Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • James L Fuehrmeyer
    An Empirical Analysis of Auditor Independence in the Banking...
    research summary posted March 19, 2013 by James L Fuehrmeyer, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services 
    Title:
    An Empirical Analysis of Auditor Independence in the Banking Industry
    Practical Implications:

    The results suggest that fees paid to auditors, even for non-audit services, can potentially threaten auditor independence, particularly among banks that are not subject to the same level of regulatory scrutiny as large banks.

    Citation:

    Kanagaretnam, K., G. V. Krishnan, and G. J. Lobo. 2010. An Empirical Analysis of Auditor Independence in the Banking Industry. The Accounting Review 85 (6): 2011-2046.

    Keywords:
    auditor independence; earnings management; auditor fees; bank loan
    Purpose of the Study:

    Auditor independence is vital to maintaining public confidence in capital markets and to the integrity of corporate financial statements. The objective of this study is to examine auditor independence in the banking industry.

    • The study provides evidence on the relation between fees paid to auditors of banks and the extent of earnings management via loan loss provisions (LLPs).
    • The study is timely and relevant given the recent banking crisis and that governments around the world are contemplating new banking regulations.
    • The research informs policymakers on the relationship that existed between fees paid to auditors and the extent of earnings management in banks prior to the current banking crisis.
    • Authors examine difference between large and small firms that face different levels of regulation. Small firms are not subject to regulation under the Federal Deposit Insurance Corporation Improvement Act (FICIA) of 1991.
    Design/Method/ Approach:

    The authors collected 1,740 bank-year observations over the years 2000–2006. The authors determine abnormal LLPs and examine the association between abnormal LLPs and unexplained total fees and unexplained non-audit fees. They then examine whether the association is different depending on whether the bank is small (total assets of less than $500 million or less than $1 billion, effective 2005, or non-accelerated filers under Section 404 of Sarbanes-Oxley Act, effective 2004) or large.

    Findings:
    • For large banks, there is no relationship between abnormal LLPs and unexplained total fees or unexplained non-audit fees.
    • For small banks, higher unexplained total fees and unexplained non-audit fees are positively associated with income-increasing earnings management through LLPs. Higher unexplained total fees and unexplained non-audit fees are negatively associated with income-decreasing earnings management through LLPs. These two results provide evidence that banks that pay higher audit fees engage in more earnings management.
  • Jennifer M Mueller-Phillips
    Audit Firm Tenure, Non-Audit Services, and Internal...
    research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 04.07 Audit Firm Rotation, 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality 
    Title:
    Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality.
    Practical Implications:

    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 thateven 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).

    Citation:

    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.

    Keywords:
    audit quality, audit firm tenure, non-audit services
    Purpose of the Study:

    This study asks whether audit quality declines when audit firm tenure becomes long or when fees from auditor-provided non-audit services become large. The financial crisis of 2008 reignited a long standing debate on the impact of audit firm tenure and auditor-provided non-audit services on audit quality. Prior literature examining effects of audit firm tenure and non-audit services on audit quality have had to use externally observable proxies for audit quality which are, therefore, indirect measures of audit-related outcomes that may not fully reflect the quality of auditors’ execution of the audit process. However, regulators focus on process-related characteristics of audit quality including (1) the extent and appropriateness of evidence supporting the auditor’s opinion and (2) the degree of correspondence between the auditor’s procedures and auditing standards. Therefore there may be a difference between indirect external proxies for audit quality and audit quality proxies actually used by regulators. This study assesses audit quality using direct assessments of attributes of the audit process made by internal reviewers at a large international audit firm in 265 US audits of publicly and privately held clients. Primary analyses are based on two quality measures developed from the review data: 1) the total number of assessed audit deficiencies across 55 separate audit process activities; and 2) a composite assessment of the overall quality of the audit.

    Design/Method/ Approach:

    The data set used in this research was obtained from a large international accounting firm by one of the authors who was employed by the firm at the time the data were collected. The author developed a questionnaire to gather information during the reviews on various audit fee, production, and other engagement characteristics. The data were gathered in October 2003.

