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  • Jennifer M Mueller-Phillips
    The Effect of China’s Weak Institutional Environment on t...
    research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality 
    Title:
    The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits.
    Practical Implications:

    This study suggests that the strength of the institutional environment can significantly influence audit quality, and subsequently financial reporting quality even for global accounting firms with standardized training and auditing procedures.  Furthermore, this study has important implications for the SEC which has voiced concerns about the quality of auditing in China, and the PCAOB which has been barred by the Chinses government from conducting inspections of auditing firms located in mainland China.

    Citation:

    Ke, B., C. S. Lennox, and Q. Xin. 2015. The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits. The Accounting Review 90 (4): 1591-1619.

    Keywords:
    Audit quality, Big 4, China
    Purpose of the Study:

    The Big 4 audit firms operate on a global scale and assert that they maintain a uniformly high level of quality around the word by providing their employees standardized training and through the global application of consistent auditing methodologies. However, there is some reason to suspect that the strength of a country’s institutional environment might influence the supply of audit quality such that Big 4 firms provide lower-quality audits in countries with relatively weak institutional environments. Because it is difficult to control for all differences between countries, this can be difficult for researchers to examine empirically. To combat this issue, this study takes advantage of a unique characteristics of Chinese firms.  Hong Kong is seen as having a stronger institutional environment relative to mainland China and firms that are listed on both the mainland exchange and the Hong Kong exchange must prepare and audit two separate sets of financial statements. This allows the authors to better isolate how variability in institutional strength affects audit quality for the clients of Big 4 firms. In particular, the study address the following research objectives:

    • Whether Big 4 firms assign their most experienced audit partners to clients who are listed on both exchanges relative to those only listed on the mainland exchange.  
    • Whether audit quality of cross-listed firms is higher than firms solely listed on the mainland exchange.
    • Whether differences in audit quality between firms that are cross-listed and firms that are only listed on the mainland China exchange lead to differences in financial reporting quality.
    Design/Method/ Approach:

    The authors use data on publicly traded Chinese companies from the years 1995-2012 to examine differences in audit quality, and financial reporting quality for firms cross-listed on both the HK exchange and the mainland China exchange, relative to firms solely listed on the mainland China exchange.  To examine differences in partner experience, the researchers utilize data from a unique dataset supplied by the Chinese Institute of Certified Public Accountants.

    Findings:
    • Partners assigned to cross-listed firms are significantly more experienced than partners assigned to clients that are not cross-listed. This suggests that Big 4 firms may assign auditors based on the strength of the institutional environment such that their more experienced auditors are assigned to stronger institutional environments.
    • Cross-listed firms are associated with higher levels of audit quality relative to firms only listed on the mainland China exchange. This is consistent with the assertion that Big 4 audit firms may provide lower-quality audits in weaker institutional environments.
    • Cross-listed firms are associated with lower levels of financial reporting quality relative to firms only listed on the mainland China exchange. This suggests that the lower level of audit quality provided by Big 4 firms in weaker institutional environments negatively impacts financial reporting quality.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Attempts to Measure Audit Quality, Diversity of Skill Sets (e.g. Tenure & Experience)
  • Jennifer M Mueller-Phillips
    The Effect of Joint Auditor Pair Composition on Audit...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 11.07 Attempts to Measure Audit Quality, 15.0 International Matters 
    Title:
    The Effect of Joint Auditor Pair Composition on Audit Quality: Evidence from Impairment Tests
    Practical Implications:

    Regulators are constantly trying to find ways to improve audit quality. The findings in this paper are useful to policymakers in understanding the benefits of a joint audit. It is also useful to companies and investors who are interested in what audit pairs provide a superior audit. 

    Citation:

    Lobo, Gerald J., L. Paugam, D. Zhang, and J. Francois Casta. 2017. “The Effect of Joint Auditor Pair Composition on Audit Quality: Evidence from Impairment Tests”. Contemporary Accounting Research 34.1 (2017): 118.

