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  • Jennifer M Mueller-Phillips
    An Examination of Partner Perceptions of Partner Rotation:...1
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality
    Practical Implications:

    The findings of this study shed light on the perceived benefits and detriments of the five versus seven year partner rotation requirements.  The results highlight the potential unintended consequences of implementing the accelerated rotation including a reduction in partner quality of life and auditor independence and audit quality. 


    For more information on this study, please contact Brian Daugherty. 
     

    Citation:

    Daugherty, B., D. Dickins, R. Hatfield, and J. Higgs.  2012.  An Examination of Partner Perceptions of Partner Rotation:  Direct and Indirect Consequences to Audit Quality. Auditing: A Journal of Practice & Theory 31 (1): 97-114. 

    Keywords:
    Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life.
    Purpose of the Study:

    This study examines practicing audit partner perceptions regarding the mandatory partner rotation and cooling off periods.  Specifically, the authors investigate how recently enacted and stringent rules might negatively impact auditor quality of life leading to deterioration in audit quality.  As a result of the Sarbanes-Oxley Act of 2002 (SOX), the US moved from a seven-year rotation with a two-year cooling-off period to a five-year rotation and five-year cooling-off period.  This change in standard provides the authors the opportunity to investigate the perceptions of partner that have worked under both standards.

    Design/Method/ Approach:

    The authors conducted in-depth semi-structured interviews with seven practicing audit partners.  Most of these partners were managing partners from various geographic locations.  Based on those interviews, the authors developed a model of the effects of mandatory rotation and created a field survey that was completed by 370 audit partners.  Collection of survey results occurred prior to May 2011. 

    Findings:

    The audit partners in the study believed that rotation generally improved independence which has a positive impact on audit quality.  However, partners also expressed that accelerated rotation reduced client-specific knowledge and had a negative impact on audit quality.  Partners suggested that the accelerated rotation and extended cooling-off period imposed by SOX has increased the need to relocate if the partner wishes to remain in the same industry.  As a result partners often choose to gain new industry experience and stay in the same location, rather than to relocate.  This decision maintains the partner quality of life, but possibly at the expense of industry depth and to the detriment of overall audit quality.  Partners also discussed a two to three-year new-client familiarization process, resulting in an increase in the amount of time that engagements suffer from “start-up efficacy”.  In sum, although the partners view rotation in general as a means to improve independence, they believe the accelerated rotation imposed by SOX may actually result in a reduction in independence and possibly audit quality.

    Category:
    Audit Quality & Quality Control, Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox, Impact of SOX, Industry Experience
  • Jennifer M Mueller-Phillips
    Audit Hours and Unit Audit Price of Industry Specialist...
    research summary posted June 2, 2016 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Audit Hours and Unit Audit Price of Industry Specialist Auditors: Evidence from Korea
    Practical Implications:

    The existing research is unclear about the mechanism behind the higher audit fees charged by the industry specialist auditors (ISAs). The fee premium can be explained either by higher audit hours or by higher audit fees per hour. Using Korean data, this study provides direct evidence of the source of the ISA fee premium. The results show ISAs spend more audit hours while charge lower unit price than non-ISAs, which indicates the ISA fee premium mainly comes from additional audit work performed by ISAs. One limitation of this study is the authors cannot differentiate the two potential explanations for the low unit price: cost savings arising from economies of scale or additional work performed by cheap audit labor.

    Citation:

    Bae, G. S., S. U. Choi, and J. H. Rho. 2016. Audit Hours and Unit Audit Price of Industry Specialist Auditors: Evidence from Korea. Contemporary Accounting Research 33(1): 314-340.

    Keywords:
    Industry specialist auditors; Audit effort; Audit fee premium; Audit quality
    Purpose of the Study:

    Prior audit research documents the total audit fees charged by industry specialist auditors (ISAs) are higher than those charged by non-industry specialist auditors (non-ISAs). There are different explanations of this finding. Some argue ISAs charge higher fees for more audit work they conduct. Others argue ISAs charge higher fees because they have greater bargaining power over client. This paper is to explore the source of audit fee premiums associated with ISAs. In particular, the authors compare total audit hours and audit price per hour between similar audit engagements of ISAs and non-ISAs. By decomposing total audit fees into total audit hours and audit price per hour, the authors would at least identify one source of the ISA audit fee premium. A higher total audit hours spent by ISAs would imply ISAs exert greater audit effort and their audit quality is higher. In contrast, a higher audit price per hour charged by ISAs would imply ISAs can extract market power rents or expertise rents from their clients. 

