There are numerous factors that go into a firm’s decision to cross-list on foreign stock exchanges. One factor firms should consider regarding entrance into the U.S. stock exchange is an increase in audit fees. The evidence from this study indicates this increase can be traced back to costs from the legal environment and increased audit effort. 

Bronson, Scott N., A. Ghosh, and C. E. Hogan. 2017. “Audit Fee Differential, Audit Effort, and Litigation risk: An Examination of ADR Firms”. Contemporary Accounting Research 34.1 (2017): 83.

U.S. investors rely on financial statements by foreign firms cross-listed on U.S. stock exchanges. Therefore, these financial statements must comply with accounting standards from the entity’s home country and U.S. standards. Previous studies have identified that audit fees are higher for cross-listed firms and attributed this to added litigation costs. This study examines if there are additional factors causing the audit fees to be higher for cross-listed firms. Specifically, about whether an increase in audit effort is incrementally related to price increases and if audit effort varies based on the stringency of an entity’s home country regulations. The authors presume the additional audit effort will result from the attestation of U.S. GAAP reconciliations and foreign auditor attestation of U.S. audit and independence standards.

The final sample consists of 36,646 observations and only includes entities audited by Big 4 firms. Compustat was used to find U.S.-based publicly traded firms, a list of foreign firms cross-listed in the United States was obtained from Bank of New York Mellon, and foreign non-cross listed publicly traded firms was listed in Worldscope and Compustat Global. The analysis was run using a regression of audit fees.

The authors find the following:

• Cross-listed firms in the United States do in fact pay significantly higher fees relative to other firms.
• This total fee difference includes both incremental costs in legal environment and audit effort. The authors attributed 29% to 48% of this additional incremental costs as the additional audit effort required.
• Cross-listed firms in countries with more stringent audit oversight pay a lower incremental audit fee compared to cross-listed firms in countries with more lax audit oversight.

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

Requiring engagement partners to sign their names to audit reports appears to result in increased audit quality, earnings informativeness, and audit fees, suggesting that the signature requirement emphasizes personal accountability for engagement partners. Requiring the identification of engagement partners in audit reports would likely have similar effects. Thus, there are both costs and benefits that the PCAOB should consider in making its decision regarding partner identification.

For more information on this study, please contact Chan Li: chanli@katz.pitt.edu.

Carcello, J. V. and C. Li. 2013. Costs and benefits of requiring an engagement partner signature: Recent experience in the United Kingdom. The Accounting Review 88 (5): 1511-1546.

The Public Company Accounting Oversight Board (PCAOB) is considering requiring the identification of the engagement partner in audit reports. Proponents of the proposal argue that it will increase accountability and transparency, which will result in improved audit quality. Opponents argue that engagement partner identification is unnecessary, as audit firms’ quality control systems and the threats of sanctions by regulators and private litigation are sufficient to hold partners accountable. Identifying engagement partners is similar to them signing audit reports in their own name, which the U.K. began requiring in 2009. Because of the similarities between the U.K. and the U.S., it is likely that the effects of requiring engagement partner identification in the U.S. will be similar to the effects of requiring the engagement partner to sign the audit report in the U.K. Therefore, the authors investigate the benefits and costs of requiring partner signatures in the U.K. in the form of changes in audit quality and audit fees. The results are likely informative of the benefits and costs of requiring partner identification in the U.S.

Using publicly-disclosed data on companies listed on the London Stock Exchange (LSE) between 2008 and 2010 (the years surrounding the implementation of the signature requirement), the authors examine audit quality changes using the following measures:

• Abnormal accruals
• Likelihood of meeting earnings thresholds
• Earnings informativeness
• Likelihood of qualified opinions

The authors also examine the change in audit fees following the implementation of the signature requirement.

