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  • The Auditing Section
    Academic Instruction as a Determinant of Judgment...
    research summary posted May 7, 2012 by The Auditing Section, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Academic Instruction as a Determinant of Judgment Performance
    Practical Implications:

    The results of this study are important for audit firms to consider providing decision aids and/or on job training. The results suggest that considerable practical experience is necessary to achieve good judgment performance. In addition, the evidence indicates that auditing firms may wish to concentrate their training earlier to more quickly create a basis for high-quality auditor judgments.

    Citation:

    Wright, William F. 2007.  Academic Instruction as a Determinant of Judgment Performance. Behavioral Research in Accounting 19: 247-259.

    Keywords:
    Audit judgment; instruction; experience;
    Purpose of the Study:

    Knowledge and personal involvement are important factors that affect auditor judgment quality. It is generally believed that sufficient knowledge can lead to good auditor judgment.  Two sources of relevant knowledge are academic instruction and practical experience. Yet the relative benefits of the two sources remain unclear. The primary purpose of the study is to test for the benefit of task-specific academic instruction and practice relative to task-specific CPA training and experience in making auditor judgments. 

    Design/Method/ Approach:

    The research evidence is collected during 1991. Three groups of people participated in the experiment: (1) graduate business students, (2) inexperienced financial institution audit seniors, and (3) experienced financial institution auditors (managers, senior managers, and junior partners). Participants were asked to complete a simulated case involving evaluating the collectability of commercial loans to a fictitious manufacturer of microcomputers.

    Findings:
    • The author finds that, compared to the inexperienced audit seniors, the graduate students who completed an elective course in credit analysis made more accurate and less biased judgments.
    • The author finds that, the graduate students who completed an elective course in credit analysis made judgment similar to that of the experience auditors.
    Category:
    Audit Team Composition, Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Industry Expertise – Firm and Individual, Prior Dispositions/Biases/Auditor state of mind, Training & General Experience
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  • Jennifer M Mueller-Phillips
    Aggregate Quasi Rents and Auditor Independence: Evidence...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Aggregate Quasi Rents and Auditor Independence: Evidence from Audit Firm Mergers in China.
    Practical Implications:

    The findings of this study have policy implications for regulators in China and other emerging economies with regard to administering the auditing profession and improving the corporate governance of public companies by fostering auditor independence. One policy implication of this finding is that simply increasing audit firm size fails to enhance auditor independence. The experience of mature markets suggests that, in addition to public regulatory enforcement, other mechanisms, such as private litigation against auditors and improved disclosures on audit services, are helpful in ensuring a well-functioning audit market.

    Citation:

    Chan, K. H., and Wu, D. 2011. Aggregate Quasi Rents and Auditor Independence: Evidence from Audit Firm Mergers in China. Contemporary Accounting Research 28 (1): 175-213.

    Keywords:
    consolidation & merger of corporations, auditor independence, aggregate quasi rents, audit quality
    Purpose of the Study:

    Prior research suggests that large audit firms have more aggregate quasi rents, which are defined as audit fees in excess of audit costs, to serve as collateral against opportunistic behavior on the part of auditors. Audit firm size affects not only auditor independence, but also auditor competence, which makes clear inferences on the relationship between audit firm size and independence difficult. The economic and regulatory changes in China’s audit market induced a large number of audit firm mergers in a short period of time, thus enabling the authors to investigate the impact of mergers on audit quality in a similar environment for an important economy. In the multi-license mergers, mergers occur between two (or more) accounting firms that are licensed to audit listed companies; in the single-license mergers, an accounting firm with such a license merges with non-licensed firms.

    Using data on audit firm mergers in China, the authors investigate the empirical relationship between audit firms’ aggregate quasi rents at stake and auditor independence in a setting that allows us to mitigate potential problems. However, they do have an immediate and significant impact on audit firm size and auditors’ aggregate quasi rents. Therefore, the changes in audit quality that occur immediately after mergers take place can be attributed mainly to changes in auditors’ independence rather than competence. The authors investigate the differences in independence between the pre-merger and immediate post-merger periods of the auditors in the same audit firms.