    Design/Method/ Approach:

    The sample comprises audit engagements of Korea listed companies from 2000 to 2010. In Korea, audit hours are required to be disclosed in the companies’ annual reports. The authors first compare total audit fees and total audit hours between audit engagements of ISAs and non-ISAs, controlling for other engagement characteristics. Next, they compare the unit audit prices charged by ISAs and non-ISAs.

    Findings:
    • Consistent with prior research, the authors find ISAs charge significantly higher audit fees than non-ISAs.

     

    • Further, the authors find the higher audit fees are driven by additional audit hours spent by ISAs, which implies ISAs make more audit efforts than non-ISAs.

     

    • They also find the audit price per hour charged by ISAs is significantly lower than that charged by non-ISAs.  They argue the lower unit price of ISAs could be either due to the benefit of economies of scale shared with clients or due to more audit work completed by low-pay junior auditors.   

     

     

    • Supporting the argument that extra audit hours are translated into higher audit quality, the authors find ISAs are positively associated with higher accounting quality.

     

    • The authors find consistent results when they limit their analysis within audit engagements of Big 4 accounting firms. Moreover, similar results exist when audit engagements are separate into large client group and small group and when the ISAs have dominant market shares. These findings refute the argument that the ISA fee premium is a result of superior bargaining power. 
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    Audit Quality and Analyst Forecast Accuracy: The Impact of...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.04 Industry Experience, 14.0 Corporate Matters, 14.01 Earnings Management 
    Title:
    Audit Quality and Analyst Forecast Accuracy: The Impact of Forecast Horizon and Other Modeling Choices
    Practical Implications:

    This paper contributes to research examining the determinants and impacts of audit quality by identifying the limitations of aspects of metrics employed in recent research that could have been utilized by practitioners and suggesting useful alternate metrics for investigating the impact of audit quality on the properties of analysts’ forecasts, including the usefulness of audited financial information and the prediction of future performance. 

    Citation:

    Wu, Y. and Wilson, M. 2016. Audit Quality and Analyst Forecast Accuracy: The Impact of Forecast Horizon and Other Modeling Choices. Auditing: A Journal of Practice and Theory 35 (2): 167-185. 

    Keywords:
    audit quality, auditor industry specialization and analyst forecast accuracy
    Purpose of the Study:

    Many studies examine the influence of auditor characteristics on the properties of analyst forecasts of client firms’ earnings. A common argument is that audit quality affects the accuracy of analyst forecasts or closely associated metrics. However, there is considerable divergence in the posited theoretical association between audit quality and forecast accuracy and in the empirical associations reported. The majority of these studies rely exclusively on measures of forecast accuracy based on analysts’ end-of-year forecasts. The authors argue that metrics drawn from these forecasts are noisy indicators of the impact of audit quality because there are convincing reasons why superior audit quality may affect the accuracy of the metrics in either direction. Financial reports of clients of higher quality auditors may be more useful for forecasting future earnings which in turn may increase forecast accuracy; however, higher quality auditors may be more effective in disallowing client attempts to manage earnings. Thus, if an auditor provides superior quality services to their client, then it is conceivable that these competing effects will offset each other, resulting in no net impact on forecast accuracy. As a result, the authors argue that the properties of analysts’ beginning-of-year forecasts provide superior measures of any of the impacts of auditor characteristics because these forecasts are less likely to induce benchmark-beating incentives for earnings manipulation and because audited financial information has a greater relative impact on analysts’ information set at the beginning-of-year than at the end-of-year. 

    Design/Method/ Approach:

    Focusing on measures of audit firm industry specialization common to papers with competing predictions and results, the authors demonstrate the noisiness and sensitivity to model specification of test based on end-of-year forecast accuracy and show that similar tests based on beginning-of-year forecast accuracy generate predicted results that are consistent over a range of modeling approaches. 

