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  • Jennifer M Mueller-Phillips
    Auditor Style and Financial Statement Comparability.
    research summary posted July 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size 
    Title:
    Auditor Style and Financial Statement Comparability.
    Practical Implications:

    The authors find support for the idea that auditors develop in-house rules to facilitate comparability within their clientele. These auditor style effects also appear to reduce comparability between clients audited by different auditors. Big 4 accounting firms may have an effect on another earnings attribute that has not previously been investigated, namely, accounting comparability. The authors find that firms audited by Big 4 auditors have greater accounting comparability than firms audited by non-Big 4 auditors, which suggests another dimension in which the two auditor groups differ. It is also the case that each Big 4 audit firm has its own style, which affects accounting comparability and is therefore another source of variation within the Big 4 group of auditors.

    Citation:

    Francis, J. R., Pinnuck, M. L., & Watanabe, O. 2014. Auditor Style and Financial Statement Comparability. Accounting Review 89 (2): 605-633.

    Keywords:
    big 4 accounting firms, comparability, earnings, expertise
    Purpose of the Study:

    Comparability is defined by the Financial Accounting Standards Board (FASB) as the quality of information that enables users to identify similarities and differences in the financial performance of two firms. The FASB states that comparability in financial reporting is the primary reason for developing accounting standards, and the centrality of comparability is stressed in accounting textbooks, particularly financial statement analysis texts accounting standards on their own do not fully determine financial reporting outcomes; economic agents and institutional incentives also play an important role.

    This motivates the investigation of the role that auditors play in the implementation of comparability in the United States. For the purpose of this study the authors define accounting comparability as the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms. In the empirical context, this means that firm-pairs in the same industry and fiscal year, and therefore subject to the same general economic shocks, are expected to have a similar accruals and earnings structure, all things being equal. The study focuses on the role of the auditor, the authors argue that each Big 4 audit firm has its own unique set of internal working rules that guide and standardize the auditor’s application of auditing and accounting standards.

    Design/Method/ Approach:

    The authors use a regression model to examine the relation between accounting comparability and auditor style. The primary tests are based on pairs of firm-year observations from Compustat in the same industry-year for the period 1987 to 2011.

    Findings:

    The authors find that two firms in the same industry-year and audited by the same Big 4 auditor have more comparable earnings than two firms audited by two different Big 4 auditors. Pairs of firms in the same industry-year with the same Big 4 auditor have more similar total and abnormal accruals; firm-pairs with the same Big 4 auditor have a higher covariation in earnings over time; and auditor fixed effects are a statistically significant determinant of accruals.  Big 4 auditors have a greater effect on accounting comparability than non-Big 4 auditors.

    A single set of uniform accounting standards is often advocated as a means to increase comparability of financial statements, reflecting the rationale for the FASB-IASB convergence project. This study documents that the role of an economic agent, the auditor, is also important in facilitating the production of accounting comparability. The authors argue that the Big 4 style effect arises from each audit firm having its own unique set of in-house rules with respect to the interpretation and implementation of GAAS (auditing standards) and the interpretation and enforcement of GAAP (accounting standards).

    Category:
    Audit Team Composition
    Sub-category:
    Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality...
    research summary posted March 4, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 14.0 Corporate Matters 
    Title:
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics?
    Practical Implications:

    The fact that the Big 4 effect is generally insignificant indirectly supports the argument that the Big 4 distinction may reflect client and not auditor characteristics. The results suggest that differences in these proxies between Big 4 and non-Big 4 auditors largely reflect client characteristics and, more specifically, client size. The study has not resolved the question, although it encourages other researchers to explore alternative methodologies that separate client characteristics from audit-quality effects.

    For more information on this study, please contact Alastair Lawrence.

    Citation:

    Lawrence, A., M. Minutti-Meza, and P. Zhang. 2011. Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics? The Accounting Review 86 (1): 259-286. 

    Keywords:
    Big 4 versus non-Big 4 audit quality; discretionary accruals; ex ante cost-of-equity capital; analyst forecast accuracy; propensity-score matching; attribute-based matching
    Purpose of the Study:

    This study examines whether differences in proxies for audit quality between Big 4 and non-Big 4 audit firms could be a reflection of their respective clients’ characteristics.

