Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • Jennifer M Mueller-Phillips
    Firm versus Partner Measure of Auditor Industry Expertise...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 11.01 Supervision and Review – Effectiveness, 11.02 Engagement Quality Review – Processes and Effectiveness, 11.04 Industry Experience, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality 
    Title:
    Firm versus Partner Measure of Auditor Industry Expertise and Effects on Auditor Quality
    Practical Implications:

    The findings of this study imply that firm level expertise impacts audit quality but has a greater impact in conjunction with office level or partner level expertise. Similarly, concurring auditors have a greater impact on audit quality when their abilities are paired with those of a lead or signing partner. This study implicitly emphasizes the importance in cooperation and the sharing of intellectual resources among partners in Big 4 firms considering that expertise is not homogeneous across a firm. Additionally, this study has implications on what could result if the Public Company Accounting Oversight Board in the United States decided to require an engagement partner’s signature on the audit report.

    For more information on this study, please contact Hsin-Yi Chi.
     

    Citation:

    Chi, H., and C. Chin. Firm versus partner measures of auditor industry expertise and effects on auditor quality.  Accounting: A Journal of Practice and Theory 30 (2): 201-229.

    Keywords:
    individual partner industry expertise; discretionary accruals; modified audit opinion; audit quality.
    Purpose of the Study:

    This study explores the relationship between Big 4 audit quality and auditor expertise with respect to both the individual partners and the audit firm. The authors used accruals analysis as well as analysis of audit opinions to assess audit quality. To take the study a step further, an examination of the possible existence of differential audit quality between signing auditors whether lead or concurring partners was also performed. An office level perspective was used and deemed appropriate under the assumption that auditor expertise is permanently tied to individual professionals and their client knowledge which cannot be readily captured and distributed across the firm offices; additionally, the individual practice office is the decision-making unit of the firm when it comes to specific clients.

    To accomplish their purpose, first the authors studied whether audit industry expertise is driven by firm expertise, individual partner expertise, or a combination of both. They also studied whether the association between audit quality and industry expertise of the signing auditor specialist was more or less prominent for the lead auditor or the concurring auditor. One would expect that the lead partner generally would exhibit a more prominent association with audit quality than concurring audit specialists because it is the lead partner who is actively engaged with daily audit proceedings; this study aims to discover if that is truly the case. The study assesses the effectiveness of an individual partner-level and firm-level auditor specialists in enhancing audit quality as well as provides evidence regarding industry expertise homogeneity between individual partners within the same firm.  
     

    Design/Method/ Approach:

    The evidence for this study was collected from Taiwanese publicly listed companies audited by the Big 4 firms from 1983 to 2004. Financial data, audit opinions data, and auditor names were obtained from the Taiwan Economic Journal. Taiwan was the chosen location for this evidence because the audit report in Taiwan contains two signing auditor names as well as the firm name. 

    Findings:
    • Both firm-level industry expertise alone and partner- level industry expertise alone are associated with lower accruals. However, a combination of the two creates an effect above and beyond either level of expertise in isolation; therefore, differential discretionary accruals due to industry expertise are driven by a combination of firm and partner expertise.
    • Differential accruals due to industry expertise of signing are primarily driven by the lead auditor rather than the concurring auditor.
    • The differential likelihood of the issuance of a modified audit opinion is primarily attributable to signing auditor specialists and partner-level expertise.
    • Firm level specialists alone are not associated with a higher likelihood of issuing a modified audit opinion. Instead, firm level specialists along with signing auditor specialists create effects above and beyond those observed with auditor specialists alone.
    • Clients of lead signing auditor specialists have smaller accruals and are more likely to receive a modified audit opinion relative to those of non-specialists  whether the auditor specialists works alone or with a concurring auditor specialist.
    • Concurring auditor specialists alone are not associated with higher audit quality.
    • Industry expertise is not homogeneous across individual auditors within the same audit firm in Taiwan.
       
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Engagement Quality Review – Processes & Effectiveness, Industry Experience, Proxies for Audit Quality, Supervision & Review – Effectiveness
  • Jennifer M Mueller-Phillips
    Audit Quality and the Trade-Off between Accretive Stock...
    research summary posted June 21, 2013 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management Behavior 
    Title:
    Audit Quality and the Trade-Off between Accretive Stock Repurchases and Accrual-Based Earnings Management
    Practical Implications:

    This study provides evidence that is important to corporate governance decisions. The results suggest that hiring a high quality auditor to constrain accruals earnings management may result in management’s use of real earnings management as a substitute. Real earnings management involves potentially costly deviations from “business as usual.” Consequently, it may be important to consider other corporate governance measures aimed at constraining real earnings management concurrently with the decision to hire a high quality auditor. 

    Citation:

    Burnett, B., B. Cripe, G. Martin, and B. McAllister. 2012. Audit Quality and the Trade-Off between Accretive Stock Repurchases and Accrual-Based Earnings Management. The Accounting Review 87 (6): 1861-1884.

