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  • Jennifer M Mueller-Phillips
    Do Abnormally High Audit Fees Impair Audit Quality?
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control 
    Title:
    Do Abnormally High Audit Fees Impair Audit Quality?
    Practical Implications:

    The study provides useful insight into current regulatory debates on the auditor’s economic dependence on the client and increases understanding to the reasons why previous research provides mixed evidence on the association between various fee metrics and the extent of earnings management. If the association between abnormal fees and the magnitude of discretionary accruals is conditioned on the sign of abnormal fees, examining the association without reference to the sign of abnormal fees most likely leads to observations of insignificant associations, as also reported in most previous studies. This study’s findings suggest that future research on similar issues should take into account the asymmetric nonlinearity in the fee-quality relation.

    Citation:

    Choi, J. H., J. B. Kim, and Y. Zang. 2010. Do Abnormally High Audit Fees Impair Audit Quality? Auditing: A Journal of Practice & Theory 29 (2): 115-140.

    Keywords:
    audit quality, abnormal audit fees, earnings management
    Purpose of the Study:

    This study examines whether the association between audit fees and audit quality is asymmetric and thus nonlinear in the sense that the association is conditioned upon the sign of abnormal audit fees. The authors define abnormal audit fees as the difference between actual audit fees (i.e., actual fees paid to auditors for their financial statement audits) and the expected, normal level of audit fees. Actual audit fees consist of two parts: (1) normal fees that reflect auditors’ effort costs, litigation risk, and normal profits, and (2) abnormal fees that are specific to an auditor-client relationship. Normal fees are mainly determined by factors that are common across different clients, such as client size, client complexity, and client-specific risk, while abnormal fees are determined by factors that are idiosyncratic to a specific auditor-client relationship. As noted by Kinney and Libby, abnormal fees “may more accurately be likened to attempted bribes” and can better capture economic rents associated with audit services or an auditor’s economic bond to a client than normal fees or actual fees.

    Design/Method/ Approach:

    The authors obtain audit and nonaudit fee data from the Compustat audit fees file and all other financial data from the Compustat Industrial Annual File. The sample period for this study is restricted to the four-year period from 2000 to 2003. The full sample consists of 9,815 firm-years over the four-year sample period. They also construct a reduced sample of 7,061 observations that meet the data requirements for computing two additional variables. 

    Findings:

    The regression results reveal the following:

    • The proxy for audit quality is insignificantly associated with abnormal audit fees for the total sample of client firms with both positive and negative abnormal audit fees.
    • When the authors split total observations into those with positive abnormal fees and those with negative abnormal fees, the results change dramatically.
    • When the abnormal fees are positive, the magnitude of absolute discretionary accruals (an inverse measure of audit quality) is positively associated with abnormal fees, suggesting a negative relation between audit quality and positive abnormal fees.
    • In contrast, the association is insignificant when the abnormal fees are negative.
    • These findings imply that positive and negative abnormal fees create different incentive effects, for clients with positive abnormal fees, auditors are more likely to acquiesce to client pressure as abnormal audit fees increase, whereas for clients with negative abnormal fees, auditors are unlikely to compromise audit quality.
    • In contrast to the findings on the asymmetric association between abnormal audit fees and audit quality, the authors find no significant, comparable relation when abnormal nonaudit service (NAS) fees or abnormal total fees are used as a measure of auditor-client economic bond in lieu of abnormal audit fees.
    Category:
    Audit Quality & Quality Control, Engagement Management, Independence & Ethics, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Audit Fees & Fee Negotiations, Earnings Management, Earnings Management, Impact of Fees on Decisions by Auditors & Management
  • 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
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  • Jennifer M Mueller-Phillips
    Does Incentive-Based Compensation for Chief Internal...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 04.02 Impact of Fees on Decisions by Auditors & Management, 08.11 Reliance on Internal Auditors 
    Title:
    Does Incentive-Based Compensation for Chief Internal Auditors Impact Objectivity? An External Audit Risk Perspective
    Practical Implications:

    The results of this study suggest that companies who offer incentive-based compensation to chief internal auditors, especially through equity, are more likely to be perceived as having a higher audit risk by external auditors. Consequently, external auditors may charge a higher fee for their services. This study gives a basis for the benefit/cost analysis of providing incentive-based compensation for chief internal auditors. While it is possible internal auditors will respond positively to an IBC and bring extra value to the organization, there is a risk that an external auditor could raise audit fees cancelling out this added benefit.   