    Design/Method/ Approach:

    The authors collect data for audit firm mergers that took place between 1999 and 2006 from the CICPA and several leading financial newspapers. Client firm financial statement and stock market data are from the China Stock Market & Accounting Research database (CSMAR). The sample consists of 59 cases, including 21 multi-license mergers (MULTI hereafter) and 38 single-license mergers (SINGLE hereafter).

    Findings:

    The evidence indicates that an increase in audit firm size does not necessarily lead to an improvement in auditor independence. What matters is the size of the public clientele, where the quasi rents are more likely to serve as collateral against auditor malfeasance.

    • The level of independence, and thus audit quality, is determined by the auditor’s trade-offs between the costs and benefits of opportunistic behavior.
    • Audit firms involved in MULTI mergers are more likely to issue MAOs (modified auditor opinions) to their clients after the mergers.
    • This increased propensity to issue MAOs is significantly related to the change in audit firm size after the mergers.
    • There is no evidence to suggest any significant change in the issuance of MAOs among audit firms involved in SINGLE mergers.
    • The different effects of mergers on audit quality support the theory that auditor independence is a positive function of the aggregate quasi rents a stake.
    • The increase in MAOs is positively correlated with the change in the size of listed clientele that results from multi-license mergers.
    Category:
    Audit Quality & Quality Control, Independence & Ethics
    Sub-category:
    Sustainability ServicesTraining & General Experience
  • The Auditing Section
    An Examination of the Effects of Auditor Rank on...
    research summary posted April 23, 2012 by The Auditing Section, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    An Examination of the Effects of Auditor Rank on Pre-Negotiation Judgments
    Practical Implications:

    This study provides evidence that there were significant differences in the pre-negotiation judgments of partners and managers. Since an outcome of an auditor-client negotiation of a contentious issue may have a significant impact on financial reporting quality, the findings of the study suggest that the using partners in the negotiation process is likely to lead to improved reporting quality. The results have implications for audit firms in allocating manager and partner time to handle negotiation.

    Citation:

    Trotman, K. T., A. M. Wright, and S.Wright. (2009). An Examination of the Effects of Auditor Rank on Pre-Negotiation Judgments. Auditing: A Journal of Practice & Theory 28(1): 191-203

    Purpose of the Study:

    Negotiations are pervasive in the auditing environment.  In general, audit firms have choices over what level of staff are involved in the process of negotiation. An important issue is that differences may exist between partner and manager negotiation judgments and strategies. This study focuses on the expectations and assessments that partners and managers take into the negotiation process, specifically the pre-negotiation stage. The authors use negotiation theory as well as other general psychology findings to investigate how rank (partner versus manager) affects the pre-negotiation judgments made by auditors.  The authors suggest and test the following assertions:

    • Partners take a tougher stand than managers in pre-negotiation judgments.
    •  Partners have greater confidence in their ability to negotiate and therefore receive a resolution that is closer to their initial position.
    • Partners’ rank, which reflects both additional experience and power (as compared to the manager), will lead them to believe they are in a better position to negotiate outcomes closer to their initial position.
    Design/Method/ Approach:

    The research evidence was collected prior to September 2007. The authors used responses collected from a computerized case about inventory write-downs, administered to partners and managers at three Big 4 firms in Australia and the U.S.

    Findings:
    • Compared to managers, partners appear to take a tougher stand in the negotiation: they expect a larger initial write-down and require a higher minimum write-down that they would accept.
    • Partners’ estimates of the maximum inventory write-down that a CFO would accept were significantly higher than managers’ estimates.
    • Partners believed they can negotiate a larger amount above the minimum adjustment than managers.
    • There were no differences in negotiation persuasion knowledge between partners and managers.
    Category:
    Audit Team Composition, Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Diversity of Skill Sets (e.g. Tenure & Experience), Prior Dispositions/Biases/Auditor state of mind, Training & General Experience
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  • Jennifer M Mueller-Phillips
    Auditors’ Overconfidence in Predicting the Technical K...
    research summary posted October 22, 2014 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Auditors’ Overconfidence in Predicting the Technical Knowledge of Superiors and Subordinates
    Practical Implications:

    In this study, we show that both subordinates and superiors are overconfident in predicting other auditor’ knowledge and that this overconfidence effect interacts with task difficulty. Inaccuracy in assessing the technical knowledge of other specific auditors has the potential to degrade audit quality. Likewise, incorrect assessments of the technical knowledge of groups of auditors may distort the audit firms understanding of training needs of auditors. More accurate and objective assessments of interpersonal knowledge of other auditors are needed to enhance audit quality.