    Findings:
    • The authors find that analysts’ beginning-of-year forecasts are a potentially superior proxy for auditors’ impact on the properties of analyst forecasts because the “decision usefulness” impact of an audit is at its strongest soon after those reports are released and is likely to dominate any effect on audit quality on client benchmark-beating behavior.
    • The authors also identify the importance of other modeling choices facing researchers, such as the deflation of forecast errors and controls for the endogenous selection of industry specialist auditors. 
    Category:
    Audit Quality & Quality Control, Corporate Matters
    Sub-category:
    Earnings Management, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Audit quality and the market value of cash holdings: the...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Audit quality and the market value of cash holdings: the case of office-level auditor industry specialization.
    Practical Implications:

    While theoretical literature has extensively examined the link between audit quality and firm value, very little empirical evidence has been provided as to the potential channels in which high-quality audits enhance firm value. This study extends and complements the existing line of research by providing useful insights into the role of audit quality in constraining managerial diversion or misuse of corporate cash resources. The results of this study are useful in assessing the effects of audit quality on firm value, specifically the market value of cash holdings.

    Citation:

    Kim, J. B., J. J. Lee, and J. C. Park. 2015. Audit Quality and the Market Value of Cash Holdings: The Case of Office-Level Auditor Industry Specialization. AUDITING: A Journal of Practice & Theory 34 (2): 27-57.

    Keywords:
    audit quality, auditor industry specialization, capital expenditures, cash holdings, cash management efficiency
    Purpose of the Study:

    In the past, research has been conducted in regards to the impact of managerial cash expenditures on the market value of cash holdings within corporations. Specifically, the misuse of corporate cash resources by management has been shown to result in investors discounting the value of cash holdings. This study investigates the monitoring role of high-quality auditors defined as office-level industry specialists in the stock market valuation of cash assets. The authors pose the idea that high-quality audits facilitate external discipline, thereby preventing potential misuse of cash holding and the associated destruction of cash values.  The study aims to provide large-sample, systematic evidence on whether higher-quality audits contribute to an increase in the market value of cash holdings.

    Design/Method/ Approach:

    Once problematic data were excluded, the sample consisted of 14,688 Big 4 client-year observations for publicly traded U.S. companies over the sample period of 20032011. The relation between audit quality and the market value of cash holdings was investigated by applying a regression model developed in previous research. The authors controlled for certain factors that have been previously shown to affect the market value of cash, including audit financial reporting quality and corporate governance.

    Findings:

    Overall, the results of the study support the idea that higher-quality audits contribute to an increase in the market value of cash holdings. Specifically:

    • The market value of cash is significantly higher for firms audited by local practice offices with both national and city-specific industry specialization.
    • The marginal value of cash is 34 cents higher for the client of a joint industry specialist at both the national and city levels than for the client of a non-specialist.
    • The positive association between joint-industry specialization and the value of cash holdings is more significant than those of national-only or city-only industry specialization.
    • When the auditor has joint-industry specialization, cash holdings are more closely associated with capital investment, and the market value of capital expenditures is significantly higher.
    • The market value of cash holdings increases significantly following the change of auditors to joint-industry specialists.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience
  • Jennifer M Mueller-Phillips
    Auditor Differentiation, Mitigating Management Actions, and...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Auditor Differentiation, Mitigating Management Actions, and Audit-Reporting Accuracy for Distressed Firms
    Practical Implications:

    SAS No. 59 requires auditors to evaluate the adequacy and feasibility of management’s plans to mitigate financial distress.  The results of this study show that industry specialization improves auditors’ ability to more accurately evaluate management’s initiatives and the likelihood of going-concern issues.  Though BRA methodology was not shown to improve reporting accuracy, the implementation of the methodology was limited to only two firms at the time of the study.     This study suggests the importance of auditor specialization in improving reporting accuracy which can impact the approach audit clients take in obtaining an auditor. 

    For more information on this study, please contact Liesbeth Bruynseels.
     

    Citation:

    Bruynseels, L., W.R. Knechel, and M. Willekens. 2011. Auditor differentiation, mitigating management actions, and audit-reporting accuracy for distressed firms. Auditing: A Journal of Practice & Theory 30 (1): 1-20.

    Keywords:
    audit reporting, going-concern, management plans, audit methodology, auditor industry specialization
    Purpose of the Study:

    Since auditors are required to evaluate the adequacy of management plans to mitigate financial distress, when bankruptcies occur that were not preceded by a going-concern report, the audit report is perceived to lack quality.   This study investigates whether enhanced industry knowledge (auditor specialization) or an increased focus on business risk auditing methodologies improves audit-reporting accuracy.  These are the two areas of focus because:

    • Prior research has shown that industry specialization produces higher audit quality.
    • A new audit approach defined as “business risk auditing” (BRA) forces an auditor to determine whether the client’s strategic objectives are being met and to assess the likelihood of going-concern issues.  BRA is embedded in international auditing standards (ISA 315) and proposed standards by the PCAOB to require the auditor to assess a client’s business environment and risks in the audit.  Recent studies have shown that BRA can lead to more efficient and effective audits.