    Purpose of the Study:

    Regulators across the globe have been trying to find ways to increase audit quality, and one idea that has been proposed is requiring joint audits. Currently, joint audits are mandatory in France for any company preparing consolidated financial statements. This paper examines whether the auditor pair composition is related to audit quality. The three auditor compositions are Big4-Big 4 (BB), Big4-non-Big 4 (BS), and non-Big 4 non-Big 4 (SS). For the purposes of this study only BB and BS pairs are analyzed. The impairment of goodwill is examined to measure audit quality. This is due to management’s large discretion for the impairment of goodwill. The way auditor’s handle the impairment of goodwill often highlights how well they are maintaining objectivity and transparency of the auditor’s tests. It is important to note in BS pairs the Big 4 firm is most likely to be the one performing the impairment test.

    Design/Method/ Approach:

    The sample includes French firms from the SBF 250 index for the years 2006-2009. There were a total of 551 observations for the BB and BS pairs. The authors examined how the auditor pair type affected recognition of economic impairment and transparency of impairment-related disclosures.

    Findings:

    Overall, the authors find that BS audit pairs are associated with having a higher audit quality when compared to BB audit pairs. The authors believe this is due to a better coordination and development of a hierarchy in BS audit pairs and a higher incentive for better audit quality from the Big 4 firm in BS audit pairs. This is because the Big 4 firm in BS audit pairs are at a higher risk of reputational harm, than if they are paired with another Big 4 auditor in a BB audit pair.

    Specifically, the authors find the following:

    • In situations where low-performance indicators are present, BS audit pairs are more likely to recognize an impairment loss and recognize a larger impairment loss than BB pairs.
    • BS audit pairs are more likely to be more transparent in the disclosure of impairment for goodwill. On the other hand, BB pairs are more likely to show reductions in impairment-related disclosures when they book an impairment.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, International Matters
    Sub-category:
    Attempts to Measure Audit Quality
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • Jennifer M Mueller-Phillips
    Understanding Audit Quality: Insights from Audit...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality 
    Title:
    Understanding Audit Quality: Insights from Audit Professionals and Investors
    Practical Implications:

    This study provides evidence that should help inform the public discussion of audit quality in the post-Sarbanes-Oxley era and adds empirical substance to theoretical frameworks of audit quality.  

    Citation:

    Christensen, B. E., S. M. Glover, T. C. Omer, and M. K. Shelley. 2016. Understanding Audit Quality: Insights from Audit Professionals and Investors. Contemporary Accounting Research 33 (4): 1648 – 1684. 

    Purpose of the Study:

    Much debate exists surrounding the definition, composition, and measurement of audit quality. This debate continues despite the importance of audit quality and the large body of research investigating the topic. This paper contributes to this debate by obtaining perceptions and measures of audit quality from audit professionals and investors, two groups heavily interested in the audit and financial reporting process.  Furthermore, this study provides evidence that contributes to understanding and defining audit quality, providing empirical evidence regarding many of the audit quality indicators proposed by the PCAOB, adding empirical substance to existing theoretical frameworks of audit quality and highlighting differences and consistencies between auditor and investor expectations about the audit process. 

    Design/Method/ Approach:

    The authors conducted a survey of audit professionals and investors to obtain their insights on audit quality.

    Findings:
    • The authors find that audit professionals define audit quality primarily in terms of compliance with professional auditing standards, while investors rely more on the individual characteristics of the engagement team performing the audit.
    • The authors find almost unanimous agreement that individual auditor characteristics influence audit quality.
    • The authors find evidence that input from parties outside the core engagement team such as the national office and engagement review partners is an important attribute of audit quality.
    • The authors find evidence that client-specific factors such as restatements, SEC enforcement actions, and the frequency of audit committee meetings are significant indicators of audit quality; however, they also find that investors’ perceptions of audit quality do not fully incorporate the importance of the audit committee in the audit process to the same extent as auditors. 
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    Understanding the Relation between Financial Reporting...
    research summary posted January 17, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality 
    Title:
    Understanding the Relation between Financial Reporting Quality and Audit Quality
    Practical Implications:

    These findings imply that recognizing the relation between financial reporting quality and audit quality and the observability of differing outcomes can provide greater insight into the interpretation of research findings. They also suggest that greater consideration of how changing and differing economic situations affect financial reporting and audit outcomes will provide deeper insight into the determinants and consequences of both audit quality and financial reporting quality. Finally, recognizing and controlling for the potential endogeneity can lead to greater insights into both financial reporting quality and audit quality. The authors also provide a framework for identifying potential areas for future research. 