    For more information on this study, please contact Hun-Tong Tan.

    Citation:

    Han, J., K. Jamal, and H-T. Tan. 2011. Auditors’ overconfidence in predicting the technical knowledge of superiors and subordinates. Auditing: A Journal of Practice & Theory 30(1): 101-119.

    Keywords:
    technical knowledge; overconfidence; auditor rank.
    Purpose of the Study:

    Prior research documents that auditors are overconfident in predicting the technical knowledge of subordinates. Overconfidence is also thought to be affected by task difficulty.

    Overconfidence on the part of subordinates has implications for audit effectiveness and/or efficiency. Audit workpaper preparers (i.e., subordinates) stylize workpapers both to manage their reputations with their superiors and to conserve cognitive effort. Prior research shows that auditors who report to a superior whom they perceive to be less technically competent (or alert to conclusion errors) may, at the margin, devote less attention to conclusion errors in workpaper preparation, with adverse effects on audit effectiveness. Subordinates who are overconfident in the knowledge of their superiors may actually exert more cognitive effort than otherwise, and may be less likely to stylize their work as a means of reputation management. Likewise, the extent to which superiors scrutinize the work of their subordinates is affected by their perceptions of the subordinate’s technical knowledge. Incorrect perceptions about subordinate technical knowledge can lead to inefficient audit review processes. In practice, auditors perform a variety of tasks that vary in difficulty. Understanding how task difficulty may moderate auditors’ overconfidence is important to assess the implications of overconfidence in actual audit settings.

    We extend the literature on auditors’ overconfidence in three ways.

    First, we examine whether auditors’ overconfidence in predicting the technical knowledge of another auditor varies as a function of the hierarchical rank of the auditor making the prediction relative to the target—i.e., whether it is the superior making a prediction of a subordinate, or a subordinate making a prediction of a superior. Subordinates are the main frontline collectors and recorders of audit data and, thus, whether subordinates are overconfident in predicting the technical knowledge of their superiors is important.

    Second, we examine whether overconfidence effects vary as a function of task difficulty. This issue is important because in practice, auditors perform a variety of tasks that vary in difficulty.

    Third, prior research focuses on auditors’ overconfidence in predicting the technical knowledge of specific individual auditors. We examine whether this effect replicates when auditors make predictions about groups of auditors. 

    Design/Method/ Approach:

    We conducted an experiment.. Participants were 14 audit managers and 28 audit seniors from a major public accounting firm. They comprised 14 natural teams of one audit manager and two audit seniors, who worked on the same team for audit assignments. The participants work on two technical audit tasks. One of these tasks is a relatively easy error frequency (EF) task. The other, more difficult task related to an accounting entry for a firm which has entered into an interest rate swap (IRS) agreement with another firm.

    Findings:
    1. Audit managers are overconfident in predicting individual audit seniors’ knowledge for the more difficult IRS task, but not for the less difficult EF task.
    2. However, the pattern reverses when audit seniors predict audit managers’ knowledge. Audit seniors are overconfident in the individual audit managers’ knowledge for the EF task but not for the IRS task.
    3. Auditors’ predictions of groups of other auditors replicate their predictions of individual auditors.
    4. Hence, auditors’ overconfidence in other auditors’ knowledge is jointly affected by the predicting direction (whether subordinates predict superiors’ knowledge; or whether superiors predict subordinates’ knowledge) and task difficulty.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Sustainability ServicesTraining & General Experience
  • Jennifer M Mueller-Phillips
    Audits of Complex Estimates as Verification of Management...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.09 Evaluation of Evidence 
    Title:
    Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice.
    Practical Implications:

    Based on the interviews and problems identified, the authors conjecture that potentially suboptimal auditing methods are being used to evaluate complex estimates which are an important and growing part of the financial statements. This may be negatively impacting audit quality. More specifically, auditors over-rely on management estimates because they lack the knowledge and incentives to behave otherwise. This possibility has direct consequences for auditor professional skepticism because increasing professional skepticism may be less effective unless auditors are also given the requisite knowledge to properly use it. These problems are reinforced by auditing standards and regulators which generally outline/criticize the current auditing methods without suggesting new or better ones.  