    Recent research has also indicated that information obtained about the client’s strategic plans to mitigate financial distress can have a significant impact on the likelihood that an auditor will issue a going-concern report.  Therefore, this paper examines the impact of auditor specialization and auditor risk methodology on audit-reporting accuracy in the setting of financially distressed firms in which managers take initiatives to reduce this distress.

    Design/Method/ Approach:
    • The data consists of U.S. public companies from manufacturing industries that declared bankruptcy between 1999-2002.
    • Auditor specialization is measured based on audit firm market share within a particular industry.
    • Two of the Big 5 firms in the study implemented the BRA methodology. Therefore, only audits conducted by these two firms are considered to have employed BRA methodology.
    • The authors also report if a company in the sample had a significant strategic or operating initiative reported in its 10-Ks as a sign of management’s actions to mitigate financial distress.
       
    Findings:
    • For companies that subsequently declared bankruptcy:
      • Specialist auditors were more likely than non-specialists to issue a going-concern opinion even when management had undertaken strategic turnaround initiatives.
      • Audit firms that used a BRA methodology were less likely to issue a going-concern opinion if the client had undertaken operating initiatives to mitigate financial distress.
      • All auditors, irrespective of type, were less likely to issue a going-concern opinion when the client had plans to raise cash in the short-term.

    Contrary to the authors’ expectations, the reporting accuracy of BRA auditors is reduced when a client implements short term operating initiatives to reduce financial distress.  Specialist auditors correctly interpret the information contained in management’s strategic long-term initiatives and more accurately signal the potential for a future bankruptcy by issuing a going-concern report. 

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Industry Experience
  • Jennifer M Mueller-Phillips
    Auditor Tenure and Stock Price Idiosyncratic Volatility: The...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Auditor Tenure and Stock Price Idiosyncratic Volatility: The Moderating Role of Industry Specialization
    Practical Implications:

    This study shows that auditor tenure is associated with the incorporation of firm-specific information into stock prices, and it contributes to the debate on whether the mandatory rotation of audit firms is necessary, finding in favor of the learning effect of auditor tenure. In other words, this study suggests that audit firm rotation should not necessarily be mandatory. This study is also related to recent studies on the moderating effect of industry expertise on the relationship between tenure and audit quality; however, this study stands out from others because it focuses on investors’ perceptions of audit quality instead of actual financial reporting quality. Finally, the study contributes to the growing literature on the determinants of stock price idiosyncratic volatility, finding that auditor tenure is another important characteristic.

    Citation:

    Su, L., Zhao, X., and Zhou, G. 2016. Auditor Tenure and Stock Price Idiosyncratic Volatility: The Moderating Role of Industry Specialization. Auditing: A Journal of Practice and Theory 35 (2): 147-166.

    Keywords:
    auditor tenure, auditor industry specialization and stock price idiosyncratic volatility
    Purpose of the Study:

    Higher stock price idiosyncratic volatility conveys firm-specific information to the financial markets, which enables investors to make better financial decisions. This leads to the more efficient allocation of capital. Auditors are instrumental in this process, yet there are few studies that examine the effect of auditors on stock price idiosyncratic volatility. This paper furthers the few studies that have been completed on this subject by examining the economic consequences of auditor tenure, which is another important auditor characteristic in terms of stock price idiosyncratic volatility. The authors decided to investigate the effects of auditor tenure as opposed to the effects of auditor brand name on stock price idiosyncratic volatility because relatively few studies examine the economic consequences of tenure compared with the large body of literature on auditor brand name. Also, limiting the sample to Big N auditors, the authors can focus on a largely homogenous group of auditors that provides a better setting in which to examine other audit characteristics such as tenure. 

    Design/Method/ Approach:

    The authors empirically examine a sample of U.S. Big 4 clients from 2003 to 2012. 

