Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • 1-4 of 4
  • Jennifer M Mueller-Phillips
    Effects of Audit Quality on Earnings Management and Cost of...
    research summary posted October 3, 2013 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.10 Impact of Quality Reviewers, 15.0 International Matters 
    Title:
    Effects of Audit Quality on Earnings Management and Cost of Equity Capital: Evidence from China
    Practical Implications:

    This study analyzes the effect of high audit quality for two types of Chinese firms, State Owned Enterprises (SOEs) and Non-State Owned Enterprises (NSOEs). It provides evidence that high audit quality may reduce cost of equity capital and earnings management more for NSOEs than for SOEs. The results of this study are useful for participants in Chinese and other emerging capital markets as well as auditors in these markets.


    For more information on this study, please contact Gerald Lobo.
     

    Citation:

    Chen, H., J. Chen, G. Lobo, and Y. Wang. 2011. Effects of Audit Quality on Earnings Management and Cost of Equity Capital: Evidence from China. Contemporary Accounting Review 28 (3): 892-925.

    Keywords:
    Audit quality, cost of equity capital, earnings management, state-owned enterprises
    Purpose of the Study:

    Growth in the Chinese economy over the past 30 years has led to the generation of a significant Chinese capital market and a burgeoning auditing profession. While numerous prior studies have examined the effect of audit quality on market participants, there has been little research on how audit quality is important in emerging economies such as China. Institutional, cultural and legal differences make Chinese firms and capital markets markedly different than those in the United States and an important new frontier for researchers.
    This study investigates the difference in the value of audit quality for Chinese state owned enterprises (SOEs) and non-state owned enterprises (NSOEs). The authors select this setting because it allows them to investigate the effects of audit quality across two types of firms with different ownership structure and agency problems. These firms also differ in managerial incentives and opportunities in the financial reporting process. The authors make and test the following hypotheses:

    Hypothesis 1: The effect of audit quality on earnings management is weaker for SOEs than for NSOEs

    Hypothesis 2: The effect of audit quality on cost of equity capital is weaker for SOEs than for NSOEs
     

    Design/Method/ Approach:

    The authors use data on publicly-traded companies in China from 2001-2004. They measure audit quality as the propensity of auditors to issue a modified opinion given that the firm being audited is qualitatively similar to a control sample. They then correlate this measure of audit quality with measures for earnings management (signed discretionary accruals) and cost of equity capital for SOEs and NSOEs and compare the two groups.

    Findings:
    • The authors find that there is a significantly lower level of earnings management for NSOEs audited by Top 8 auditors as compared to NSOEs audited by lower tier auditors. This result is not found for SOEs.
    • The authors find cost of equity capital is significantly lower for NSOEs audited by top 8 auditors as compared to NSOEs audited by lower tier auditors. This result is not found for SOEs.
    • Finally, the authors find that, for NSOEs, both cost of equity capital and earnings management decrease more after hiring a top 8 auditor compared to hiring a lower tier auditor.

    Taken together, these findings are indicative of higher audit quality leading to a greater reduction in earnings management and cost of equity capital for NSOEs than for SOEs. However, the authors note that these firms have many potential monitoring and corporate governance mechanisms that could have a similar effect on earnings management and the cost of equity capital. They cannot rule out the possibility that these results are driven by some additional aspect of corporate governance.

    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Impact of Quality Reviewers
  • Jennifer M Mueller-Phillips
    The impact of anecdotal data in regulatory audit firm...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.10 Impact of Quality Reviewers, 11.11 Impact of Firm and External Inspection Programs 
    Title:
    The impact of anecdotal data in regulatory audit firm inspection reports.
    Practical Implications:

    This study should be of interest to audit regulators around the world currently employing or contemplating the employment of firm-specific reporting formats. A critical and consistent feature of firm-specific reporting is the presence of descriptions of deficiencies uncovered in the inspection process. This study serves to warn audit regulators that reporting lists of deficiencies, as in the manner currently employed by the PCAOB, can lead to misperceptions of audit firm quality. The study also serves to inform audit regulators of two decision aids that the authors found useful in counteracting such misperceptions.

    Citation:

    Wainberg, J. S., T. Kida, M. D. Piercey, and J. F. Smith. 2013. The impact of anecdotal data in regulatory audit firm inspection reports. Accounting, Organizations & Society 38 (8): 621-636.