    Citation:

    Chen, Lucy Huajing, H. H. Chung, G. F. Peters., and J. P. Wynn. (Jeannie).2017. Does Incentive-Based Compensation for Chief Internal Auditors Impact Objectivity? An External Audit Risk Perspective. Auditing, A Journal of Practice and Theory 36 (21): 21-44

    Keywords:
    Incentive-based compensation; internal auditor objectivity; audit fees
    Purpose of the Study:

    The internal audit function (IAF) is increasingly seen as a key component of corporate governance. The extent to which external auditors can rely on information from the IAF depends largely on the internal auditor’s objectivity. The researchers question whether receiving incentive-based compensation (IBC) linked to company performance threatens internal audit employees’ objectivity. Subsequently, this threat would lead to a higher assessment of client audit risk and therefore higher audit fees. The authors also consider whether external auditors view stock- and option-based compensation differently from cash incentives. Finally, the authors examine whether the objectivity threat from IBC depends on the company’s financial reporting risks, alignment of IAF compensation with CEO compensation, and presence of any internal audit outsourcing arrangements.

    Design/Method/ Approach:

    The authors surveyed chief internal auditors of NYSE-listed firms in 2007. The participants were asked to rank the performance measures in order of their emphasis and to indicate the form of IBC payment. By asking survey respondents to provide their company names, the authors could match the financial, audit fee, governance, and incentive data from various databases (Compustat, Audit Analytics, proxy statements, etc.). The final sample included 183 companies. Authors used multivariate regression to analyze their research questions.

    Findings:

    The overall finding is that when a company offers incentive-based compensation to a chief internal auditor, external audit fees increase. This finding suggests that external auditors do consider IBC for chief internal auditors as a threat against objectivity.

     

    Additionally, the authors find that:

    • External auditors are more likely to charge higher fees for stock- and option-based compensation compared to cash bonuses. They attribute this result to employees placing more of an emphasis on personal wealth rather than firm value.
    • There is a stronger positive effect of chief internal auditors receiving IBC and external auditor fees increasing when inherent risk is higher in the audit. Specifically, the authors focused on inherent risk related to inventory levels.
    • In situations where the CEO’s equity incentives are aligned with IAF’s equity incentives there is an even greater rise in external auditor fees.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Client Risk Assessment
  • Jennifer M Mueller-Phillips
    Fee Discounting and Audit Quality Following Audit Firm and...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence.
    Practical Implications:

    The study results are important to regulators and audit practitioners as they show the consequences of initial year audit fee low-balling on the performance of the audit. Lower audit quality occurs when an audit firm change includes a change to both audit partners along with a reduction in audit fees. This indicates that retaining one or both of the former audit partners in the new audit firm can offset the reduced audit quality effect in the initial years of the audit engagement. 

    Citation:

    Huang, H.-W., K. Raghunandan, T.-C. Huang, and J.-R. Chiou. 2015. Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence. The Accounting Review 90 (4): 15171546.

    Keywords:
    audit fees, auditor changes, audit quality
    Purpose of the Study:

    Global regulators have voiced concerns regarding the low-balling of initial audit fees and the effect on audit quality. Although prior studies in the United States provide evidence of the low-balling effect, the emergence of China as a global economic power provides motivation to examine the low-balling effect in the Chinese audit market. In addition, there is limited evidence on the audit quality effects of low-balling the initial audit fee.  

    This paper addresses whether: 1) the low-balling of initial audit fees occurs in China; 2) there is an association between the low-balling of initial audit fees and the type of audit partner change related to an audit firm change; and 3) the reduction of the initial audit fees influences low quality audits.

    The Chinese audit market expanded in the late 1990s primarily through mergers. In some cases, audit partners changed firms but retained their audit client base. With the public disclosure of audit partner names in China, the authors can determine if the audit firm change results in an audit partner change.  For this study, a normal audit firm change occurs when both of the audit partners are new to the audit engagement. For this normal change, the authors expect a higher instance of low-balling of initial year audit fees. Alternatively, if one or both of the audit partners continue on the audit engagement after an audit firm change, the authors expect a reduced low-balling effect.