    Findings:
    • Audit quality is lowest in first-year audits, improves shortly thereafter, and then declines somewhat as audit firm tenure becomes long. The decline in quality in the long-tenure range is attributable to audits of private clients.
    • In public-client audits, quality increases slowly over the entire tenure range and is not significantly higher than in a first-year audit until the longest period where tenure exceeds 13 years.
    • In contrast, quality in private-client audits improves quickly after the first year but declines with very long tenure to the point where it is indistinguishable from audit quality in the first year.
    • Audit quality is not associated with non-audit fees in the full sample but, as above, the public- and private-client subsamples exhibit different patterns of association. The association of audit quality with non-audit fees is positive in audits of public clients and negative in the audits of private clients.
    • For public clients, the probability of a high-quality audit is 7 percentage points higher for clients purchasing non-audit services than for clients not purchasing these services.
    • For private clients, the probability of a high-quality audit of a private client purchasing non-audit services is 18 percentage points lower than for those not purchasing non-audit services.
    Category:
    Audit Quality & Quality Control, Independence & Ethics
    Sub-category:
    Audit Firm Rotation, Audit Firm Rotation, Non-audit Services, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    Audit Firm Tenure, Non-Audit Services, and Internal...
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 04.07 Audit Firm Rotation, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality 
    Title:
    Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality.
    Practical Implications:

    The lower quality and higher effort associated with first-year audits represent additional costs that should be considered in the ongoing debate on mandatory audit firm rotation. The differential findings for private and public clients suggest that market and related regulatory forces discipline auditors of SEC clients to maintain a high level of audit quality even when tenure is long or NAS fees are high. The findings are important for regulatory policies related to audit firm tenure and auditor-provided NAS. The finding that quality declines in private-client audits as NAS fees increase or tenure becomes long should be of interest to standard setters in the private sector.

    Citation:

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

    Keywords:
    audit firm tenure, audit quality, non-audit services, independence
    Purpose of the Study:

    After decades of debate and research, the auditing profession, regulators, and researchers continue to wrestle with two longstanding concerns about perceived threats to auditor independence and audit quality: (1) Social bondingbecoming personally friendly with, or increasingly trusting of, client management, and (2) Economic bondingbecoming financially dependent on multiperiod fees from audits and non-audit services (NAS) provided to the client. Regulators have argued that social bonding from long tenure erodes professional skepticism and induces auditor complacency, while economic bonding from non-audit fees prompts auditor concessions or shirking in response to management’s financial reporting demands. On the other hand, the auditing profession has argued that there is no systemic decline in audit quality as audit firm tenure or fees from NAS increase, and that restrictions on tenure or NAS disrupt auditor learning, constrain the financial and human resources available for audit production, and impede knowledge spillovers.

    The authors use data from internal assessments of audit quality in a Big 4 firm to investigate the impact of audit firm tenure and auditor-provided non-audit services (NAS) on audit quality.

    Design/Method/ Approach:

    The data used in this study consists of audit quality assessments, audit firm tenure, audit and NAS fees, total and staff-level audit labor hours, and other key client and engagement characteristics for 265 U.S. audits conducted by a Big 4 firm for both publicly listed (57%) and privately held (43%) clients. Audit firm personnel collected the data during the annual internal quality reviews performed during late spring through early fall of 2003.

    Findings:
    • Audit quality is lowest in first-year audits, improves shortly thereafter, and declines somewhat as tenure becomes very long.
    • The probability that a second-, third-, or fourth-year audit receives a high quality rating is, on average, 21 percentage points higher than the probability for a first-year audit, while audit quality for audits where tenure is greater than 13 years is not significantly different from that of a first-year audit.
    • Audit effort is significantly higher in first-year audits in spite of discounted fees.
    • In audits of SEC registrants, quality increases slowly over the entire tenure range, while audits of private clients exhibit a rapid increase in quality in early years and an equally steep decline in later years.
    • Audit partner specialization in the client’s industry is associated with higher audit quality in both the full sample and in first-year audits. For SEC clients, the authors also find that audit quality and audit effort each are positively associated with discretionary accruals (DAs), suggesting that auditors recognize the risks associated with unusual accruals and respond by conducting more effective procedures.
    • When ex-Andersen clients are removed from the sample, the authors no longer observe lower audit quality in first year audits.
    Category:
    Audit Quality & Quality Control, Independence & Ethics
    Sub-category:
    Attempts to Measure Audit Quality, Audit Firm Rotation, Audit Firm Rotation, Non-audit Services
  • Jennifer M Mueller-Phillips
    Auditor fees and auditor independence ‒ Evidence from g...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Title:
    Auditor fees and auditor independence ‒ Evidence from going concern reporting decisions in Germany.
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    Auditor independence, auditor reporting, non-audit fees, audit fees, Germany
    Purpose of the Study:

    On October 13, 2010, the European Commission published a Green Paper entitled “Audit Policy: Lessons from the Crisis”. Against the background of the recent global financial and economic crisis, this Green Paper proposes primarily reforms to improve auditor independence, and therewith audit quality, and to improve the structure of the audit market. One of the main areas of interest in this Green paper is whether the provision of consulting services by statutory auditors endanger the independence of auditors. This paper examines whether this concern can be empirically substantiated by investigating the potential for non-audit services to impair auditor independence using going concern modifications as a proxy for audit quality. While prior research has focused primarily on Anglo-Saxon environments, this study focuses on Germany because of the country’s unique reporting attributes (i.e., Lagebericht, which is a management report, and its associated Risikobericht, which is a risk report) and lower litigation risk when compared to Anglo-Saxon settings.

    Design/Method/ Approach:

    The analysis is based on a sample of financially distressed, capital market-oriented companies from the study period 2005-2009. Companies are defined as financially distressed if they meet one of the following five criteria: (1) negative equity, (2) negative operating cash flow, (3) negative working capital, (4) negative EBIT in the previous year, and (5) net loss in the previous year. These criteria are taken from a survey of German auditors, asking these to estimate the relevance of a number of indicators relating to the going concern assumption. These indicators are very similar to the criteria used in international studies for identifying financially distressed companies. In light of recent research findings on auditor reporting behavior from the United States, which, using strict control samples, report different results compared to previous U.S.-American studies, this study includes a second control sample. In alignment with the U.S.-American literature, this second control sample includes companies showing both a net loss in the previous year and a negative operating cash flow in the previous year. 

    Findings:
    • The results show no evidence of a significant negative relationship between the level of non-audit fees and the likelihood that an auditor issues a going concern opinion (GCO).
    • However, there is some evidence that the potential for non-audit services to impair auditor independence depends on the type of audit firm conducting the audit (Big 4 compared to non-Big 4). If the level of non-audit fees is relatively high, then Big 4 audit firms are less likely to issue a GCO. However, this result holds only for highly financially stressed clients.
    • The results for the examined unique German reporting environment show a positive association between liquidity risks explicitly presented in the Risikobericht and the likelihood that the auditor includes a GCO in the audit report.
    Category:
    Independence & Ethics
    Sub-category:
    Going Concern Decisions, Non-audit Services
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization, Service Bundling, and...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City.
    Practical Implications:

    The authors contribute by providing some of the first evidence of service bundling in the economics of auditing literature. In doing so, they broaden the notion that strategic pricing occurs around audit switches. This study contributes to prior mixed findings of the existence of industry specialist premiums in the small-client segment, suggesting an additional reason why these mixed findings might occur. Where opportunities to package services are attractive, auditors may strategically price and discount audits with bundling premiums in mind. Where potential for such bundling opportunities is less attractive, it is possible the auditor may instead seek to generate premiums in the audit service.

    Citation:

    Ferguson, A., G. Pündrich, and A. Raftery. 2014. Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City. Auditing: A Journal of Practice & Theory 33 (3): 153-180.

