower audit process quality and higher total audit hours are possible additional costs that should be considered in the ongoing debate on mandatory audit firm rotation. Moreover, study results are consistent with the notion that—even prior to the effective date of the Sarbanes-Oxley Act (SOX)—market and related regulatory forces disciplined auditors of public entities to achieve a high level of audit quality when tenure was long or fees from auditor-provided non-audit services were large. In order to serve the public interest, these considerations should be included in assessments of the economic costs and benefits of restrictions on audit firm tenure and non-audit services.

Furthermore, the results suggest that, in the private-client market, audit process quality declines in the long tenure range and when non-audit fees become large, which may be of interest to standard setters in the private sector (e.g., the Auditing Standards Board and US State Boards of Accountancy).

Bell, T.B., M. Causholli, and W.R. Knechel. 2015. Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality. Journal of Accounting Research 53(3):461-509.

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The results of this study show that in general market-based incentives, such as loss of reputation, constitute more important factors with regard to auditor independence than an economic dependence caused by higher non-audit fees. However, those safeguards may not be adequate in all situations given the relatively low litigation risk in Germany. The relatively high importance of consulting services performed in audit engagements by the Big 4 group seems to give Big 4 auditors an incentive to continue the auditor-client relationship, and is therefore to be regarded as an additional economic dependence between auditor and client. The explicit representation of liquidity risks through management appears to influence auditor reporting behavior in relation to going concern risks. This information—even if it is not presented in a separate reporting instrument, such as the Lagebericht—could also determine auditor reporting behavior outside Germany.

For more information on this study, please contact Nicole Ratzinger-Sakel.

Ratzinger-Sakel, N. V. S. 2013. Auditor fees and auditor independence ‒ Evidence from going concern reporting decisions in Germany. Auditing: A Journal of Practice and Theory 32 (4): 129-168.

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The results of this study have implications to both New Zealand and the United States. Regulators in New Zealand should assess these results as possible indications that the profession’s self-regulated status may need to be revised in light of the existence of lower financial reporting quality for clients that have weak audit committee oversight and are economically important clients to the auditor. Additionally, these results provide evidence to contribute to the ongoing debate in the United States regarding the merits and the intended and unintended consequences of independent auditor oversight through regulatory bodies such as the PCAOB.

For more information on this study, please contact Vineeta D. Sharma.
 

Sharma, V., D.S. Divesh, and U. Ananthanarayanan. 2011. Client importance and earnings management: the moderating role of audit committees. Auditing: A Journal of Practice and Theory 30 (1): 125-156.

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This study presents new evidence that suggests the presence of AFAPs and UFAPs on the audit committee has the potential to reduce threats to auditor independence by pre-approving the purchase of less NAS form the auditor. The findings of this study are consistent with the view that AFAPs serving as independent audit committee members appear not to make economic decisions in favor of their former audit firm, and, thus, may be exercising objective and independent oversight to enhance auditor independence. This evidence is also in line with the goal of SOX to reduce actual or perceived threats to auditor independence. From a regulatory perspective, the findings suggests that concerns about audit firm alumni on client’s audit committees may not be warranted in the post-SOX environment and the three-year cooling period rule may be unnecessary. However, further research in other contexts is needed.

For more information on this study, please contact Vic Naiker.
 

Naiker, V., D. S. Sharma, and V. D. Sharma. 2013. Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor? The Accounting Review 88 (1): 297–326.

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The authors contribute to the literature in three ways. First, the results provide support for the agency-based demand for publicly available audit quality signals in a powerful test setting. They find SOX supply-side approach of banning certain NAS may have hurt some registrants if those banned NAS services previously served to increase overall audit quality. Second, the evidence provided herein suggests that registrants learned from the market’s negative price protection reaction and, in accordance with agency theory, recalibrated their subsequent year NAS purchases. Finally, the results provide archival, empirical support for the audit committee incentive arguments of Gaynor et al.

Abbott, L. J., S. Parker, and G. F. Peters. 2011. Does Mandated Disclosure Induce a Structural Change in the Determinants of Nonaudit Service Purchases? Auditing: A Journal of Practice & Theory 30 (2): 51-76.

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