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  • Jennifer M Mueller-Phillips
    A Reexamination of Audit Fees for Initial Audit Engagements...
    research summary posted December 3, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 04.0 Independence and Ethics 
    Title:
    A Reexamination of Audit Fees for Initial Audit Engagements in the Post-SOX Period
    Practical Implications:

    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.

    Citation:

    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

    Keywords:
    Audit fees, auditor independence, lowballing, PCAOB
    Purpose of the Study:

    On August 16, 2011, the Public Company Accounting Oversight Board (PCAOB) issued a concept release seeking comments on ways to enhance auditor independence. The Board notes that higher failure rates in new audit engagements might be linked to unrealistic pricing. The Board’s concern is that a new auditor might be more susceptible to management pressure if initial-year audit fees are set artificially low.

    Prior to the passage of the Sarbanes-Oxley Act (SOX) of 2002, empirical evidence shows that auditors discounted their initial-year audit fees. This practice is known as lowballing and it occurs when auditors price initial-year audit fees lower for new clients with the expectation of increasing the fees substantially in later years in order to recoup their initial losses. Lowballing was expected to decrease significantly after the enactment of SOX.

    Indeed, findings of a study on audit pricing in initial-year audits seem to confirm that Big 4 auditors charged a fee premium on new auditor-client relationships in 2006. However, it is not clear if more recent post-SOX initial-year audits are free of lowballing. In the current study, the authors investigate whether lowballing exists in new auditor-client relationships in an ‘‘extended’’ post-SOX environment for the years 2007 to 2010. 

    Design/Method/ Approach:

    The authors analyze audit fee data for years 2006 through 2010 for publicly-traded companies that are Big 4 and non-Big 4 clients. The focus of the study is on initial audits following auditor dismissals as there are very few auditor resignations. The audit fee data were collected from Audit Analytics database and financial data – from Compustat.

    Findings:

    The results suggest that both Big 4 and non-Big 4 accounting firms discounted their initial-year audit fees during the sample period (2007–2010), with fee discounts ranging from 16 to 34 percent. In addition, the authors find no evidence of initial-year audit fee discounts (or premiums) in 2006. 

    Category:
    Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc
  • Jennifer M Mueller-Phillips
    Agency Conflicts and Auditing in Private Firms
    research summary posted September 12, 2013 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes 
    Title:
    Agency Conflicts and Auditing in Private Firms
    Practical Implications:

    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.
     

    Citation:

    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.

    Keywords:
    N/A
    Purpose of the Study:

    The purpose of this study is to determine how privately held firms handle agency costs; specifically agency costs related to ownership structures. Also, this study examines how those agency costs affect audit fees and auditor selection criteria.

    Design/Method/ Approach:

    Using data from 2000 to 2002 and 2006 to 2007, which were obtained with special permission from the Norwegian government, the authors test the agency costs associated with familial ties in private settings. Specifically, the authors are interested in effort, as measured by audit fees, and desire to send a strong signal as measured by hiring a big 4 auditor.

    Findings:

    This paper tests several hypotheses but some of the most important findings are:

    • Audit fees decrease as ownership concentration increases and as the proportion of shares held by the second largest shareholder increases
    • As CEO ownership increases audit fees decrease
    • When the CEO is a member of the largest owning family audit fees increase
    • Audit fees decrease as the proportion of board members from the largest owning family decreases
       
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Board/Audit Committee Oversight
  • The Auditing Section
    An Analysis of Forced Auditor Change: The Case of Former...1
    research summary posted May 7, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 04.0 Independence and Ethics, 04.07 Audit Firm Rotation 
    Title:
    An Analysis of Forced Auditor Change: The Case of Former Arthur Andersen Clients
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    auditor selection, auditor change, mandatory auditor rotation, audit quality, earnings quality, Arthur Andersen
    Purpose of the Study:
    • To investigate the factors that contributed to firms' decisions to either retain their Andersen audit team who migrated to another audit firm, or engage a new auditor, after the collapse of Andersen.
    • To investigate the effect of forced auditor change on client firms' financial statement quality.
    • To examine the costs (switching costs and agency costs) a company faces in switching to a new auditor.
    Design/Method/ Approach:

    The authors use a sample of 407 Andersen clients.  The authors classify companies as retaining their Andersen audit team if the audit report in the year after Andersen's collapse indicates the new auditor within a city acquired the Andersen audit practice in that same city. Companies that did not adhere to this were classified as having switched to a different auditor.  In performing this analysis, the authors examine “Switching costs” (i.e. Andersen industry expertise, auditor tenure, auditee size, auditee complexity, and discretionary accruals) and “Agency Costs” (i.e. auditee size, auditee complexity and transparency, insider ownership, leverage, presence of a blockholder, and audit committee expertise and independence.