    Keywords:
    audit fees, industry specialization, mining industry, non-audit services, second-tier firms, service bundling
    Purpose of the Study:

    This study examines auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms. In this study, the authors consider whether an auditor industry specialist may strategically price a bundle of services in the small-client segment. They argue that the small company sector is a good environment to consider the existence of service bundling. The setting is the mining development stage entity (MDSE) market in Perth, the biggest industry and city in Australia by client numbers. This market is characterized by small (high-growth) firms where auditing is arguably of less importance to the client compared to tax advisory, the other primary service provided to them. Further, the firms are relatively homogeneous, an appealing feature of industry studies. Thus, the authors have arguably an attractive setting to observe service bundling by an industry specialist.

    First, the authors examine whether industry specialist auditors earn audit fee premiums in the Perth MDSE segment. To do this, an audit pricing model is developed and includes controls likely to impact on audit fees in a mining industry context. Second, the authors redefine the dependent variable to consider the pricing implications of the bundle of services provided by industry specialists.

    Design/Method/ Approach:

    The authors utilize an OLS regression model to test for audit fee premiums with respect to brand name and industry leadership. A sample of 1,799 firms listed on the ASX as of December 31, 2009 is obtained. Of the 1,799 listed entities nationally, 668 (37.13 percent) are domiciled in Perth, making it the largest city-level market by client numbers in Australia. At the city-level, the market share of non-Big 4 firms is 70.1 percent in Perth.

    Findings:

    The authors find no evidence of auditor industry leadership audit fee premiums accruing to either Big 4 (EY) or non-Big 4 (BDO) leaders. However, when the dependent variable is redefined to include non-audit services (NAS), the industry leader, BDO, obtains a total fee premium. This finding is of added interest given that the industry leader is a second-tier firm, implying that strategic audit pricing, such as service bundling, is not confined to Big 4 auditors. Nor is it confined to merely one location, since bundling premiums are observed at the national level. The authors argue MDSEs have little in the way of financial statement complexity, so they do not value specialist audits, but rather are willing to pay more for NAS. Last, in supplementary analysis, the authors find some evidence of partner-scale effects.

    Category:
    Audit Team Composition, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Industry Expertise – Firm and Individual, Non-audit Services
  • Jennifer M Mueller-Phillips
    Client Importance and Earnings Management: The Moderating...
    research summary posted October 24, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    Client Importance and Earnings Management: The Moderating Role of Audit Committees
    Practical Implications:

    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.
     

    Citation:

    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.

    Keywords:
    audit committee; auditor independence; accruals; corporate governance; fees, earnings management; non-audit
    Purpose of the Study:

    As a result of declining investor confidence in the quality of financial information due to financial scandals, many countries have implemented corporate governance reforms that specifically identify the audit committee as the primary mechanism for the oversight of auditor independence and financial statement quality. This study investigates how the association between the economic importance of a client to the auditor and earnings management is moderated by the audit committee. Client importance is a potential threat to auditor independence and thus is a potential threat to audit quality. The authors suggest that the possibility exists that auditors may view the audit wealth provided from a client as more important than maintaining independence which is determinant of the audit quality; therefore, the authors examine if there is a positive correlation between client importance and earnings management. Certain circumstances, such as management ownership, leverage, high growth, and firm size, could potentially promote an environment that is conducive to earnings management independent of the external audit. In consideration of these circumstances, the auditors studied whether the association between client importance and earnings management was effected by these firm environmental factors. The audit committee’s response and efforts to mitigate these factors were also examined, specifically in light of the best practices recommendations. 

    Design/Method/ Approach:

    The authors conducted this study by gathering empirical evidence from firms listed on the New Zealand Stock Exchange in the fiscal years 2004 and 2005. The NZSE was chosen as a proper natural laboratory because there is no ban or limit on non-audit services, no mandate on the roles and composition of the audit committee exists, the audit profession is self-regulated, it is a less litigious environment, and it is geographically and economically small.