    The question of Big 4 superiority is important, given that many studies rely on the Big 4 versus non-Big 4 distinction as an audit-quality proxy. Hence, it is prudent to confirm that this distinction does not simply reflect client characteristics. Furthermore, incorrectly classifying Big 4 auditors as superior to non-Big 4 auditors has unnecessary negative ramifications for smaller auditors, such as audit committee’s auditor selection bias and discriminatory clauses in loan and underwriting agreements, which could result in a loss of current and future clients.

    Design/Method/ Approach:

    In the research, the authors use three audit-quality proxies – discretionary accruals, the ex ante cost-of-equity capital, and analyst forecast accuracy – and employ propensity-score and attribute-based matching models in attempt to control for differences in client characteristics between the two auditor groups while estimating the audit-quality effects. Also, they use propensity-score matching models in an attempt to control for differences in client characteristics between the two auditor groups while estimating auditor treatment effects.

    Findings:

    Using the matching models and full samples, the authors find that the treatment effects of Big 4 auditors are insignificantly different from those of non-Big 4 auditors with respect to our three audit-quality proxies.

    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit Fee Decisions, Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Committed to professionalism: Organizational responses of...
    research summary posted June 6, 2014 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.08 Impact of Office Size, 11.0 Audit Quality and Quality Control 
    Title:
    Committed to professionalism: Organizational responses of mid-tier accounting firms to conflicting institutional logics.
    Practical Implications:

    This study attempts to extend the current understanding of the impact of multiple institutional logics and the heterogeneity of organizational responses. The authors set out to investigate organizational responses by mid-tier accountancy firms in the face of conflicting institutional logics. Through the analysis of interviews with top management level informants and an investigation of secondary material, the authors make three main contributions:

    • Enhanced understanding of how the characteristics of accounting as a profession affect organizational resistance and change in mid-tier firms. 
    • Shed light on the concrete organizational responses in mid-tier firms to institutional change. 
    • Question the generalizability of PSF research. 

     

    Citation:

    Lander, M. W., B. A. Koene, and S. N. Linssen. 2013. Committed to professionalism: Organizational responses of mid-tier accounting firms to conflicting institutional logics. Accounting, Organizations and Society 38 (2).

    Keywords:
    professionalism; organizational structure; decision making
    Purpose of the Study:

    The accounting profession has recently come under increasing institutional pressure. Financial globalization along with technological innovation and a broad shift towards neo-liberal principles of market economics are changing the face of accounting. For many firms, this marks a change in their institutional environment that resulted in a shift in emphasis from the trustee logic to the commercial logic. This study attempts to determine how mid-tier accounting firms deal with these changes. 

    Design/Method/ Approach:

    The sample selected consisted of the 22 largest accounting firms listed directly behind the big 4 firms. The primary sources of data are interviews with 34 senior-level informants within 11 mid-tier accounting firms in the Netherlands. The informants were theoretically sampled on a number of characteristics. They needed to have insight in the strategic plans of the firms. Preferably, the informants needed to be managing partners and have decision making authority. They also needed to represent the different service areas of the firm. Using a two-step process, the researchers conducted the interviews with a focus on the following three questions:

    1. What forces for change are mentioned by the firm?
    2. What elements of the firm did these pressures influence?
    3. What were the organizational responses given by the firm?
    Findings:
    • For mid-tier accounting firms, there is a clash of logics and the drivers of this clash place divergent demands on the organizations. 
    • These mid-tier firms selectively adopt practices related to commercial logic, while retaining a principal commitment to the trustee logic. 
    • The interviews show how specific strategic choice opportunities serve as independent critical events framing practice-adoption decisions. 
    • Main strategic issues for the mid-tier firms relate to the changing role of the accountant and changes in organizational structure and practices. 
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Impact of Office Size
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  • Jennifer M Mueller-Phillips
    Office-Level Characteristics of the Big 4 and Audit Report...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 10.0 Engagement Management, 10.01 Budgeting and Audit Time Management, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
    Title:
    Office-Level Characteristics of the Big 4 and Audit Report Timeliness.
    Practical Implications:

    This study provides further support for the importance of office-specific characteristics on audit and financial reporting outcomes and provides evidence of the benefit of office-specific industry expertise. The study should be of interest to financial reporters and audit firms interested in reducing audit report lag times and to regulators and investors interested in increasing the timeliness of financial reporting information.

    Citation:

    Whitworth, J. D., and T. A. Lambert. 2014. Office-Level Characteristics of the Big 4 and Audit Report Timeliness. Auditing: A Journal of Practice & Theory 33 (3): 129-152.