    Citation:

    Griffith, E., J. Hammersley, and K. Kadous. 2015. Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice. Contemporary Accounting Research 32 (3): 833-863.

    Keywords:
    Complex Estimates, Subjectivity, Institutional Theory, Valuation Specialists, Professional Skepticism, Interviews
    Purpose of the Study:

    Complex estimates are increasingly important to financial statements and of growing concern to both regulators and investors. While auditors have well-established procedures for auditing more objective account balances (i.e., valued at historical cost), little is known about the process auditors use to evaluate more subjective, complex estimates. This article conducts interviews with experienced audit personnel to determine how auditors evaluate such estimates, determines the problems with such approaches, and uses “institutional theory” to theorize the reason such problems exist and persist. The authors consider the influence of both audit firms themselves and regulators (i.e., information from PCAOB inspection reports) on auditors’ complex estimate audit procedures.

    Design/Method/ Approach:

    The authors conducted semi-structured phone interviews with experienced audit personnel. Participants are from 6 large accounting firms with at least manager level experience. Interviews were conducted between October and November 2010. The authors analyzed the audit process steps discussed by participants for complex estimates and coded these steps according to the PCAOB auditing standards related to accounting estimates (AU 342 and 328).  For steps that could not be appropriately classified into ones discussed by the auditing standards, the authors developed additional classifications.

    Findings:

    While auditing standards allow for different approaches to evaluating complex estimates (e.g., testing management process, preparing independent estimate, etc.), the authors find that auditors usually just test management’s process (i.e., verifying inputs such as historical cost, understanding who and how estimate is generated, testing controls surrounding process, and testing sensitivity of assumptions used).  

    Based on institutional theory, the authors theorize two key reasons that auditors mainly use management process verification when auditing complex estimates instead of other (potentially more creative and skeptical) approaches. The reasons are:

    • Both audit firm policies and professional standards generally emphasize management process verification techniques over other potential techniques. Additionally, regulators (i.e., PCAOB) reinforce/encourage this behavior because inspection findings largely focus on problems with auditing management’s process instead of suggesting alternative, superior auditing methods.
    • Audit firms employ valuation specialists who have the necessary knowledge to more critically analyze complex estimates. This fact means that financial statement auditors generally do not have the necessary knowledge to critically analyze management’s models or develop an independent expectation. When auditors do use such specialists, they over-rely on their work.
    • Given the lack of guidance regarding complex estimates, firms tend to use practices that have been previously legitimized. For auditing of complex estimates, verification (which works well to audit less subjective accounts) is used to audit more subject complex estimates. Auditing standards also mainly emphasize verification.
    • Given inspection pressures, firms find it safer and more legitimate to mimic each other’s policies and procedures for auditing complex estimates instead of develop new ones.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence, Auditors’ Professional Skepticism, Evaluation of Evidence, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections), Sustainability ServicesTraining & General Experience, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Characteristics of Relatively High-Performance Auditors
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Characteristics of Relatively High-Performance Auditors
    Practical Implications:

    Auditors who are higher-performing perceive technical knowledge and abilities, client interaction skills, and professional attitudes/behaviors as being important.  Prioritizing training in these areas or recruiting new auditors who prioritize these areas may have a beneficial impact to firms.  In addition, these auditors rely less on standard audit procedures and perceive that their role can influence the outcome of the audit.  Therefore, it may be helpful for firms to emphasize the importance of using standard audit procedures only as a guideline for the audit, as overreliance on these procedures could lead to a lack of professional skepticism.  Evaluating prospective hires in terms of their locus of control could also indicate their willingness to be more comfortable in ill-structured tasks and exert more effort on audit tasks.
       