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study. They obtain audit fees, financial data, return data, and corporate governance information from the China Center for Economic Research (CCER) database. Audit partner and audit firm information is from the Taiwan Economic Journal (TEJ) database. The sample period is from 2002-2012. All data is for clients listed on the Shanghai and Shenzhen stock exchanges.

    Findings:
    • The authors find evidence of the low-balling of initial audit fees in the Chinese audit market. Specifically, they show the greatest reduction in initial audit fees when the audit client engages a new firm and both of the audit partners are new to the engagement. Using an audit fee changes model, the initial audit fee discount is approximately 4% when both audit partners are new to the client. 
    • When evaluating audit quality, the authors find that audit sanctions from the Chinese regulator are more likely when there is an audit firm change with two new audit partners and an initial audit fee discount. Using discretionary accruals, they find consistent results with the sanctions results of lower audit quality. Using modified audit opinions, the results provide weaker evidence of lower audit quality than when using sanctions or discretionary accruals. 
    • The authors noted no evidence that audit partner changes, without a related audit firm change, result in lower audit quality.
    • Interestingly, the authors find that initial audit fee reductions become smaller over time and the association between fee reductions and lower audit quality is insignificant after the first two years of the audit.   
    Category:
    Audit Quality & Quality Control, Independence & Ethics, International Matters
    Sub-category:
    Audit Partner Identification by Name, Impact of Fees on Decisions by Auditors & Management
  • Jennifer M Mueller-Phillips
    How Do Regulatory Reforms to Enhance Auditor Independence...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.07 Audit Firm Rotation, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    How Do Regulatory Reforms to Enhance Auditor Independence Work in Practice?
    Practical Implications:

    This study sheds light on what underlies decision making in the imperative audit committee responsibility of auditor appointment: nuanced interactions and power asymmetry among management, the audit committee, and auditors. The auditors viewed the CFO as the client and tailored the proposal accordingly. The audit committee will not be effective unless both auditors and audit committee members fundamentally change their mindsets about their respective roles in relation to client management. As large public companies employ multiple Big 4 firm, the viability of severing existing relationships to bring in a truly independent auditor mindset through audit firm rotation is questionable.

    Citation:

    Fiolleau, K., Hoang, K., Jamal, K., & Sunder, S. 2013. How Do Regulatory Reforms to Enhance Auditor Independence Work in Practice? Contemporary Accounting Research 30 (3): 864-890.

    Keywords:
    audit committees, reforms, auditor independence, audit firm rotation, independence
    Purpose of the Study:

    This article presents a study on regulatory reforms that aim to enhance auditor independence work. In order to achieve the right balance between the auditors serving commercial versus professional interests, regulators implemented a set of alternative remedies that include mandatory audit partner rotation and enhanced audit committee responsibilities, expertise and independence. As of September 2013, regulators based in Europe and the U.S. are considering to extend rotation requirement to encompass audit firm rotation rather than partner rotation. In this paper, the authors conduct a field study to investigate how regulatory reforms designed to promote auditor independence (specifically audit committee reforms and proposed audit firm rotation requirements) may actually work in the context of auditor change. This study of auditor change also yields insights into the potential consequences of increasing the frequency of auditorclient courtships through mandatory audit firm rotation, which has recently been proposed by regulators as a way of reinforcing auditor independence. The underlying premise is that audit quality would be enhanced by weakening the economic and relationship bonds between auditors and their clients. The authors investigate how the audit committee interprets and executes its legislative mandate in appointing an independent external auditor.

    Design/Method/ Approach:

    The authors collected data six months after the company’s RFP process and new auditor appointment. The authors obtained a copy of the company’s RFP document from the CFO, and copies of the bid documents directly from all Big 4 audit firms who bid for this audit. They interviewed the company’s CFO and the chair of the audit committee. The authors interviewed each of the four proposed engagement audit partners for 60-90 minutes.