    Findings:
    • A positive correlation was observed between client importance and the observed proxies for earnings management, which included both performance-adjusted discretionary total and current accruals. This implies that as client importance, as related to the wealth production to the external auditors, increases the possibility of the existence of earnings management in the financial statements also increases.
    • The association became more pronounced for income-increasing accruals that potentially diminish the quality of earnings and are of greater concern to regulators; however, this was moderated by the audit committee.
    • The association between client importance and earnings management is conditional on other firm characteristics such as inside ownership, growth, leverage, and firm size. These factors could create potential agency conflicts but are moderated by the audit committee.
    • Accounting expertise on the audit committee and committees composed completely of outside directors explain the moderating effects of the audit committee.
    • The association with earnings management became more pronounced when the audit committee did not meet the best practices outlined by the NZSEC. These practice suggestions from the NZSEC are merely recommendations, not requirements, as the auditing profession is self- regulated in New Zealand.
       
    Category:
    Governance, Independence & Ethics
    Sub-category:
    Board/Audit Committee Oversight, Impact of Fees on Decisions by Auditors & Management, Non-audit Services
  • Jennifer M Mueller-Phillips
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Imp...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 04.0 Independence and Ethics, 04.03 Non-Audit Services 
    Title:
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality?
    Practical Implications:

     This study serves the purpose of examining the PCAOB’s role as overseer of public company auditing, while separating from previous studies by targeting the PCAOB’s restrictions on auditors’ tax services, which have not been examined in the past. This study also examines whether APTS pose a threat to audit quality but again differentiates itself from previous literature by focusing on only the tax services that the PCAOB chose to ban and by utilizing the difference-in-differences design to address the limitation of the cross-sectional approach utilized by other studies in the past. After reviewing these findings, it is possible that the PCAOB restrictions did not fully accomplish their objective.

    Citation:

     Lennox, C. S. 2016. Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality? The Accounting Review 91 (5): 1493-1512.

    Keywords:
    PCAOB, audit quality, and auditors’ tax services.
    Purpose of the Study:

    In 2005, the Permanent Subcommittee on Investigations of the U.S. Senate reported that audit firms were selling potentially abusive or illegal tax-planning strategies to audit clients and their top executives on a contingent fee basis. This concerned regulators for many reasons; consequently, the PCAOB adopted three new rules to address these potential threats to audit quality. First, Rule 3521 reaffirms the ban on contingent fees that existed under Rule 302 of the American Institute of Certified Public Accountants’ Code of Professional Conduct. Second, Rule 3522 bars audit firms from selling aggressive tax services to audit clients. Finally, Rule 3523 forbids audit firms from selling tax services to executives in a financial reporting role. These three rules became effective from October 31, 2006 onward. The PCAOB stated that the rules were intended to improve audit quality, and, by extension, the quality of financial reporting. The purpose of this study is to test whether the restrictions met this objective.

    Design/Method/ Approach:

    Because audit quality is not directly observable the author focuses on accounting misstatements, both misstatements that are tax-related and other types, and the issuance of going-concern opinions. The author separates companies into groups based upon the reduction of APTS purchases between July 26, 2005 and October 31, 2006. He then compares the differences in misstatements and going-concern opinions between the treatment and control groups and tests whether these differences change after the PCAOB imposed the restrictions on auditors’ tax services. 

    Findings:
    • The author finds that in the period before the restrictions, there is no difference in the incidence of going-concern opinions between the treatment and control companies; however, the treatment companies are more likely than the control companies to have accounting misstatements and tax-related misstatements. This supports the premise of regulators that the treatment companies had lower-quality auditing before the restrictions were introduced. 
    • The author finds no significant changes in misstatements, tax-related misstatements, or going-concern opinions subsequent to the APTS restrictions after using a difference-in-differences research design. In fact, the treatment companies continue to have significantly more accounting misstatements and more tax-related misstatements in the period subsequent to the APTS restrictions.
    • The author finds large and highly significant reductions in APTS fees when the restrictions were introduced. 
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of PCAOB, Non-audit Services
  • Jennifer M Mueller-Phillips
    Do Former Audit Firm Partners on Audit Committees Procure...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor?
    Practical Implications:

    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.
     

    Citation:

    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.