    For more information on this study, please contact Constance McKnight.
     

    Citation:

    McKnight, C. A. and W. F. Wright.  2011.  Characteristics of relatively high-performance auditors.  Auditing: A Journal of Practice and Theory 30 (1): 191-206.

    Keywords:
    job performance; tacit knowledge; task structure; locus of control; expertise
    Purpose of the Study:

    Previous research has examined some determinants of auditor job performance, but has not examined what in particular distinguishes auditors with superior overall job performance.  Determinants of superior job performance could be factored into training or hiring practices, depending on whether the determinants can be taught or are innate.  Attributes such as technical knowledge and abilities, client interaction skills, and professional attitudes/behaviors are predicted to be perceived as more important determinants of overall job performance by higher-performing auditors.  Predicted indicators of higher job performance are less reliant on standard audit procedures (indicating a higher willingness to be professionally skeptical) and having a personality resulting in an internal “locus of control” (believing in their ability to influence outcomes, as opposed to the outcome being primarily influenced by external factors).

    Design/Method/ Approach:

    The authors obtained the two most recent performance evaluations from eight public accounting firms for 56 auditors (including staff, seniors, and managers) prior to 2008; these were used to split the auditors into higher-performance and lower-performance.  The auditors then performed self-evaluations of their overall performance on their last two jobs and assessed their relative performance in terms of technical knowledge and abilities, client interaction skills, and professional attitudes/behaviors.  They also completed evaluations of how much they rely on standard procedures as well as completing a locus of control survey.

    Findings:
    • Auditors with higher firm performance evaluations assessed their relative performance in terms of technical knowledge and abilities, client interaction skills, and professional attitudes/behaviors as higher than those with lower evaluations
    • Staff auditors with higher firm performance evaluations rely less on standard audit procedures than those with lower evaluations
      • Seniors and managers had no difference of reliance on standard audit procedures across the firm performance evaluation levels
    • Auditors with higher firm performance evaluations are more likely to have an internal locus of control than those with lower evaluations
       
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Diversity of Skill Sets (e.g. Tenure & Experience)
  • Jennifer M Mueller-Phillips
    Costs and Benefits of Requiring an Engagement Partner...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Costs and Benefits of Requiring an Engagement Partner Signature: Recent Experience in the United Kingdom
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    PCAOB; engagement partner signature; United Kingdom; audit quality; audit fees; costs and benefits.
    Purpose of the Study:

    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.

    Design/Method/ Approach:

    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.

    Findings:

    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.

    Category:
    Accountants' Reporting, International Matters
    Sub-category:
    Audit Partner Identification by Name, Changes in Reporting Formats
  • Jennifer M Mueller-Phillips
    Do Industry-Specialist Auditors Influence Stock Price Crash...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.07 Attempts to Measure Audit Quality 
    Title:
    Do Industry-Specialist Auditors Influence Stock Price Crash Risk?
    Practical Implications:

    This study shows that industry specialists reduce a specific type of risk, stock price crash risk, which has become increasingly important following the Enron scandal and the recent financial market crisis. It also shows that the effects of opacity and conservatism on crash risk are moderated by auditor quality, furthering the emerging literature on the determinants of crash risk. 

    Citation:

    Robin, J. Ashok and Hao Zhang. 2015. Do industry-specialist auditors influence stock price crash risk? Auditing: A Journal of Practice and Theory 34 (3): 47-79.