    Findings:
    • Companies faced with greater switching costs were more likely to stay with their Andersen audit team.  (Note: Greater switching costs include aggressive accruals, a financial expert on the audit committee, and Andersen industry specialization)
    • Companies with greater agency concerns (higher monitoring costs faced by outside shareholders) were more likely to sever ties with their Andersen audit team and hire a new auditor.
    • Companies in the highest quintile of performance-matched discretionary accruals that followed Andersen curbed their accrual behavior in the year after Andersen’s collapse, while there was no change for those that did not follow Andersen.
    • Overall company governance characteristics were not associated with the decision to retain or switch.
    • Overall, the evidence suggests that switching costs likely often outweigh benefits of changing auditors, which explains why we observe infrequent auditor changes for most companies.
    • Evidence in the study suggests mandatory rotation may not be effective in improving client firms' overall financial statement quality.
    Category:
    Auditor Selection and Auditor Changes, Independence & Ethics
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Audit Firm Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    An Experimental Investigation of the Influence of Audit Fee...
    research summary posted October 15, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management 
    Title:
    An Experimental Investigation of the Influence of Audit Fee Structure and Auditor Selection Rights on Auditor Independence and Client Investment Decisions
    Practical Implications:

     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.
     

    Citation:

    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.

    Keywords:
    Audit fees; auditor independence; experimental economics; manager investment; auditor selection.
    Purpose of the Study:

    The purpose of this paper is to investigate the effect of audit fee structure on auditors, their clients, and investors. The author wanted to specifically investigate how a lowballing audit fee structure as opposed to a flat rate fee structure impacts:

    • manager investment decisions
    • the degree of investigation of management decisions by auditors
    • the price that investors pay for shares of the company

    The author also investigated whether a cause-effect relationship exists between the use of a lowballing audit fee structure (in which auditors provide initial services at reduced prices but at higher prices in later periods) and auditor independence when retention is of concern to the auditor.

    Design/Method/ Approach:

    The author utilized an experimental market using undergraduate accounting majors that were randomly assigned to the roles of managers, investors, and auditors.  The auditors followed either a lowballing fee structure or a flat rate fee structure. Auditor selection was performed by either the managers or the investors. The managers bid on firm assets and provided a disclosure of the value of the assets to the investors. Auditors decided the extent to which they investigated managers’ claims and either concurred with manager’s disclosures or they provided information that the auditors believed to be more accurate.

    Findings:

    Compared to the flat-rate fee structure, managers under a lowballing fee structure scheme were:

    • more willing to make a high cost/return investment
    • more concerned with the credibility of their reports
       

    Auditor behavior is summarized as a response to past manager choices: when managers were especially willing to invest and be honest, auditors performed fewer tests of manager disclosures. Additionally, under manager selection and when lowballing existed, auditors attributed a higher accuracy to investigations indicating high manager investment than tests that suggest low investment, while accuracy assessments of favorable and unfavorable test results did not differ under investor selection. Finally, auditor retention under manager selection was negatively impacted by both unreliable auditing and disagreements with managers, but retention was only affected by unreliable auditing under investor selection.

    Category:
    Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Impact of Fees on Decisions by Auditors & Management
  • The Auditing Section
    Are the Reputations of the Large Accounting Firms Really...
    research summary posted April 23, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk 
    Title:
    Are the Reputations of the Large Accounting Firms Really International?
    Practical Implications:

    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.

    Citation:

    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. 

    Keywords:
    Auditor reputation, international audit markets, Arthur Andersen, Enron, auditor selection and auditor changes
    Purpose of the Study:

    The Big 4 accounting firms market themselves as global firms that deliver a uniform level of service across countries. While such a global reputation helps build worldwide demand for high-quality audits, it also creates risks if service quality becomes questionable in one of the countries in which a firm operates. Questionable audit practices in one of the countries, especially in the home jurisdiction, may  raise doubts as to whether sub-standard audits also occur in other countries. 