    Keywords:
    Real earnings management; stock repurchases; audit quality; audit industry specialization
    Purpose of the Study:

    When managers decide to manipulate earnings they must make a choice about how they will achieve their goal. The two broad methods for manipulating earnings are the manipulation of accounting choices and estimates (i.e. accrual earnings management) and the manipulation of real business practices (i.e. real earnings management). The authors of this study argue that either method could be considered questionable because the intent of earnings management is to mislead investors or influence accounting-based contractual arrangements. The choice between the two methods is of interest because governance activities that are taken to constrain one type of earnings management behavior may result in another.

    This study investigates whether audit quality affects management’s choice between accrual earnings management and accretive stock repurchases when firms manage earnings per share (EPS) to meet or beat analysts’ forecasts. The use of accretive stock repurchases to manage EPS is a type of real earnings management that involves the firm repurchasing shares in order to boost EPS figures. The authors believe that, because this form of real earnings management can be done quickly and with little disclosure, it is a good comparison to accrual management in this scenario. The authors make and test the following hypotheses (stated in null form):

    H1: High audit quality is unrelated to the use of accretive stock repurchases to meet or beat consensus analysts’ forecasts.

    H2: High audit quality is unrelated to the trade-off between the use of accretive stock repurchases and accrual-based earnings management to meet or beat consensus analysts’ forecasts.

    Design/Method/ Approach:

    The authors use data on publicly-traded companies that meet or beat analysts’ earnings forecasts but would have missed these forecasts if they had not managed their earnings. Using this subset of firms, the authors compare companies that hired an industry specialist auditor to those that had a non-specialist auditor. The sample period includes data from years 1989-2009.

    Findings:

    The authors document (1) a positive and significant relationship between having a high quality auditor and employing accretive stock repurchases in order to meet or beat EPS estimates, and (2) a negative and significant relationship between having a high quality auditor and employing accrual-based earnings management in order to meet or beat EPS estimates. The authors claim that these results suggest the use of accruals-based earnings management is constrained by high quality auditors and, as a result, when managers are faced with a high quality audit they employ accretive stock repurchases instead of accrual-based earnings management to meet or beat analysts’ EPS forecasts.

    Category:
    Audit Quality & Quality Control, Corporate Matters
    Sub-category:
    Earnings Management, Earnings Targets & Management Behavior
    Home:

    home button

  • The Auditing Section
    Auditor Conservatism and Investment Efficiency
    research summary posted May 7, 2012 by The Auditing Section, tagged 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality 
    Title:
    Auditor Conservatism and Investment Efficiency
    Practical Implications:

    This study provides an additional perspective on the economic implications of Section 201 of SOX, arguing that a one-size-fits-all requirement that restricts auditors from providing their clients with many nonaudit services is generally suboptimal.

    Citation:

    Lu, T. and H. Sapra. 2009. Auditor Conservatism and Investment Efficiency. The Accounting Review 84 (6): 1933-1958.

    Keywords:
    Auditor conservatism, audit quality, investment efficiency, nonaudit services
    Purpose of the Study:

    Auditing reduces information risk in companies’ financial statements, thus improving investors’ investment decisions. However, empirical research suggests that auditors have become increasingly conservative following the demise of Arthur Anderson and the enactment of the Sarbanes-Oxley Act (SOX). This study develops a theoretical framework to investigate how auditor conservatism and audit quality arise (i.e. determinants) and how they affect the information content of financial statements (i.e. consequences) to determine whether: 

    • Client characteristics exist that either induce or deter auditor conservatism (i.e. determinants).
    • Audit quality is impaired or improved by auditor conservatism.
    • Investment efficiency is affected. That is, whether auditor conservatism triggers over/under investment decisions.
    • The results provide any insight on the potential effects of Section 201 of SOX, which aims at constraining client pressure on auditors by prohibiting auditors from providing many nonaudit services to their clients.
    Design/Method/ Approach:

    The authors develop a theoretical model to investigate the tension between the auditor’s expected fees from the client and the expected legal liability of overstatements in the client’s financial statements to determine the auditor’s supply of auditing. Next they model the market’s interpretation of the audited financial statements in order to value that company and make investment decisions. They then explore how the capital market’s pricing rule generates demand for auditing. Finally, the authors characterize how the company makes its audit fee decision in light of its demand for auditing. Taken with the auditor’s supply of auditing, the authors determine equilibrium auditor conservatism and audit quality.

    Findings:
    • Clients with high business risk induce auditor conservatism, while clients with low business risk induce auditor aggressiveness.
    • If auditor conservatism is in force (high business risk), then a greater client pressure on auditors improves audit quality; but if auditor aggressiveness is in force (low business risk), then a greater client pressure on auditors impairs audit quality. This finding is contrary to the widely-held belief that client pressure on an auditor is always harmful.
    • The nature of investment efficiency depends upon the auditor’s attestation. Auditor conservatism triggers overinvestment, while auditor aggressiveness triggers underinvestment.
    • Mandatory restriction of client pressure in general and nonaudit services in particular increases auditor conservatism, decreases a conservative auditor’s audit quality and increases an aggressive auditor’s audit quality, increases overinvestment and decreases underinvestment, and increases the audit fee.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Proxies for Audit Quality
    Home:
    home button

Filter by Type

Filter by Tag