    Findings:
    • The authors find that clients that have a longer relationship with their auditors exhibit greater stock price idiosyncratic volatility after controlling for the actual financial reporting quality, supporting the notion that investors perceive longer tenure to produce more credible financial reporting and encourage more specific information.
    • The authors find that the aforementioned effect is present only for auditors who are industry specialists, consistent with the interpretation that investors perceive that auditors with longer tenure produce higher quality audits through their industry expertise.
    • The authors’ results confirm the conjecture that audit quality and auditor characteristics play an important role in investors’ perceptions and incentives to collect private information, as reflected by the idiosyncratic volatility of stock prices.
    • The authors’ findings suggest that elongated auditor tenure contributes to the learning effect enhancing audit quality, as opposed to harming audit quality through overfamiliarity.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Client-Auditor Supply Chain Relationships, Audit Quality,...
    research summary posted March 2, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Client-Auditor Supply Chain Relationships, Audit Quality, and Audit Pricing
    Practical Implications:

    The results of this study provide empirical evidence of an association between supply chain knowledge and improved audit quality, as well as audit efficiency when this knowledge exists at a local level.  Audit firms often attempt to differentiate themselves by a certain level service and audit quality that can be provided based on specialized knowledge, such as industry experience.  Supply chain knowledge can add a new dimension to auditor knowledge and specialization.  By identifying an association between supply chain knowledge and audit quality and fees, this study demonstrates to audit firms an additional value-adding, quality-differentiating audit service. 

    For more information on this study, please contact Karla Johnstone.

    Citation:

    Johnstone, K. M., C. Li, and S. Luo. 2014. Client-Auditor Supply Chain Relationships, Audit Quality, and Audit Pricing. Auditing: A Journal of Practice and Theory 33 (4): 119-166

    Keywords:
    audit pricing; audit quality; supply chain relationships; industry expertise
    Purpose of the Study:

    This study examines the implications of auditor supply chain knowledge on audit quality and audit fee pricing.  The auditor may develop supply chain knowledge when performing the audit of both the supplier and its major customer.  This supply chain knowledge is a specialized understanding of the accounting and auditing issues in the revenue cycle that relates to both the supplier and its major customer.  This study examines the following potential impacts on an audit engagement as a result of supply chain knowledge:

    • As revenue recognition is often a significant audit area, as well as one of the highest areas subject to restatement, an auditor’s level of understanding of the revenue cycle is hypothesized to improve audit quality. 
    • An improved understanding of an audit client’s revenue cycle could also lead to audit efficiencies.  These efficiencies are hypothesized to be reflected in lower audit fees for auditors with supply chain knowledge. 
    • Supply chain knowledge can be developed and transferred at the local office and audit firm level.  The study hypothesizes that this knowledge transfer is stronger when the same office performs the audit of the both the supplier and customer rather than when both the supplier and customer are audited by difference offices in the same firm.  
    Design/Method/ Approach:

    The supply chain relationships for the years 2003 through 2010 were collected using the Compustat customer segment file , which identifies the names of major customers disclosed in the footnotes of the supplier’s 10-K.  Auditor supply chain knowledge was measured as the ratio of the number of supplier and major customer companies employing the same auditor divided by the total number of the supplier companies for the same auditor in the year.  This ratio was measured at both the city-office level and national level.

    Audit quality was measured using three common proxies: absolute discretionary accruals, existence of a restatement, and the propensity to meet or beat analyst’s earnings forecasts.

    Findings:
    • Auditor’s supply chain knowledge at the city level is associated with higher audit quality and lower audit fees for supplier companies compared to companies employing auditors with supply chain knowledge at the national level only, or auditors without supply chain knowledge.
    • This association is present only for suppliers that are highly dependent on their major customer.
    • The association is stronger among a subsample of companies for which the revenue cycle accounts are particularly important (those with high level of accounts receivable balances). 

    The results suggest that knowledge redundancy exists when a supplier and its major customer are audited by audit teams out of the same city level office.  They further suggest that this knowledge redundancy contributes to audit efficiencies, thus reducing audit fees where the city level supply chain knowledge exists.

    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Fair Value Measurements and Audit Fees: Evidence from the...
    research summary posted March 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Fair Value Measurements and Audit Fees: Evidence from the Banking Industry
    Practical Implications:

    Overall, the results support concerns expressed by some observers that greater use of fair value measurements for financial instruments will trigger increased audit fees. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010).

    For more information on this study, please contact Michael Ettredge.

    Citation:

    Ettredge, M. L., Xu, Y., & Yi, H. S. (2014). Fair value measurements and audit fees: evidence from the banking industry. Auditing: A Journal of Practice & Theory 33(3): 33-58.