    This study examines whether the damage to the name brand of Arthur Andersen following the Andersen-Enron scandal in the U.S. spilled over into other countries. The study focuses on two key event dates leading up to Andersen’s demise: (1) January 10, 2002, when Andersen announced it had shredded documents related to the Enron audit, and (2) February 4, 2002, when Enron’s board released the Powers report that was critical of Andersen and when Andersen announced the establishment of an Independent Oversight Board (IOB) to investigate the firm’s audit policies and procedures. This study investigates the market reaction to Andersen’s clientele base around these two dates to determine whether: 

    • the events caused investors to reassess the reputation of Andersen’s non-U.S. audit units. 
    • investors’ reevaluation of Andersen’s reputation is more pronounced in cases where there is a higher demand for audit quality or credible financial statements. 
    • the effect is due to the perceived assurance or insurance value of an audit. The assurance value relates to an auditor’s ability to communicate with investors about the overall quality of client financial statements, while the insurance value relates to an auditor’s legal and financial liability for an audit failure.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies audited by Arthur Andersen in 2001 to examine whether there is a negative market reaction to Andersen’s non-U.S. clients around the two event dates discussed above.

    Findings:
    • The authors document that an adverse market reaction to Andersen’s clients exists in non-U.S. countries, which suggests that the damage to Andersen’s reputation and audit quality in the U.S. spilled over to other countries.  
    • The market reaction is more negative in countries where there is a greater demand for high-quality auditing and credible financial reporting. More specifically, more-pronounced adverse market reactions are observed in common law (compared to code law) countries where investor protection is higher, ownership is more dispersed, and conflicts of interest between owners and managers are more likely to occur. 
    • The authors find that the market reaction for the shredding event is more negative for Andersen’s non-U.S., cross-listed clients than for Andersen’s non-U.S., non-cross-listed clients. This suggests that the shredding event may have been anticipated by the U.S. market as triggering lawsuits against Andersen and reducing its ability to pay for possible legal claims. 
    • The authors also report a similar market reaction for Andersen’s non-U.S., cross-listed clients and Andersen’s U.S. clients, suggesting similar levels of perceived audit quality across Andersen as a whole.
    Category:
    Auditor Selection and Auditor Changes, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Litigation Risk
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  • Jennifer M Mueller-Phillips
    Audit Report Restrictions in Debt Covenants
    research summary posted August 30, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Title:
    Audit Report Restrictions in Debt Covenants
    Practical Implications:

     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.

    Citation:

     Menon, K., and D. D. Williams. 2016. Audit Report Restrictions in Debt Covenants. Contemporary Accounting Research 33 (2): 682–717.

    Keywords:
    going concern, auditor choice, debt covenants, audit fees, audit reports
    Purpose of the Study:

    Prior studies on debt contracting mainly focus on financial covenants. This paper extends prior research by investigating why lenders put an audit-related covenant – GCAR covenant – into the loan agreement and the effect of this covenant on auditors. The authors argue a GCAR serves as an effective warning for potential defaults even if common financial covenants are not violated. They expect borrowing firms with low credit quality to have a GCAR covenant. They also expect long-term loans to have a GCAR covenant because the lenders face higher probability that the firm’s financial condition deteriorates before the loan matures. To prevent opinion shopping and for insurance purpose, lenders who impose a GCAR covenant are expected to restrict the borrower’s freedom on auditor selection. From the auditor’s stand point, the authors believe the GCAR covenant increases litigation risk to the auditor and/or require additional audit effort. As a result, audit fees are expected to increase and the borrowers are more likely to receive a GCAR.  

    Design/Method/ Approach:

    The initial sample comes from new private debt placement made by public companies between 2003 and 2009. The final sample consists of 7,749 loan contracts (firm-years) from 3,304 unique companies. The authors obtain debt information from DealScan, financial information from COMPUSTAT and audit-related data from Audit Analytics. The authors first test what factors determine the inclusion of a GCAR covenant and then examine the effect of this covenant on audit-related issues.  