    Findings:
    • Management controlled access to documents and people, and played a powerful role in making the auditor appointment decision.
    • Management engaged the audit firm that offered the least senior level expertise and the lowest fee.
    • The audit committee adopted management’s priorities in encouraging prospective auditors to demonstrate responsiveness to management.
    • Prospective auditors were reticent to probe the client for information that would have helped them identify risks before accepting the engagement.
    • The auditors were focused on winning the client and were willing to cut fees, move partners to the client’s head office city, and curtail quality control.
    • If management, with private information and interests, continues to have substantial influence over hiring the auditor, then regulatory reforms for audit firm rotation and/or audit committee empowerment are likely to be ineffective.
    • Auditor change puts pressure on audit fees, and requires auditors to demonstrate commitment and responsiveness to the management of both prospective clients and current ones used as referees.
    • Instead of strengthening independence and providing a fresh auditor perspective, the authors find that the auditor change process is dominated by management and is characterized by gestures from prospective auditors to win client favor during the courtship, potentially rendering proposed audit firm rotation ineffective.
    Category:
    Corporate Matters, Independence & Ethics
    Sub-category:
    Audit Committee Effectiveness, Audit Firm Rotation, Audit Firm Rotation, Impact of Fees on Decisions by Auditors & Management
  • The Auditing Section
    Independence Threats, Litigation Risk, and the Auditor’s D...
    research summary posted May 4, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Title:
    Independence Threats, Litigation Risk, and the Auditor’s Decision Process
    Practical Implications:

    This study is important for audit firms and audit regulators, as it provides a more complete picture of how threats to auditor independence and litigation risk affect auditor performance. Rather than just focusing on the auditor’s final decision, this study demonstrates that the above incentives affect auditors through their evaluation of information during the decision process. Therefore, firms and regulators may be interested in research that specifically addresses processing biases. This research advocates using decision aids, such as artificial neural networks, to attenuate processing bias. Accountability-inducing controls, like those promoted by audit documentation standards, are unlikely to achieve this goal. Further, reviews conducted by individuals within the same firm are less likely to detect process bias. Review by independent parties, such as an audit committee, would likely be more effective.

    Citation:

    Blay, A.D. 2005. Independence Threats, Litigation Risk, and the Auditor’s Decision Process. Contemporary Accounting Research 22 (4): 759-789.

    Keywords:
    Auditor independence, auditor reporting, decision process, going concern, motivated reasoning
    Purpose of the Study:

    The preservation of auditor independence is a concern of audit regulators. The Sarbanes-Oxley Act of 2002 attempts to minimize the economic bond between the auditor and the client, but cannot completely eliminate it. Litigation risk is often proposed as a safeguard to mitigate independence threats. Prior studies about auditor independence focus solely on auditors’ final reporting choices, but this paper addresses auditors’ judgment and decision-making process as well. Particularly, this paper investigates whether independence threats (high versus low) and litigation risk (high versus low) influence auditors’ evaluation of information and their subsequent reporting choices. 

    The author expects that when high threats to auditor independence are present, auditors will be more supportive of the client-preferred position (unqualified opinion) both during the decision process and in the final reporting decision.  However, when high litigation risk is present, the author expects auditors will be less supportive of the client-preferred position. 

    These expectations are derived from the psychology literature on directional goals and motivated reasoning. Directional goals arise when an individual is dependent on a particular decision outcome. Though accurate judgment should be the auditor’s ultimate goal, the literature on motivated reasoning suggests that, as long as the conclusion is justifiable, individuals will evaluate information consistent with a desired conclusion. Thus, economic incentives associated with independence threats and litigation risk are likely to affect not just the auditor’s final decision, but also his/her evaluation of information during the decision process.

    Design/Method/ Approach:

    The research evidence was collected in the early-2000s (pre-SOX). Audit managers from three Big-4 firms participated in the experiment.  Participants completed a simulated task involving a hypothetical manufacturing client where they assessed the initial likelihood of going-concern, searched for informational cues, and reassessed the likelihood of going-concern. As informational cues were obtained, auditors also assessed whether the cues provided positive or negative support for the client’s going concern.

