The results of the study strongly suggest that initial-year audit discounts are quite common and substantial in the post-SOX period. Although the existence of lowballing seems to be a threat to independence, at least in appearance, the existing research on lowballing provides mixed results on its impact on audit quality. The findings will likely be of interest to the PCAOB as it searches for ways to bolster auditor independence and other regulators because many, including the GAO, believe that without non-audit service fees, auditors are less likely to offer ‘‘loss-leader’’ fees for audits.
For more information on this study, please contact Rosemond Desir.
Desir, R., J. R. Casterella, and J. Kokina. 2014. A Reexamination of Audit Fees for Initial Audit Engagements in the Post-SOX Period. Auditing: A Journal of Practice & Theory 33 (2): 59-78
By understanding the auditor selection decisions and the agency costs faced in many private firms, auditors of private firms can more appropriately gauge risk and better understand their clients.
For more information on this study, please contact Ole-Kristian Hope.
Hope, O., Langli, J. C., and Thomas, W. B. 2012. Agency Conflicts and Auditing in Private Firms. Accounting, Organizations and Society 37 (7): 500-517.
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.
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.
Lowballing has been cited as a threat to auditor independence and manager performance in regulatory reports and academic research. This study suggests that auditors may face independence issues at the beginning of a client relationship under the lowballing fee structure because of the uncertainty of retaining a client. The study also suggests, however, that these independence issues seem to dissipate over time. Therefore, auditors should be aware of these potential opportunities to lose objectivity when they acquire new audit clients and continue to rely on professional skepticism to evaluate management assertions.
For more information on this study, please contact Darius J. Fatemi.
Fatemi, D. J. 2012. An Experimental Investigation of the Influence of Audit Fee Structure and Auditor Selection Rights on Auditor Independence and Client Investment Decisions. Auditing: A Journal of Practice and Theory 31(3): 75-94.
This study provides an important implication for audit firms in maintaining their worldwide brand name reputation. The results suggest that, for global audit firms, the damage to auditor reputation in one country may spill over and cause concern among investors about the quality of their services in other countries. Further, the damage to reputation is greater where the demand for auditing and assurance is higher.
Cahan, S. F., D. Emanuel, and J. Sun. 2009. Are the Reputations of the Large Accounting Firms Really International? Evidence from the Andersen-Enron Affair. Auditing: A Journal of Practice and Theory 28 (2): 199-226.
Private debt lenders are more likely to include a covenant that prohibits the borrower from receiving an audit report with going-concern modifications (GCAR) when the borrower has poor creditworthiness and the loan term is long. The auditor choice is more likely to be specified in the loan agreement when a GCAR covenant is included. The borrower with a GCAR covenant experiences both increased audit fees and higher probability of getting a GCAR when financial distress occurs. The results imply the GCAR covenant may complement traditional financial covenants in protecting the lenders but comes with a cost borne by the borrowers. It also shows the lenders’ use of audit reports can influence the auditors’ behavior.
Menon, K., and D. D. Williams. 2016. Audit Report Restrictions in Debt Covenants. Contemporary Accounting Research 33 (2): 682–717.
The results of this study confirm the importance of management reputation issues in auditor change decisions, while also extending our understanding of nonprofit organizations. For nonprofits, a change in auditor is more likely when the organization’s operational structure changes. As the organization grows and becomes more reliant on federal funding, the likelihood of changing auditors, particularly to bigger audit firms, increases.
Tate, S. L., 2007. Auditor changes and auditor choice in nonprofit organizations. Auditing: A Journal of Practice & Theory 26 (1): 47-70.
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.
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.
http://commons.aaahq.org/groups/e5075f0eec/summary
The results of this study should be of interest to policymakers. An August 2011 Public Company Accounting Oversight Board (PCAOB 2011) concept release asked for comments on the advisability of using mandatory auditor rotation to enhance auditor independence. It aroused concerns from commenters that such rotation could adversely affect clients benefiting from auditor industry specialization. Although these comments did not elaborate on the nature of the benefits from industry specialization, this study’s evidence that equity investors value industry-expert auditors is relevant to the debate about the desirability of mandatory auditor rotation
For more information on this study, please contact Jagan Krishnan.
Krishnan, J., C. Li, and Q. Wang. 2013. Auditor industry expertise and cost of equity. Accounting Horizons 27(4): 667-691.
The results of this study are important for audit firms to consider given interest from regulators on the role of shareholder ratification on auditor selection. The evidence indicates that proxy advisor recommendations significantly influence the number of dissenting auditor ratification votes. Unfavorable recommendations are more likely when there are concerns regarding auditor independence rather than audit quality.
Lauren M. Cunningham (2017) Auditor Ratification: Can't Get No (Dis)Satisfaction. Accounting Horizons: March 2017, Vol. 31, No. 1, pp. 159-175.