    Keywords:
    audit fees, fair value measurements, FAS 157, ASC 820, banks
    Purpose of the Study:

    This study examines the association between audit fees and the proportions of fair-valued assets held by the sample of public U.S. bank holding companies. Motivated by claims that fair-valued assets are unusually difficult to audit (Bratten et al., 2013), we explore

    • whether audit fees are positively associated with the proportions of bank assets that are fair-valued, and whether this relation is more evident for the least verifiable (Level 3) fair-valued assets. 
    • whether auditors who are bank industry specialists charge more or less than other auditors to audit banks and, in particular, to audit fair-valued bank assets.

    Consistent with the view that audit risk and effort increase with the extent of fair-valued assets, we provide evidence that auditors charge more for higher proportions of assets held in the form of fair-valued assets. Furthermore, within fair-valued assets, the positive association between logged audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010). 

    Design/Method/ Approach:

    Our data cover the years 2008-2011 with 299 unique banks for our main tests.

    Findings:

    The paper documents that

    • the proportions of fair-valued assets held by banks are positively associated with audit fees.
    • The positive association between audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs.
    • We also document that bank specialist auditors charge lower audit fees to bank clients on average, suggesting cost efficiencies passed to clients as lower fees. However, bank expert auditors charge more for auditing the proportions of total assets that are fair-valued. 
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Firm versus Partner Measure of Auditor Industry Expertise...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 11.01 Supervision and Review – Effectiveness, 11.02 Engagement Quality Review – Processes and Effectiveness, 11.04 Industry Experience, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality 
    Title:
    Firm versus Partner Measure of Auditor Industry Expertise and Effects on Auditor Quality
    Practical Implications:

    The findings of this study imply that firm level expertise impacts audit quality but has a greater impact in conjunction with office level or partner level expertise. Similarly, concurring auditors have a greater impact on audit quality when their abilities are paired with those of a lead or signing partner. This study implicitly emphasizes the importance in cooperation and the sharing of intellectual resources among partners in Big 4 firms considering that expertise is not homogeneous across a firm. Additionally, this study has implications on what could result if the Public Company Accounting Oversight Board in the United States decided to require an engagement partner’s signature on the audit report.

    For more information on this study, please contact Hsin-Yi Chi.
     

    Citation:

    Chi, H., and C. Chin. Firm versus partner measures of auditor industry expertise and effects on auditor quality.  Accounting: A Journal of Practice and Theory 30 (2): 201-229.

    Keywords:
    individual partner industry expertise; discretionary accruals; modified audit opinion; audit quality.
    Purpose of the Study:

    This study explores the relationship between Big 4 audit quality and auditor expertise with respect to both the individual partners and the audit firm. The authors used accruals analysis as well as analysis of audit opinions to assess audit quality. To take the study a step further, an examination of the possible existence of differential audit quality between signing auditors whether lead or concurring partners was also performed. An office level perspective was used and deemed appropriate under the assumption that auditor expertise is permanently tied to individual professionals and their client knowledge which cannot be readily captured and distributed across the firm offices; additionally, the individual practice office is the decision-making unit of the firm when it comes to specific clients.

    To accomplish their purpose, first the authors studied whether audit industry expertise is driven by firm expertise, individual partner expertise, or a combination of both. They also studied whether the association between audit quality and industry expertise of the signing auditor specialist was more or less prominent for the lead auditor or the concurring auditor. One would expect that the lead partner generally would exhibit a more prominent association with audit quality than concurring audit specialists because it is the lead partner who is actively engaged with daily audit proceedings; this study aims to discover if that is truly the case. The study assesses the effectiveness of an individual partner-level and firm-level auditor specialists in enhancing audit quality as well as provides evidence regarding industry expertise homogeneity between individual partners within the same firm.  
     

    Design/Method/ Approach:

    The evidence for this study was collected from Taiwanese publicly listed companies audited by the Big 4 firms from 1983 to 2004. Financial data, audit opinions data, and auditor names were obtained from the Taiwan Economic Journal. Taiwan was the chosen location for this evidence because the audit report in Taiwan contains two signing auditor names as well as the firm name. 