    Findings:
    • The author finds that auditors facing greater threats to independence will be more supportive of an unqualified opinion (client-preferred) when:
      • Assessing initial information,
      • Evaluating additional information cues,
      • Making a final report choice.  
    • The author finds that auditors facing higher litigation risk will be less supportive of an unqualified opinion (client-preferred) only when:
      • Evaluating additional information cues,
      • Making a final reporting choice  
    • The author finds that both threats to independence and litigation risk affect final report choice completely through their influence on the auditor’s evaluation of additional information cues. Thus, it appears that independence threats and litigation risk lead to information processing bias, as opposed to an up-front choice bias. 
    • The author finds that when both threats to independence and litigation risk are high, auditors gather additional information cues and spend more time evaluating evidence.  Further, there is no significant difference in final reporting choice when independence threats and litigation risk are low, supporting regulators’ claim that litigation risk offsets independence threats.
    Category:
    Independence & Ethics, Auditor Judgment, Accountants' Reporting
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent, Going Concern Decisions, Going Concern Decisions
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  • Jennifer M Mueller-Phillips
    Materiality Judgments and the Resolution of Detected...
    research summary posted October 13, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.01 Earnings Management 
    Title:
    Materiality Judgments and the Resolution of Detected Misstatements: The Role of Managers, Auditors, and Audit Committees.
    Practical Implications:

    The results of this study shed light on the complex interplay between analyst following, the pressure that managers face to manage earnings, the pressure that auditors face to protect their reputations in the post-SOX environment, and the important role that audit committees can play in settings in which managers may act strategically to achieve desired financial reporting outcomes.

    Citation:

    Keune, M. B., and K. M. Johnstone. 2012. Materiality Judgments and the Resolution of Detected Misstatements: The Role of Managers, Auditors, and Audit Committees. Accounting Review 87 (5): 1641-1677.

    Keywords:
    audit committees, audit fees, error correction, materiality, stock analysts
    Purpose of the Study:

    Auditors detect and inform client managers and audit committees of misstatements, and these agents must reach agreement about whether managers will correct the misstatements prior to issuing the financial statements. Managers may waive correcting misstatements if auditors and audit committees conclude that the misstatements do not render the financial statements materially incorrect. Yet, the Securities and Exchange Commission (SEC) and others have asked the rhetorical question: If a misstatement is immaterial, then why not correct it? Given the absence of bright-line criteria for assessing materiality, judgments about resolving misstatements may be strategic to achieve desired financial reporting outcomes. Analysis of the role of managers, auditors, and audit committees in misstatement materiality judgments is therefore important because it can aid understanding of observed audit and financial reporting outcomes that can affect users.

    In this study the authors make use of regulation concerning the resolution of detected misstatements contained in Staff Accounting Bulletin No. 108 (SAB 108). The implementation of SAB 108 provides disclosure data on detected misstatements that were previously judged immaterial and were not corrected in the financial statements until the release of the new guidance. The authors use the SAB 108 disclosures to measure both the qualitative and the quantitative materiality of misstatements during the periods in which they remained uncorrected.

    Design/Method/ Approach:

    The data-collection period covers 10-Qs filed from November 15, 2006 to February 28, 2007 and 10-Ks filed from November 15, 2006 to February 15, 2008, and the analyses examine waived misstatements that existed in the financial statements during the period January 1, 2003 to September 30, 2006. To identify these misstatements, the authors read SAB 108 disclosures to find companies that corrected misstatements under SAB 108. 

    Findings:
    • The authors find that managers are generally more likely to waive qualitatively material misstatements as analyst following increases, but this effect is primarily present when audit fees are relatively low.
    • They find auditors are less likely to allow managers to waive quantitatively material misstatements as audit fees increase.
    • The authors also find a negative interaction between audit fees and analyst pressure on the likelihood that auditors will allow managers to waive qualitatively material misstatements.
    • Specifically, auditors’ incentives to protect their reputations weaken the effect of managerial incentives associated with the pressure created by analyst following; auditors are less likely to allow managers to waive qualitatively material misstatements as audit fees increase.
    • The authors find that audit committees with greater financial expertise are less likely to allow managers to waive qualitatively or quantitatively material misstatements than are audit committees with less expertise.
    Category:
    Corporate Matters, Governance, Independence & Ethics, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Board/Audit Committee Oversight, Earnings Management, Earnings Management, Impact of Fees on Decisions by Auditors & Management
  • The Auditing Section
    The Influence of Client Importance on Juror Evaluations of...
    research summary posted May 9, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management 
    Title:
    The Influence of Client Importance on Juror Evaluations of Auditor Liability
    Practical Implications:

    The results of this study are useful for understanding what factors affect jurors’ decisions regarding whether, and to what extent, an auditor should be held responsible for audit failure. These results should be of interest to audit firms and their respective attorneys when making litigation decisions regarding whether to settle or pursue a jury trial.