    Keywords:
    audit report lag, industry expertise, office-level characteristics, product specialist strategy, timeliness
    Purpose of the Study:

    Timeliness of annual financial reporting information has long been a concern of investors, regulators, financial reporters, and auditors. Recent changes in the audit and financial reporting environment have resulted in longer audit report lags and have increased the importance of identifying factors associated with a timely audit. The authors examine timeliness implications of office specific attributes of the audit firm. Specifically, they examine whether office-specific industry expertise, office size, and the importance of the client to the local office are associated with audit delay (i.e., the time between fiscal year-end and the audit report date). The authors explore the sensitivity of the results to various measures and consider the impact of earnings quality. They examine two types of industry expertise and whether the aforementioned audit firm attributes are associated with a propensity to issue an early earnings announcement.

    Design/Method/ Approach:

    The authors use a regression model to test their hypotheses. They obtain audit delay, audit fees, and other audit-related information from Audit Analytics and financial information from Compustat for the years 20032008. Combining the Audit Analytics and Compustat samples provides a sample of 14,948 firm-year observations after excluding firms not audited by one of the Big 4 auditors.

    Findings:
    • The authors find that office-specific industry expertise is negatively associated with audit delay (for all but the largest quartile of firm offices, suggesting that such expertise allows audit firms and their clients to realize efficiencies within the audit process in the form of reduced post-fiscal-year-end audit time.
    • However, sensitivity analyses suggest that office-specific industry expertise is not significantly associated with audit delay for firms with the lowest accruals quality.
    • Office size and client importance are both positively associated with audit delay.
    • However, the most important clients are associated with a more timely audit.
    • Office-specific industry expertise is positively associated with the propensity to announce earnings substantially early and such expertise garnered via a product-specialist strategy is positively associated with audit delay relative to a low-cost specialist strategy.
    Category:
    Accountants' Reporting, Audit Team Composition, Engagement Management
    Sub-category:
    Budgeting & Audit Time Management, Changes in Reporting Formats, Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Small Audit Firm Membership in Associations, Networks, and...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.0 Audit Team Composition, 05.08 Impact of Office Size 
    Title:
    Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees
    Practical Implications:

    The results of this study are important for regulators concerned about the lack of competition in the audit market for large publicly-traded companies.  These data indicate that audit firm associations can increase competition in this sector of the market by providing small firms with the necessary resources to adequately audit large, global, and complex audit clients.  These findings should also be of interest to small audit firms interested in better serving larger audit clients.  Lastly, these results should be of interest to corporate governance bodies and investors interested in the relationship between audit firm type and audit quality.

    Citation:

    Bills, K. L., L. M. Cunningham, and L. A. Byers. 2016. Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees. The Accounting Review 91 (3): 767-792.

    Keywords:
    associations; networks; small audit firms; audit fees
    Purpose of the Study:

    Small audit firms are often restricted in their ability to audit large public companies because these companies often have global operations and complex business and financial reporting environments which demand a level of resources difficult for smaller firms to provide.  Many of these small firms seek membership in accounting firm associations in an effort to overcome these barriers.  Accounting firm associations are autonomous organizations in which all firm members are independent in legal name and structure, but membership affords participating firms access to resources provided by the association itself as well as fellow association members.

    Because accounting firm associations can pre-screen affiliate members and provide access to resources that would otherwise be more difficult or costly for small audit firms to obtain, audit quality for the clients of these affiliate members is likely to be higher than the clients of unaffiliated small audit firms.  Addressing this issue is important because over half of all publicly traded companies are audited by small audit firms and little accounting research to date examines differences in audit quality across the clients of small audit firms.  Below are three objectives the authors address in their study:

    • Examine whether audit quality is higher for clients of affiliated audit firms relative to the level of quality provided by nonmember firms.  The pre-screening process and access to additional resources is expected to result in higher quality for affiliated small audit firms relative to unaffiliated small audit firms.
    • Examine whether clients who choose to engage an affiliated small audit firm pay a fee premium.  If membership in an accounting firm association is associated with a perceived reputation for higher audit quality, then audit fees for affiliated small audit firms should be higher relative to unaffiliated small firms.
    • Examine whether the potential increase in audit quality associated with membership in an accounting firm association affects the extent to which audit quality differs between Big 4 firms and small, but affiliated audit firms. While prior research indicates audit quality is lower for small audit firms relative to Big 4 firms, affiliation in an accounting firm association may provide small firms with the additional resources necessary to close this gap.
    Design/Method/ Approach:

    The authors use hand-collected audit firm association membership data from 2010-2013, along with financial statement data for publicly traded firms, to examine whether audit quality and audit fees for publicly traded clients differs between small audit firms affiliated with an audit firm association and small firms with no such affiliation.  Audit quality was measured using PCAOB inspection findings, financial statement misstatement rates, and differences in levels of client discretionary accruals.