    Keywords:
    Auditor quality, industry specialization, crash risk
    Purpose of the Study:

    In the past, a great deal of research has been done examining the idea that high-quality auditors benefit reporting quality in a variety of ways.  Other research has been done to focus on direct economic consequences for investors.  Some of this research has found that high-quality auditors can reduce the cost of debt, lower equity costs, diminish IPO underpricing, and even influence loan syndicate structure.  One issue that has not been examined, however, is whether high-quality auditors can reduce the crash risk for equity investors.  This paper focuses on this question.  Because crash risk is primarily caused by bad news hoarding, the authors believe that high-quality auditors can function as information mediators and reduce the crash risk in the following ways:

     

    • High-quality auditors are more likely to uncover bad news and suppress the mangers’ bad-news hoarding activities due to their greater capability
    • High-quality auditors have stronger incentives to disclose bad news in a timely manner and suppress managers’ bad-news hoarding activities

     

    In addition to mediating some of the bad news, the authors also believe that high-quality auditors also reduce crash risk by decreasing agency costs, decreasing malfeasance by managers, improving operating decisions, and decreasing expropriation.  This study could prove very valuable to investors, as crash risk is an important consideration in portfolio management. 

    Design/Method/ Approach:

    The research evidence is collected from a twenty-year sample period ranging from 1990-2009.  The authors obtained stock return data from the Center for Research in Security Prices (CRSP) database.  Accounting data and auditor characteristics were obtained from the Standard and Poor’s Compustat database. After making exclusions based on a number of criteria, the final sample amounted to 58,365 firm-year observations. Regression models were run on these observations to arrive at the author’s findings. 

    Findings:
    • The authors find that across all six models tested, to a statistically significant degree, stock price crash risk is lower for firms audited by industry-specialist auditors.
    • Results also indicated that crash risk is higher in firms with higher standard deviation and mean of stock returns, younger age, higher ROA, greater intangible assets, greater share turnover, and lagged negative skewness.
    • Concentrated institutional ownership can induce effective monitoring and lead to lower further crash risk.
    • Conservatism is negatively and significantly related to crash risk.
    • Auditor specialization provides benefits beyond reporting benefits.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality
  • Jennifer M Mueller-Phillips
    Do Manages Intend to Use the Same Negotiation Strategies as...
    research summary posted November 5, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.04 Interactions with Client Management, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Do Manages Intend to Use the Same Negotiation Strategies as Partners?
    Practical Implications:

    The findings of this study are important for audit firms to consider when resolving financial reporting issues with client management. The overall pattern of our results illustrates that audit managers and audit partners intend to use different negotiation strategies and, therefore, substituting managers for partners in order to increase audit efficiency may in some contexts undermine audit effectiveness. Indeed, concern is warranted based on these results that suggest that a manager’s intended strategy entering negotiations with client management may be, pending context, substantially different and more client-outcome-oriented than the partners’ intended strategy would be. This could be worrisome for audit partners if they are not aware of negotiations that managers are undertaking on their own while out in the field. From a practice perspective, partners need to be aware of circumstances where managers negotiate with client management, since the tactics employed and potentially the outcomes obtained by the manager may be different than if the partner had been involved. Thus, based on our findings, audit partners may be the more effective negotiators and, thus, will have better negotiated outcomes than less experienced managers.

     

    For more information on this study, please contact Susan McCracken.

    Citation:

    McCracken, S., S.E. Salterio, and R.N. Schmidt. 2011. Do managers intend to use the same negotiation strategies as partners? Behavioral Research in Accounting 23 (1): 131-160.

    Keywords:
    Negotiation, strategy, experience, power, surrogate, auditor
    Purpose of the Study:

    Auditor-client management (ACM) negotiations frequently occur between the audit partner and the Chief Financial Officer, but there is also evidence that the audit manager attempts to negotiate resolutions to issues in order to increase audit efficiency, to increase the manager’s image of competence with the partner or in response to time pressures. Given the importance of ACM negotiations to the resulting financial statements shown in previous work in the ACM negotiation area, as well as the tendency for managers to conduct these negotiations in place of the partners, it is important to determine whether partners and managers intend to utilize similar or different negotiation strategies. From a practice perspective, if audit partners’ and managers’ intended negotiation strategies are different, then audit effectiveness may be compromised when managers undertake ACM negotiations. However, if the intended negotiation strategies of the partner and manager are the same, then there would be evidence to suggest that improvements in audit efficiency may be achieved by having managers undertake the ACM negotiations. Furthermore, from a research perspective, if there are differences in intended negotiation strategies between partners and managers, then results from prior studies that utilize managers as participants may not generalize to audit partners.