    Citation:

    Brandon, D. M. and J. M. Mueller. 2006. The Influence of Client Importance on Juror Evaluations of Auditor Liability. Behavioral Research in Accounting 18: 1-18.

    Keywords:
    client importance, auditor liability, juror evaluations, punitive, compensatory
    Purpose of the Study:

    Previous research suggests that there is a common perception that auditor independence is impaired by an economically important client (i.e. a client whose audit fees represent a large proportion of gross revenues). Evidence also suggests that client importance may even lead to a higher incidence of litigation against the auditor. For example, jurors may be more likely to blame and punish the  auditor if they perceive that the auditor had intentions or motives, such as profitability or client retention, to act in favor of the client.  This paper examines whether client importance is significantly related to juror evaluations of responsibility and blame as well as auditor liability and damage awards. 

    Design/Method/ Approach:

    The authors collected data from 187 undergraduate students enrolled in economics and introductory business courses. Participants reviewed a litigation case against the auditor of a bankrupt toy company for incorrectly providing a favorable audit report prior to the bankruptcy filing. Half of the participants reviewed a case which indicated that the client represented approximately 60% of the office revenues and half reviewed a case where the client represented approximately 2% of the office revenues.

    Findings:
    • The authors find that when an auditor is involved in litigation associated with an audit client that is financially more important to the auditor, participants evaluated the auditor as less objective, more blameworthy, and more deserving of punishment. A
    • Although, the authors do find that client importance significantly affects jurors’ liability assessments, the relationship can largely be attributed to independence perceptions. Thus, the authors conclude that client importance marginally affects punitive damage awards but does not influence compensatory damage awards.
    Category:
    Independence & Ethics
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent
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  • Jennifer M Mueller-Phillips
    The Institutionalization of Commercialism in the Accounting...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management 
    Title:
    The Institutionalization of Commercialism in the Accounting Profession: An Identity-Experimentation Perspective
    Practical Implications:

    This paper synthesizes many theories of institutional experimentation and identifies work for advancing the understanding of commercialism in the accounting profession. It also contributes through the explication of identity experimentation as a key mechanism used by the accounting profession to institutionalize commercialism. The paper works to demarcate boundary work and practice work as two different types of identity experimentation. Finally, the paper delineates the difference between deriving an auditor identity from audit practice and deriving expert work from a versatile expert identity.

    Citation:

    Guo, K. 2016. The Institutionalization of Commercialism in the Accounting Profession: An Identity-Experimentation Perspective. Auditing: A Journal of Practice and Theory 35 (3): 99-118.

    Keywords:
    professionalism, commercialism, institutional work, institutional experimentation, identity experimentation, institutional logic
    Purpose of the Study:

    As the system of accounting stands today, auditors are hired by clients for a fee to examine and opine on their financial reports while maintaining independence from the client; however, it follows that the independence of the auditor could be questioned due to the financial dependence of the auditor on the client. In fact, many are beginning to believe that auditors have become more commercialistic (serving economic self-interest) than professional (serving the public interest) as a result of deregulation in the professional services area. The author chooses to investigate how the accounting profession, collectively, has become more committed to commercialism in the recent decades. The author separates his work from the work of previous researchers by truly focusing on the collective identity of the profession by developing an identity-experimentation framework. 

    Design/Method/ Approach:

    To develop the identity-experimentation framework, the author reviewed and synthesized many relevant studies in the accounting and management literature. Furthermore, he utilizes recent cases as examples to highlight the accounting profession’s efforts to institutionalize commercialism. 

    Findings:
    • The framework highlights two key identity-experimentation strategies: boundary work and practice work.
    • Boundary work has two different forms.
      • The first involves making identity claims about auditor expertise and traits and largely focuses on how auditor expertise and traits can claim to help achieve pragmatic ends.
      • The second involves the redefinition of the auditor boundary.
    • Practice work involves the creation of an expert-work identity; by reinventing the audit and tailor-making expert work for versatile experts, the accounting profession aims to achieve the taken-for-grantedness of “versatile experts doing expert work.”
    • The author finds that identity experimentation in the accounting profession can be viewed as an ongoing and trial-and-error process that involves what is termed as “constant jockeying” and aims to “fashion shared meanings and identities.”
    Category:
    Independence & Ethics
    Sub-category:
    Impact of Fees on Decisions by Auditors & Management

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