The authors find that following the implementation of the signature requirement, abnormal accruals and the likelihood of meeting earnings thresholds decrease in the U.K. These results suggest that audit clients’ earnings management declines due to the signature requirement. Further, the association between return on assets and stock market returns increases following the signature requirement, implying that reported earnings becomes more informative of firm value to investors following the implementation of the signature requirement. The likelihood of audit clients receiving a qualified audit opinion following the signature requirement also increases, suggesting that audit reporting becomes more conservative with the signature requirement. Finally, audit fees increase with signature requirement. Thus, signature requirement appears to result in higher fees for audit clients. These changes do not occur for U.S. firms or other European firms during the same period and do not occur for the U.K. in the period prior to the introduction of the signature requirement, providing evidence that the changes in the U.K. are the result of the signature requirement.

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 These findings should be of interest to policy makers in China because, among other implications, the results suggest that Chinese regulators should pay attention to the switching of audit partners before they reach tenure limit for mandatory rotation. Partner-level opinion shopping could be more difficult to detect in markets in which the identity of the engagement partner is not disclosed, and it may therefore be prevalent in those markets, such as the United States.

 Chen, F., A. Peng, S. Xue, Z. Yang, and F. Ye. 2016. Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence. Journal of Accounting Research 54 (1): 79-112.

Opinion shopping refers to the practice by which audit clients seek alternative auditors willing to give a clean audit opinion when the incumbent auditor is likely to issue an unclean opinion. Existing studies examine whether companies successfully engage in opinion shopping through switching audit firms using data from such countries as China, the United Kingdom, and the United States. In this study, the authors examine evidence of switching audit partners within the same firm rather than switching to another firm for clean audit opinions, which they term “partner-level opinion shopping.” Statements from the PCAOB suggest that partner-level rotation shopping has become a regulatory concern and the regulators believe that this practice may be more prevalent if the names of engagement partners are not publicly disclosed; however, there is no empirical evidence on the existence and extent of partner-level opinion shopping to the best of the authors’ knowledge. Consequently, the authors attempt to fill this gap in the auditing literature by testing whether companies successfully engage in partner-level opinion shopping.

The authors decided to use data from China because engagement partners in China are required to sign the audit report, which enables the authors to identify partner switches before partners reach their mandatory rotation limit. The sample consists of observations from 1998 to 2012. They use an audit reporting model to determine a company’s probability of receiving a modified audit opinion (MAO) with and without a partner switch. 

• The authors find consistent results for partner-level opinion shopping for both field partner and review partner switching.
• The authors’ findings support the notion that partner-level opinion shopping is less likely to be successful for companies audited by firms organized as partnerships.
• The authors find no evidence suggesting that outgoing audit partners are overly conservative compared with an average audit partner with an expected conservatism score of zero; the authors do not find evidence that incoming partners are less conservative than outgoing partners.
• The authors find evidence that Chinese companies successfully engage in partner-level opinion shopping.
• The authors find that the extent of success in opinion shopping is affected by client importance and the organizational forms of audit firms.
• The authors’ results show that companies that successfully engage in opinion shopping report significantly lower-quality earnings, as indicated by higher discretionary accruals and a higher likelihood of reporting small profits.
• The authors find direct evidence that incoming audit partners, for companies that obtain more favorable audit opinions after a partner switch, have a higher propensity to issue clean opinions than outgoing partners.

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 This paper provides new evidence on how higher-audit quality benefit companies in debt contracting. Specifically, the authors show that Big 4 audit clients enjoy a longer debt maturity than non-Big 4 clients. This audit quality effect on debt maturity exists worldwide but varies with each country’s legal institutions governing property rights and creditor rights. This paper helps to resolve the mix views in prior literature on the role of Big 4 auditors and stresses the importance of considering legal institutions in analyzing the link between auditor choice and economic outcomes.

 Ghoul, S. E., O. Guedhami, J. A. Pittman, and S. Rizeanu. 2016. Cross-Country Evidence on the Importance of Auditor Choice to Corporate Debt Maturity. Contemporary Accounting Research 33 (2): 718–751.