    Design/Method/ Approach:

    The experimental research evidence was collected in 2005. The authors measured the level of auditor participants (audit manager or audit partner) and manipulated the client management’s initial accounting position flexibility and ACM relationship in the experimental case context. After reading the case, participants were asked to indicate their likelihood of employing each of the 25 tactics related to the five negotiation strategies (expanding the agenda, problem solving, contending, compromising and conceding) in an upcoming negotiation with the client.

    Findings:
    • The integrative strategies’ results show that partners are less likely than managers to use the integrative strategy “expanding the agenda”. While less conclusive, our results also suggest that partners are less likely than mangers to use the integrative strategy “problem solving”. We find that this difference in planned strategy is not due to years of experience, but rather both of these findings are consistent with the power/status theory in the generic negotiation literature.
    • The distributive strategies’ results show that managers are less likely to use the contending strategy and more likely to use the concessionary and compromising strategies than partners. Our conclusions, however, must be qualified by the interaction of level with the accounting context factors embedded in the experimental case (prior client relationship and flexibility of client’s initial accounting position). An exception is the less commonly used concessionary strategy where we find managers are more likely to intend to use this strategy than the partners, irrespective of the accounting context. When examining the pattern of the interactions, we see a greater reaction to the accounting context by the partners than by the managers, again, likely due to partners’ greater experience and power/status in negotiations
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Interactions with Client Management, Sustainability ServicesTraining & General Experience
  • Jennifer M Mueller-Phillips
    How a Systems Perspective Improves Knowledge Acquisition and...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    How a Systems Perspective Improves Knowledge Acquisition and Performance in Analytical Procedures
    Practical Implications:

    This experiment provides evidence that training in a systems perspective could help auditors analyze complex relationships between accounting data. This could be used to set appropriate analytics expectations and, more importantly, provide a credible way to determine whether management’s representations are well-grounded or not.  This method also appears to require less mental effort to implement, since it moves the complicated relationship structure out of memory and onto a model.  Given the added complexity of many estimates in today’s companies, systematic methods of processing information like a systems perspective may help to simplify the analysis of the estimates.

    For more information on this study, please contact Billy Brewster.
     

    Citation:

    Brewster, B. E.  2011.  How a systems perspective improves knowledge acquisition and performance in analytical procedures.  The Accounting Review 86 (3), 915-943.

    Keywords:
    analytical procedures; knowledge organization; learning; mental models
    Purpose of the Study:

    Understanding complicated relationships with multiple links between information is difficult, as people have limited memory to keep all the relationships straight.  This problem is evident in setting analytics expectations, as there are many reasons why accounting numbers change from year to year (and the reasons are often related to each other in varying, nonlinear ways).  In order to avoid a “reductionist” perspective where pieces of information are considered in isolation and linearly, auditors may be able to construct a better mental model of the situation by using a “systems perspective”.  This involves considering how all the parts of a system are related as well as their behavior from how they interact.  Using a systems perspective (compared to a reductionist perspective) is predicted to be more accurate, more efficient, better able to detect management representations that are inconsistent with the evidence, and better able to integrate new information into their expectations accurately.

    Design/Method/ Approach:

    In an experiment conducted prior to 2008, undergraduate accounting students (juniors/seniors) are given training in evaluating stocks and flows (systems perspective) or business risks (reductionist perspective).  They then learn about an audit client and its industry which has a particularly complicated relationship between multiple factors over time and the resulting product price.  Using the technique they were taught, they then graph the product price over time.  The students are then provided management’s estimate of the price and evaluate its credibility.  Finally, the participants learn new information about the industry and are asked to factor it into their price evaluation.

    Findings:
    • When compared to a computer simulation of how the product price should change over time, participants who used a systems perspective were closer to the simulation than those using a reductionist perspective
    • Those using a systems perspective did not need to exert as much mental effort to perform their evaluations
    • Using a systems perspective made it more likely to identify inconsistent management representations of the product price
    • When encountering new information, a systems perspective allows participants to incorporate the information more appropriately than a reductionist perspective
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Substantive Analytical Review – Effectiveness, Sustainability ServicesTraining & General Experience

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