    Findings:
    • Private debt lenders are more likely to impose a GCAR covenant in the loan contract when the credit quality of the borrower is poor and/or the debt’s maturity is long. Additional analyses show the GCAR covenant can capture events or situations lead to potential defaults even if traditional covenants are not violated.

     

    • If the loan contract contains a GCAR covenant, it is more likely that the lenders will require the borrower to engage a specific auditor. The auditors accepted by the lenders are usually the Big 4 auditors or at least national auditors. The auditor choice reflects the view that reputable auditors are stricter in going-concern assessment and have deep pockets to settle litigations.

     

    • Auditors charge higher audit fees on and are more likely to issue a GCAR to clients who have loan contracts contain a GCAR covenant, holding the degree of financial distress constant. The results are consistent with the argument that the GCAR covenant increases auditors’ perception on litigation risk and the demand on audit effort. 
    Category:
    Accountants' Reporting, Auditor Selection and Auditor Changes
    Sub-category:
    Going Concern Decisions
  • The Auditing Section
    Auditor Change and Auditor Choice in Nonprofit Organizations
    research summary posted April 16, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications 
    Title:
    Auditor Change and Auditor Choice in Nonprofit Organizations
    Practical Implications:

    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.

    Citation:

    Tate, S. L., 2007. Auditor changes and auditor choice in nonprofit organizations.  Auditing:  A Journal of Practice & Theory 26 (1): 47-70.

    Keywords:
    Auditor switching, auditor choice, nonprofit organizations
    Purpose of the Study:

    Accounting frauds of the early 2000’s coupled with the passage of the Sarbanes-Oxley Act of 2002 (“SOX”) resulted in increased focus on the role of the independent auditor in monitoring public companies.  Although the new SOX rules were not directed at nonprofit organizations, the public support of these organizations suggests that adequate levels of monitoring are also important in this sector.  This study specifically evaluates the auditor choice decisions of nonprofit organizations.

    Design/Method/ Approach:

    The author uses publicly available data for the years 1998 through 2002 to examine the effects of operational structure, management reputation and contracting, and audit fees on a nonprofit organization’s choice of auditor and decision to change auditors.

    Findings:
    • Consistent with prior research from other sectors, the author finds that management reputation and audit fees are important in the decision to change auditors. 
    • The author finds that changes to the organization’s operational structure, including revenue sources and resource uses, are important factors in the decision to change auditors.
    • The author also finds that organization size is an important factor in selecting a large audit firm over another smaller audit firm.  Changes in revenue sources, resource uses, leverage, and management contracting as well as management reputation may also be factors in the selection of the auditor.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
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  • Jennifer M Mueller-Phillips
    Auditor Changes and the Cost of Bank Debt
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes 
    Title:
    Auditor Changes and the Cost of Bank Debt
    Practical Implications:

    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. 

    Citation:

    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.

    Keywords:
    auditor change; information risk; financial reporting quality; information signaling; loan contracting; cost of bank debt; loan spreads; private credit market
    Purpose of the Study:

    Companies change auditors for various reasons, however due to the costs associated with switching, it is often an indication of potential problems between the auditor and company. This study examines the effects that an auditor change has on bank loan contracting. Specifically, whether companies that switch auditors incur increased costs and more stringent nonprice terms on loans. The authors address two potential reasons of why an auditor change would lead to information risk, and subsequently higher costs on loans. The first is if creditors perceive that the auditor change is opportunistic, such as management trying to find a more compliant auditor. The second information risk is related to the new auditor’s lack of client-specific knowledge. Both of these risks would cause for audit quality to decrease and, therefore loan costs would increase. The authors also consider the type of switch and its effect on loan costs. The three types examined are from (Non)Big 4 to (Non)Big 4, Big 4 to Non-Big 4, and Non-Big 4 to Big 4.

    Design/Method/ Approach:

    The sample includes 312 pairs of auditor change companies and non-audit change companies from 1998-2014. The audit change information was gathered using Audit Analytics and the bank loan data was from DealScan. Additionally, the authors excluded all audit switches due to the collapse of Arthur Andersen in 2002. The authors utilize a difference-in-differences (DID) research design comparing loan spreads between auditor change companies (before and after switch) and non-audit change companies.

