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  • Jennifer M Mueller-Phillips
    Speak Up or Shut Up? The Moderating Role of Credibility on...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 06.0 Risk and Risk Management, Including Fraud Risk, 06.10 Impact of office size 
    Title:
    Speak Up or Shut Up? The Moderating Role of Credibility on Auditor Remedial Defense Tactics
    Practical Implications:

    The results of this study have practical implications relating to auditor defense strategies. Results indicate that when negligence is alleged on high-importance clients, audit firms should be cautious about using remedial tactics to avoid inadvertently increasing juror negligence assessments by calling attention to the firm’s incentives to appease management (e.g., high audit fees). Rather, for high-importance clients, audit firms would likely benefit from procuring external firms or expert witnesses who may be perceived as more credible. Conversely, when negligence is alleged on low-importance clients, audit firms likely can reduce negligence assessments by utilizing various remedial tactics (e.g., preemptively denying prior knowledge of an undetected fraud). Lastly, results indicate that, if possible, audit firms should implement remedial tactics at the national, as opposed to local, office level.

    Citation:

    Grenier, J., B. Pomeroy, and A. Reffett. 2012. Speak Up or Shut Up? The Moderating Role of Credibility on Auditor Remedial Defense Tactics. Auditing: A Journal of Practice and Theory 31(4): 65-83.

    Keywords:
    Auditor negligence; auditor independence; credibility; remedial defense tactics.
    Purpose of the Study:

    Audit firms face lawsuits worth hundreds of millions of dollars each year. Because of the litigation that they regularly face, audit firms are interested in how to best defend themselves in the courtroom. Audit firms may utilize remedial defense tactics (such as asserting compliance with standards and denying prior knowledge of undetected fraud) to attempt to reduce juror assessments of auditor negligence. The purpose of this study was to examine how the use of these tactics affects juror assessments of auditor negligence in lawsuits against audit firms. The other purpose of the study was to examine how factors that are related to the credibility of these defense tactics impact how effective the tactics are at influencing juror assessments of auditor negligence. The factors the authors examined included the following:

    • Client importance
    • The source of the defense tactic (the national or local office of the audit firm).

    The authors wanted to examine circumstances where the credibility of the remedial defense tactics was compromised which could possibly result in backfiring (higher, rather than lower, juror assessments of auditor negligence). 

    Design/Method/ Approach:

    The authors conducted an experiment sometime before November 2011 with undergraduate students that had no prior knowledge of the main issues of the case in order to simulate actual jurors in auditor negligence lawsuits. Participants read a case about a fictional company and its auditor and learned the details about the auditor negligence lawsuit. The participants rendered a verdict (negligent or not negligent), assessed the likelihood of negligence, and if they rendered a negligent verdict, assigned damages that they would require the audit firm to pay.

    Findings:
    • Participants’ assessments of auditor negligence are negatively associated with their perceptions of the remedial tactic’s credibility.
    • When client importance was low and the tactic was implemented by the firm’s national office, the examined remedial tactic was perceived to be credible and resulted in lower negligence assessments.
    • When client importance was low and the tactic was implemented by the firm’s local office, the remedial tactic was perceived as less credible, and did not result in lower negligence assessments.
    • When client importance was high, the remedial tactic was perceived to lack credibility, leading to backfiring with higher negligence assessments, irrespective of the tactic’s source (national versus local).
       
    Category:
    Independence & Ethics, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Litigation Risk
  • Jennifer M Mueller-Phillips
    The Contagion Effect of Low-Quality Audits
    research summary posted April 28, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.10 Impact of office size, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
    Title:
    The Contagion Effect of Low-Quality Audits
    Practical Implications:

    The findings of this study should be of interest to regulators, audit standard-setters, accounting firms, and investors because they provide a method to infer the overall quality of an auditor office location though the use of easily obtainable and publicly available information on restatements. This information can be used to identify offices where audits are more likely to be of lower quality, and to develop standards that emphasize the potential for quality-control problems in the offices of multi-location audit firms. Investors may be able to use it as one piece of additional information with which to infer something about the earnings quality of a particular company based on the history of the auditor office that performs the audit.

    For more information on this study, please contact Jere R. Francis.
     

    Citation:

     Francis, J. R., and P. N. Michas. 2013. The Contagion Effect of Low-Quality Audits. The Accounting Review 88 (2).

    Keywords:
    audit quality; auditor offices; contagion
    Purpose of the Study:

    A low-quality audit is defined as the presence of one or more clients with overstated earnings that were subsequently corrected by a downward restatement. A “contagion” of low quality audits could occur in an auditor office location due to office-specific characteristics including personnel and quality-control procedures. Prior research provides evidence that differences in characteristics across offices of accounting firms are an important determinant of audit quality, and that  differences in audit quality can exist even within the same audit firm, depending on office-level characteristics. The authors of this study investigate if the existence of at least one low-quality audit in an auditor office indicates the presences of a contagion effect on the quality of other audits conducted by the office.
     

    Design/Method/ Approach:

    The authors first developed the following three hypotheses for testing:

    H1: The existence of an audit failure in an auditor office is indicative of a contagion effect that reveals the presence of other concurrent low-quality audits in the office.

    H2: There is lees contagion in large Big4 offices than in small Big 4 offices.

    H3: There is less contagion in a Big 4 office where relatively more audits are conducted in the office’s area of industry expertise, compared to Big 4 offices where relatively fewer audits are conducted in the office’s area of industry expertise. 

    The authors use the Audit Analytics database to identify restatements and the original filing year for which the financial statements were subsequently restated. The Compustat Unrestated U.S. Quarterly Data File was used to obtain originally released and subsequently restated accounting data and cross referenced this sample with the one pulled from the Audit Analytics database. The final sample is comprised of 22,626 firm-year observations for 4,765 unique companies from 2000 through 2008.
     

    Findings:
    • Offices with client restatements in the past are more likely to have new client restatements for up to five years in the future.
    • In auditor offices where an audit failure occurred, the concurrent clients of that office have a higher level of abnormal accrual compared to offices with zero audit failures.
    • The results above hold for all but the largest quartile of office size, indicating that office size is also an important factor in contagion.
    • A relatively high use of industry expertise in a Big 4 office can mitigate the negative effect of small office size.
       
    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Impact of Office Size, Restatements

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