    Findings:
    • Both firm-level industry expertise alone and partner- level industry expertise alone are associated with lower accruals. However, a combination of the two creates an effect above and beyond either level of expertise in isolation; therefore, differential discretionary accruals due to industry expertise are driven by a combination of firm and partner expertise.
    • Differential accruals due to industry expertise of signing are primarily driven by the lead auditor rather than the concurring auditor.
    • The differential likelihood of the issuance of a modified audit opinion is primarily attributable to signing auditor specialists and partner-level expertise.
    • Firm level specialists alone are not associated with a higher likelihood of issuing a modified audit opinion. Instead, firm level specialists along with signing auditor specialists create effects above and beyond those observed with auditor specialists alone.
    • Clients of lead signing auditor specialists have smaller accruals and are more likely to receive a modified audit opinion relative to those of non-specialists  whether the auditor specialists works alone or with a concurring auditor specialist.
    • Concurring auditor specialists alone are not associated with higher audit quality.
    • Industry expertise is not homogeneous across individual auditors within the same audit firm in Taiwan.
       
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Engagement Quality Review – Processes & Effectiveness, Industry Experience, Proxies for Audit Quality, Supervision & Review – Effectiveness
  • Jennifer M Mueller-Phillips
    Industry Audit Experts and Ownership Structure in the...
    research summary posted March 2, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Industry Audit Experts and Ownership Structure in the Syndicated Loan Market: At the Firm and Partner Levels
    Practical Implications:

    The results of this study are important for the PCAOB and other regulatory bodies tasked with considering the economic consequences of requiring an audit partner signature. The motivation behind the PCAOB’s proposal for the signature and disclosure is to increase transparency for interested parties who rely on the financial statements and accountability on the part of the audit partner. In this research, the authors focus on one important interested party, namely lenders, and find that lenders value industry audit experts at the partner level when structuring the ownership of syndicate loans. The findings add to the intense debate on the merits of the PCAOB’s proposal and can be helpful for regulators. The study also provides some evidence that industry audit expertise is viewed as a useful mechanism that mitigates information asymmetry problems faced by lenders in a syndicated loan.

    For more information on this study, please contact Wei-Ren Yao.

    Citation:

    Chin, C.L., W.R. Yao and P.Y. Liu. 2014. Industry Audit Experts and Ownership Structure in the Syndicated Loan Market: At the Firm and Partner Levels. Accounting Horizons 28(4):749-768

    Keywords:
    Partner-level audit expertise; firm-level audit expertise; syndicated loan; ownership structure.
    Purpose of the Study:
    • In 2009 and 2011, the Public Company Accounting Oversight Board (PCAOB) issued two successive releases that seek feedback on the proposal that requires audit firms to disclose the name of engagement partner in standard audit report. The rationale behind the PCAOB’s proposal is that the signature and disclosure requirements can increase transparency and audit partner accountability and, in turn, result in enhanced audit quality. To understand the economic consequences of this requirement further, the authors explores whether industry audit expertise at the partner level is valued by stakeholders, i.e. lenders in the syndicated loan market.
    • In contrast to prior empirical studies on the effect of partner-level industry expertise on audit fees and audit quality, the authors provide further supporting evidence that partner-level industry expertise is valued by stakeholders, consistent with the PCAOB’s argument that the signature and disclosure requirements increase transparency regarding the engagement partner’s identity and, in turn, create an opportunity for the general public (e.g., lenders) to evaluate the engagement partner’s experience and track record (PCAOB 2011, 6).
    • Private loan has become the largest source of worldwide corporate financing; however, little work to date explores the role of audit quality, especially the effectiveness of industry expertise at individual partner level, on mitigating agency cost and reducing information asymmetry between the contracting parties from the viewpoint of debt holders.
    Design/Method/ Approach:

    The research data are collected from a unique sample of listed firms in Taiwan that have syndicated loan data in the 1992-2010 time periods. The audit report in Taiwan is issued in the name of two signing auditors, as well as the audit firm, which provide us with an opportunity to examine whether industry audit experts at the partner level are valued by stakeholders. The impacts of industry audit experts at the individual level on the ownership structure in the syndicated loan are examined using statistical analysis.

    Findings:
    • The authors find that partner-level industry audit experts, either alone or in conjunction with firm-level industry audit experts, are associated with a lower share held by lead arrangers.
    • The authors find that the number of lenders in general (or the number of foreign lenders in particular) in a loan is the largest when borrowers retain industry audit experts at both the firm- and partner-levels.
    • The authors also find that firms audited by industry audit expertise are more likely to gain a larger amount of loan than those retaining non-expertise.
    • These findings suggest that lenders in the syndicated loan market consider part of auditors’ expertise, despite residing within the same audit firm, not to be transferable and homogeneous across individual partners.
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of PCAOB, Industry Expertise – Firm and Individual

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