    Findings:
    • Affiliated small audit firms provide on average higher quality audits to their publicly traded clients relative to small, un-affiliated audit firms.  In particular affiliated small audit firms are less likely to receive accounting related deficiencies, or audit related deficiencies in their PCAOB inspection reports.  In addition, the clients of affiliated members report fewer annual financial statement misstatements, and less extreme discretionary accruals.  In addition, the findings indicate that when a small audit firm joins an accounting firm association, audit quality increases in subsequent years.  Lastly audit quality is increasing in the size of the audit firm association.  This indicates that the increase in audit quality is driven by an increased access to valuable resources provided by the affiliation.
    • Affiliated small audit firms receive an audit fee premium from their clients relative to unaffiliated small audit firms and this premium is increasing in the size of the audit firm association. 
    • The researchers observe no significant differences in audit quality between affiliated small audit firms and Big 4 firms.  This indicates that affiliated small audit firms provide high-quality audits to large publicly-traded companies.  In addition, while affiliated small audit firms experience a fee premium relative to unaffiliated firms, these fee premiums remain lower than those experienced by Big 4 firms.
    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Impact of Office Size
  • Jennifer M Mueller-Phillips
    Spatial Competition at the Intersection of the Large and...
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 05.0 Audit Team Composition, 05.08 Impact of Office Size 
    Title:
    Spatial Competition at the Intersection of the Large and Small Audit Firm Markets
    Practical Implications:

     This study illustrates new measures of spatial competition that incorporate the separate and distinct effects of competition within and between the large and small audit markets. This study also provides evidence that the pricing in the large firm market segment is affected by competitive pressure from small audit firms; furthermore, the study provides evidence of a differentiation premium that small audit firms are able to obtain by being perceived as competing in a bigger league than other small audit firms. Finally, the study contributes by examining measures of competition beyond the Herfindahl index in the audit firm market.

    Citation:

    Bills, K.L. and N.M. Stephens. 2016. Spatial Competition at the Intersection of the Large and Small Audit Firm Markets. Auditing: A Journal of Practice and Theory 35 (1): 23-45.

    Keywords:
    spatial competition, market for audit services, market space, differentiation, small audit market
    Purpose of the Study:

    Research in the past including a study performed by the Government Accountability Office (U.S. GAO) of the United States suggest that the large and small audit firm markets are two distinct markets in many respects; however, prior research also suggests that there is a component of the small audit firm market that competes for clients directly with firms operating in the large audit firm market.  Within this study, the authors create measures of competition that take into account these two distinct markets and how their interaction may affect the competitive positions of the players in both markets.  This is achieved by separately examining spatial competition within and between audit firms in both the large and small audit firm markets. Because the Department of the Treasury has emphasized the importance of small audit firms becoming viable suppliers for companies typically served by the large audit firm market, there is a need for a closer look at the smaller audit firm market and how its members can potentially compete with larger audit firms. 

    Design/Method/ Approach:

    Data from Audit Analytics and Compustat was used to perform the tests of the hypotheses. Two separate samples were constructed– one sample including large audit firm clients and another sample including small audit firm clients. Large audit firms are defined as the Big 4 audit firms, and small audit firms are defined as all non-Big 4 audit firms.

    Findings:
    • The authors find that the audit fee large audit firms charge decreases with the success of small audit firms at aligning themselves with the large firms in their market space.
    • The authors’ findings suggest that spatial competition from small audit firms significantly impacts the large audit firm market; in fact, spatial competition from small audit firms has a greater effect on the large audit firm market than spatial competition from other large audit firms.
    • The authors find that small audit firms that enter the large audit firm market and are perceived as being competitors with the Big 4 firms can improve their competitive positions as compared to other small audit firms.
    • The authors find that small audit firms benefit from obtaining market shares similar to those of large audit firms, whereas large audit firms are harmed by the added competition.
    • The authors find that distance from the closest competitors by market share is an important factor of competition in the small audit firm market; however, it is important to determine distance from whom, large audit firm or small audit firm, as they have opposite signs. 
    Category:
    Audit Team Composition, Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Impact of Office Size

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