 Prior research finds audited financial statements provide useful information to lenders and help lenders to better monitor the borrowing companies. However, there is little empirical evidence on how higher-audit quality affects the lender’s choice on monitoring mechanisms. The authors intend to provide the initial and international evidence on how lenders weigh the monitoring from auditors against their own monitoring through shorter debt maturity. Because the Big 4 auditors is generally accepted in academic literature as a proxy for higher-audit quality, the authors examine whether engaging Big 4 auditors benefits the companies in debt contracting. The degree of legal institutions governing property rights and creditor rights various across countries. The authors argue strong legal institutions can amplify the effect of audit quality on debt maturity because monitoring from the Big 4 auditors is more rigorous and borrowers are ex ante incentivized to be honest. Therefore, the authors next investigate whether legal institutions mediate the link between auditor choice and debt maturity.

 The initial sample consists of all public companies from 42 countries around the world, including the U.S., the U.K., Canada, Malaysia, Hong Kong, and so on, for 10-year period from 1994 to 2003. The company financial and audit data are from COMPUSTAT Global database. The authors first examine whether companies with Big 4 auditors have higher proportion of long-term debt in their capital structure. They then test whether legal institutions have a mediating effect on the relationship between audit quality and debt maturity.

The initial sample consists of all public companies from 42 countries around the world, including the U.S., the U.K., Canada, Malaysia, Hong Kong, and so on, for 10-year period from 1994 to 2003. The company financial and audit data are from COMPUSTAT Global database. The authors first examine whether companies with Big 4 auditors have higher proportion of long-term debt in their capital structure. They then test whether legal institutions have a mediating effect on the relationship between audit quality and debt maturity.  

www.auditingresearchsummaries.org

 This study provides useful insights into how audit-partner quality affects engagement-level quality and underscores the importance of audit-partner identification; furthermore, this study could lead to future research which can explore whether audit-partner quality affects the cost of equity and debt capital above and beyond audit-firm and audit-client characteristics with the hopes of deepening the understanding of auditor performance and the market perception of auditor reputation at the audit-partner level.

Wang, Yanyan, Lisheng Yu, and Yuping Zhao. 2015. The Association between Audit-Partner Quality and Engagement Quality: Evidence from Financial Report Misstatements. Auditing: A Journal of Practice and Theory 34 (3): 81-111.

This paper attempts to address two specific research questions in this paper:

• Does audit-partner quality affect engagement-level audit quality?
• How do engagement-team-level and audit-firm-level quality reviews moderate the influence of audit-partner on engagement-level quality?

Most of the research that has been done on this subject focuses on firm-level or office-level audit quality; however, it is the opinion of the authors that both firm-level and office-level audit quality is driven by the quality of the engagements supervised by individual audit partners.  As a result, the authors decided to investigate just how integral of a role audit partners actually play in the engagement quality equation.  This research is especially interesting for the following reasons:

• The complex nature of auditing implies that it is a judgment and decision-making process which is heavily affected by the characteristics of the person making the decisions.
• Some insight will be shared on the current debate regarding mandatory disclosure of the engagement partner in the audit report.

           The authors collected their evidence by merging data from the following sources for the period 2004-2009:

• All available firm-year observations from the China Stock Market and Accounting Research database (CSMAR), which included financial and stock market data, audit opinions, and names of audit firms
• All identities of the signing audit partners, obtained from CSMAR
• All restatement announcements collected from annual report disclosures

• The authors find that the probability of future restatements is higher for annual reports audited by audit partners with higher past-audit failure rates.
• The authors find that engagement partners who actually conduct the audit have significantly greater influence on future restatement probability than review partners
• The authors find that clients audited by high-quality audit firms are less likely to restate; however, older firms and firms with higher book-to-market ratio are more likely to restate current year annual reports.
• The authors find that audit-firm-level quality control slightly attenuates the influence of review partners, but no quality control effectively weakens the influence of engagement partners.  Given that engagement partners play much more of a ro0le in the audit than the review partners, the findings fail to substantiate the mitigating effects of quality control.
• The authors find that economic incentives amplify engagement partner’s influence on audit quality.

www.auditingresearchsummaries.org