    Citation:

    Gaynor, L. M., A. S. Keaton, M. Mercer and T. L. Yohn. 2016. Understanding the Relation between Financial Reporting Quality and Audit Quality. Auditing: A Journal of Practice and Theory 35 (4): 1 – 22. 

    Keywords:
    financial reporting quality, audit quality, quality proxies, and quality determinants.
    Purpose of the Study:

    Understanding the determinants of high quality reporting is an important goal of both auditing and financial accounting research. These two areas share many related issues; however, the research within each area tends to draw on prior research within that area. This exclusion has created a pressing need for a review of each stream of literature, with a special focus on how the areas of research intersect and relate to each other. This paper attempts to bridge the gap between the financial reporting quality and audit quality literatures.

    Design/Method/ Approach:

    The authors begin by developing definitions of financial reporting quality and audit quality that are grounded the authoritative literature. Next, they link the new definitions to the operational measures of these constructs used in financial reporting and audit quality research. With this understanding, the authors create a person/task/environment framework for conceptualizing the determinants of financial reporting and audit quality. 

    Findings:
    • The authors find that both audit quality and financial reporting quality literatures often underplay the distinction between pre-audit financial reporting quality and audit quality and use the same metric as a proxy for either financial reporting or audit.
    • The authors find that financial reporting quality and audit quality are often inseparable in terms of observable financial reporting outcomes in archival research.
    • The authors find that both financial reporting quality and audit quality are heavily influenced by the underlying economics of the business.
    • The authors find that financial reporting quality and audit quality are often endogenously determined. 
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder...
    research summary posted June 22, 2014 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.11 Impact of Firm and External Inspection Programs 
    Title:
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors.
    Practical Implications:

    The objective of this study is to determine whether PCAOB inspection reports of triennially inspected auditors are used as audit quality signals. The study was based upon the premise that the reports may serve as a publicly-available proxy of perceived audit quality. Clients were found to react differently to the PCAOB inspection reports contingent upon their severity with GAAP-deficient reports are more likely to trigger an auditor dismissal than a clean or GAAS-deficient report. The results suggest that clients of non-Big 4/non-national auditors are using certain PCAOB inspection reports as a publicly-available signal of audit quality and not as a means of procuring more favorable audit reporting or audit fees. 

    Citation:

    Abbott, L., K. A. Gunny, and T. C. Zhang. 2013. When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors. Auditing 32 (2).

    Keywords:
    audit quality signals, PCAOB inspection process
    Purpose of the Study:

    The PCAOB conducts inspections of registered public accounting firms that provide audits for publicly traded companies. The results of the inspection process are summarized in publicly available reports at the PCAOB website. Using these reports, this study categorizes the inspection reports into three levels of increasing severity: clean, GAAS-deficient, and GAAP-deficient. GAAP-deficient PCAOB inspection reports are examined for potential use as perceived audit quality signals for the clients of GAAP-deficient auditors that are inspected on a triennial basis by the PCAOB. The investigation is predicated on the notion that audit quality is generally not directly observable. Thus the clients of these auditors may seek to signal their desire for audit quality by dismissing their GAAP-deficient auditors.

    Design/Method/ Approach:

    The authors obtained all inspection reports from the PCAOB from January 21, 2005, to December 31, 2007. The sample chosen included 54 GAAP-deficient, triennially inspected auditors with complete data for 379 of the auditors’ reported clients. This sample was used to test the following hypotheses:

    • H1: There is a positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient auditor.
    • H2: Greater agency conflict values magnify the positive relation between the receipt of GAAP-deficient PCAOB inspection reports and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.  
    • H3: Independent and expert audit committees magnify the positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor. 
    • H4: Outside blockholdings magnify the positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.
    • H5: Securities issuance magnify the positive relation between the receipt of GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.
    Findings:
    • Dismissal rate is high for GAAP-deficient auditors
    • A majority of the clients also received a going-concern modification
    • The subsequent auditor is virtually always a triennially inspected auditor that is not GAAP-deficient
    • Agency conflict and audit committee effectiveness are helpful in predicting which GAAP-deficient auditors are more likely to be dismissed.
    Category:
    Audit Quality & Quality Control, Auditor Selection and Auditor Changes
    Sub-category:
    Attempts to Measure Audit Quality, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Impact of Firm & External Inspection Programs
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