    Keywords:
    alumni; audit committee; cooling-off period; former partner; independence; nonaudit; revolving-door
    Purpose of the Study:

    This study focuses on how the presence of a former audit firm partner (FAP) on the audit committee is related to nonaudit services (NAS) procured from the external auditor. The Sarbanes-Oxley Act of 2002 requires the audit committee to pre-approve nonaudit services procured from the auditor to prevent potential independence issues. The presence of a FAP affiliated with the current auditor on the audit committee could undermine the audit committee’s due diligence over the NAS pre-approval process. To alleviate these concerns, the SEC implemented a three-year cooling-off period for appointing audit form alumni as independent directors. This study analyzes the effects of these relationships on auditor independence.

    Design/Method/ Approach:

    A sample of 2,748 firm-year observations with available corporate governance, director, and CFO biographical data for fiscal years ending in 2004 and 2005 was selected. The sample was tested using regression models to investigate the association between affiliated former audit partners (AFAPs) and unaffiliated audit partners (UFAPs) on the audit committee and nonaudit services purchased from the auditor.

    Findings:
    • Firms with FAPs purchase significantly less NAS compared to firms without and FAP.
    • The capacity of the audit committee to reduce dependency on auditor-provided NAS in the post-SOX era may be enhanced when committee members possess partner-level experience.
    • AFAPs on the audit committee adopt a more conservative NAS pre-approval strategy by reducing NAS purchased from the auditor.
    • Audit committees including AFAPs not meeting the mandatory three-year cooling off periods are equally conservative when pre-approving NAS purchased for the auditor relative to audit committees that include AFAPs satisfying this rule and UFAPs.
       
    Category:
    Governance, Independence & Ethics, Standard Setting
    Sub-category:
    Board/Audit Committee Composition, Impact of SOX, Non-audit Services
  • The Auditing Section
    Do Investors’ Perceptions Vary with Types of Nonaudit F...
    research summary posted April 13, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.01 Scope of Services, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services, 04.08 Impact of SEC Rules Changes/SarbOx 
    Title:
    Do Investors’ Perceptions Vary with Types of Nonaudit Fees? Evidence from Auditor Ratification Voting
    Practical Implications:

    This paper added to the discussion on what types of services audit firms should and should not provide to their audit clients. The evidence in this paper supports the view that investors do not view tax services provided to audit clients in the same light as audit-related services.  The findings of this study are relevant to managers and boards of directors who purchase non-audit services (audit-related, tax or other) from the external auditor.  This study is also useful to practicing auditors to address audit committee concerns on non-audit services.

    Citation:

    Mishra, S., K. Raghunandan, and D.V. Rama. 2005. Do Investors’ Perceptions Vary with Types of Nonaudit Fees? Evidence from Auditor Ratification Voting. Auditing: A Journal of Practice & Theory 24 (2): 9-25.

    Keywords:
    audit fees; audit committees
    Purpose of the Study:

    Beginning in 2001, the Securities and Exchange Commission (SEC) required registrants to disclose fees paid to auditors in the following categories: audit, financial information system design and implementation (FISDI), and other fees.  In 2003 the SEC updated the disclosure requirements by adding two new fee categories: tax fees and audit-related fees (which were previously reported in “other fees”) and eliminating FISDI, based on the prohibition of these services by the Sarbanes-Oxley Act.  The SEC  suggested the expanded disclosure would provide better information for investors to determine for themselves if auditor ndependence is impaired as a result of non-audit services provided and the nature of fee arrangements.            

    The SEC asserted that investors and financial statement users would view audit-related and tax fees more favorably than “other” fees.  The authors test this assertion by examining the relation between shareholder auditor ratification votes and ratios of audit-related, tax, and other fees to audit fees.  If investors view audit-related and tax fees differently than other non-audit fees then the authors expect auditor ratification voting to vary by fee ratio.      

    Design/Method/ Approach:

    Using firms in the S&P 1500 the authors select a sample of 248 firms that submit auditor ratification for shareholder vote during 2003.  The authors then gather the results of the ratification votes for these firms from the subsequent Form 10-Q or 10-K filings. The authors also gather company financial information from various public sources and evaluate the impact of fee ratios on the outcome of shareholder ratification votes.