    Findings:

    Overall, the authors find that when companies initiate a loan within a year of changing auditors there is a 22% increase in loan costs.           

    Specifically, the authors find the following:

    • There is no significant difference in the incremental loan spread between the three types of auditor switches. This evidence suggests creditors place a stronger emphasis on the two information risks instead of the potential differences between Big 4 and Non-Big 4 audit quality.
    • There is still a substantial increase in information risk following the change regardless of whether the company initiates the auditor switch (dismissal) or the auditor resigns
    • There is a 13.65% increase in the probability that banks add collateral requirements following an auditor change. The upfront and annual fees also increase by an average of about 53% and 25% respectively.
    Category:
    Auditor Selection and Auditor Changes
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  • Jennifer M Mueller-Phillips
    Auditor industry expertise and cost of equity
    research summary posted March 10, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications 
    Title:
    Auditor industry expertise and cost of equity
    Practical Implications:

    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.

    Citation:

    Krishnan, J., C. Li, and Q. Wang. 2013. Auditor industry expertise and cost of equity. Accounting Horizons 27(4): 667-691.

    Keywords:
    audit quality; cost of equity; auditor expertise; auditor change.
    Purpose of the Study:

    The study examines (1) the association between auditors’ industry expertise and their clients’ cost of equity capital, and (2) the change in cost of equity capital when companies switch from industry non-expert (expert) auditors to industry-expert (non-expert) auditors.

    Design/Method/ Approach:

    This study uses the city-national framework of auditor expertise, examine the effects of national-only, city-only, and joint city-national industry expertise on cost of equity.  The sample used in this study is derived from publicly traded companies employing Big N auditors. The period covers the years 2000 through 2008.     

    Findings:
    • Clients of city-only and joint city-national industry-expert auditors enjoy lower cost of equity capital. This is consistent with the assertion that investors’ positive perceptions about auditor reputation exist at the city level, either alone or jointly with national level.
    • Firms that move from non-experts to city-only and joint city-national industry experts experience a decline in cost of equity, and firms that switch from joint city-national experts to non-experts experience an increase in cost of equity. In addition, firms that switch from non-experts to experts issue more equity in the two years following the switch.
    • Further analyses suggest that, while the effects of national-only and city-only experts vary across some subsets of the sample, joint city-national experts enjoy lower cost of equity in the majority of subsamples.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
  • Jennifer M Mueller-Phillips
    Auditor Ratification: Can’t Get No &...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications 
    Title:
    Auditor Ratification: Can’t Get No (Dis)Satisfaction
    Practical Implications:

    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.

    Citation:

    Lauren M. Cunningham (2017) Auditor Ratification: Can't Get No (Dis)Satisfaction. Accounting Horizons: March 2017, Vol. 31, No. 1, pp. 159-175.

    Keywords:
    auditor ratification; corporate governance; proxy advisor; proxy disclosure; shareholder voting.
    Purpose of the Study:

    This study looks at the role of proxy advisor recommendations in shareholder voting on auditor ratification.  Given the importance of shareholder involvement and the influence of proxy advisors to influence other voting outcomes, the author investigates the characteristics of the company and audit firm that lead to an unfavorable recommendation on auditor ratification.

    Design/Method/ Approach:

    The author uses company-year observations for the Russell 3000 firms with shareholder voting on auditor ratification occurring during shareholder meetings from January 1, 2009 to June 30, 2012.  More than ninety percent of firms in their sample voluntarily include auditor ratification on the ballot.

    Findings:

    The author finds that:

    • On average, the percentage of dissenting votes on an Auditor ratification is 8.6 percent when proxy advisors issue an Against recommendation.
    • The dissenting votes are higher when there are concerns over auditor independence (non-audit service fees are higher, auditor tenure is longer) or when the proxy advisor’s recommendation is more influential (percentage of blockholders is lower and institutional ownership is higher).
    • Proxy advisors are less likely to issue an unfavorable recommendation when firms have stronger performance or a willingness to disclose internal control issues and are more likely to issue an unfavorable recommendation when the auditor tenure is longer or when the audit firm is a Big 4 Audit firm.
    • Proxy advisors issue more unfavorable recommendations when there are suspected concerns about auditor independence (69 to 85 percent) then when there are concerns regarding audit quality (4 to 12 percent).
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)

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