    Findings:
    • Shareholders voting against auditor ratification increased substantially from 2001 to 2002 to 2003.  The authors posit that this result is largely driven by Andersen’s failures and Enron’s demise. As expected, other fees impact shareholder ratification votes unfavorably.
    • Tax fees impact shareholder ratification votes unfavorably; which is contrary to the SEC assertion that investors view these tax fees favorably.  However, this supports the PCAOB’s actions in 2005 relating to restricting some auditor-provided tax services.
    • Audit-related fees are viewed favorably by investors, which is consistent with the SEC’s assertion and opposite of the result of tax fees.
    • Overall, the results support the SEC assertion of a need for separate categories of non-audit fees (audit-related, tax and other) as shareholder voting on auditor ratification appears to be influenced by these non-audit fees. 
    Category:
    Standard Setting, Auditor Selection and Auditor Changes
    Sub-category:
    Impact of SOX, Scope of Services, Impact of Fees on Decisions by Auditors & Managmeent, Non-audit Services, Impact of SEC Rules Changes/SarBox
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Does Mandated Disclosure Induce a Structural Change in the...
    research summary posted October 13, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 09.0 Auditor Judgment, 09.06 Adequacy of Disclosure 
    Title:
    Does Mandated Disclosure Induce a Structural Change in the Determinants of Nonaudit Service Purchases?
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    auditor fees, mandatory disclosures, nonaudit services
    Purpose of the Study:

    The impact of nonaudit services (NAS) on perceived audit quality has been the subject of a considerable amount of prior research. This stream of research includes investigations of stock and bond markets’ reactions to NAS disclosure as a proxy for perceived auditor independence. In this study, the authors investigate whether the introduction of mandated NAS disclosures is associated with structural changes in the relations between certain company characteristics and NAS purchases in pre- and post-disclosure settings. The authors accomplish this by comparing NAS purchases made in 2000 (pre-disclosure) with those made by the same set of firms (employing the same auditor) in 2001 (post-disclosure). 

    By examining the impact of mandated NAS disclosure on NAS purchasing behavior, the study seeks to provide evidence on the potential regulatory efficacy of disclosure requirements such as the Securities and Exchange Commission’s (SEC) Auditor Independence Rules of 2000, which mandated audit fee and NAS disclosures. During the rule-making deliberations, the SEC adopted a demand-side approach to regulating NAS purchases. In particular, the SEC sought to let the market decide the optimal level of NAS purchases by imposing a mandatory NAS disclosure regime. However, the subsequent Sarbanes-Oxley Act (SOX) took a supply-side approach to the NAS issue by banning several NAS services. Consequently, the test setting represents a unique window of opportunity since it occurs after the Auditor Independence Rules of 2000, but before the SEC altered the NAS definitions and before SOX.

    Design/Method/ Approach:

    For comparative purposes, the authors utilize the sample previously used in Abbott et al. The original sample consisted of the 310 nonfinancial firms filing proxies with the SEC between February 5, 2001, and March 16, 2001. The final sample used by the authors is a sample of 338 firms available for both 2000 and 2001.

    Findings:
    • The authors find little support for an agency-based model for NAS purchases in a nondisclosure environment.
    • In contrast, the authors document statistically significant structural differences in the relation between the NAS/audit fee ratio and three of the four primary agency conflict variables when switching to a disclosure environment.
    • They also find similar results when they use the same model to predict which firms were more likely to reduce 2001 NAS purchases relative to 2000 NAS purchases.
    • They document that inside ownership and financing activity become statistically significant determinants of NAS purchasing behavior in the disclosure environment.
    • In addition, the positive association between company size and the demand for NAS decreases during the post-disclosure environment, consistent with the larger agency costs of larger firms.
    • They also document a statistically significant increase in the magnitude of the audit committee effectiveness coefficient for the subsequent year NAS purchases.
    • The agency-based model’s R2 increases over 70 percent from the initial year (i.e., nondisclosure environment) to the subsequent year of NAS disclosure (i.e., disclosure environment).
    Category:
    Auditor Judgment, Independence & Ethics
    Sub-category:
    Adequacy of Disclosure, Non-audit Services

Filter by Type

Filter by Tag