    Keywords:
    audit firm inspection reports, audit firm quality, audit firms, audit quality
    Purpose of the Study:

    The financial scandals of the last decade have spurred the establishment of independent audit regulators in most countries possessing highly developed market-based economies. The primary goal of statutory auditor oversight has been to restore investor confidence in capital markets by promoting high quality audits of public companies. Inspections of audit firms along with annual public reporting on inspection findings are now considered routine in many jurisdictions. The form and content of these public reports can vary greatly as regulators across the globe struggle to strike a balance between their constituent’s desire for ever-greater disclosures and the confidentiality needs of audit firms in practice.

    A critical and pervasive component of firm-specific inspection reporting is the release of detailed lists of weaknesses, or deficiencies, uncovered by the regulatory inspection teams for individual audit firms. While such information is ostensibly meant to provide useful information for audit committees and other stakeholders, prior research in psychology indicates that this type of information can, in fact, lead to biased perceptions of auditor quality. As a result, the purpose of this study is to investigate whether the anecdotal information typically provided in firm-specific inspection reports can lead to misperceptions of audit firm quality and whether two decision aids can help to mitigate this problem.

    Design/Method/ Approach:

    The participants were 207 managers and other professionals attending a management training program. The participants included individuals from upper level management, middle level management, and others with significant professional experience. On average, participants had nine years of business experience. The instrument was administered online using Qualtrics research software. Participants were asked to assume the role of an audit committee member and to make a hiring decision between two audit firms that were being considered to perform the company’s year-end audit. The data was collected prior to 2013.

    Findings:

    The results indicate that the previous manner of reporting only anecdotal deficiencies by the PCAOB can lead to incorrect perceptions of audit firms. In addition, the authors find that the addition of statistical information as currently provided by the PCAOB is ineffective. That is, users continue to focus on anecdotal deficiencies in the presence of the presented statistical data. Finally, the authors find that participants are more likely to incorporate the implications of statistical data when a salience enhancement of the statistical data and a judgment orientation were introduced. These findings suggest that biases induced by the inclusion of anecdotal data in statutory audit firm inspection reports can be mitigated by incorporating these easily implemented decision aids.

    Category:
    Audit Quality & Quality Control
    Sub-category:
    Impact of Firm & External Inspection Programs, Impact of Quality Reviewers
  • Jennifer M Mueller-Phillips
    The Influence of PCAOB Inspections on Audit Committee...
    research summary posted March 30, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.05 Interactions with Audit Committee Members, 11.0 Audit Quality and Quality Control, 11.10 Impact of Quality Reviewers 
    Title:
    The Influence of PCAOB Inspections on Audit Committee Members’ Judgments
    Practical Implications:

    Research completed in the past has shown that short-term option compensation weakens audit committee member objectivity and oversight quality; this study confirms these findings. These results encourage investigation toward increasing saliency of the oversight role that the PCAOB plays, further research involving the role of an Engagement Quality Review, and understanding what characteristics of the members of the study led them to react to incentives.

    For more information on this study, please contact Julie Persellin.

    Citation:

    Persellin, J. S. 2013. The Influence of PCAOB Inspections on Audit Committee Members' Judgments. Behavioral Research in Accounting 25 (2).

    Keywords:
    Audit committees; PCAOB inspection, audit committee compensation, proposed audit adjustments, corporate governance
    Purpose of the Study:

    Prior research suggests that short-term option compensation possibly weakens audit committee member objectivity and oversight quality; in contrast, holding individuals accountable for their actions has been shown to result in less self-serving decisions in other former studies. These two results seem to be at odds, so a study was designed to develop a consensus and allow stakeholders to gain valuable insights into ways in which loyalties that have been potentially misaligned may be realigned by regulatory requirements aimed at improving the corporate governance process. Recent changes in PCAOB culture give the auditor more accountability over their decisions, so one would assume, based on the research described above, that the auditors would weigh each of their options more carefully. This paper investigates this scenario by manipulating the form in which audit committee members are compensated to determine whether:

    • The likelihood of an inspection by the PCAOB has the potential to serve as a monitoring mechanism for the audit firm
    • The likelihood of a PCAOB inspection has the potential to serve as a monitoring mechanism for the issuer’s audit committee
    Design/Method/ Approach:

    The authors use data from relevant previously conducted research articles from the late 2000’s and early 2010’s. Based on this data, they conducted an experiment in which they manipulated the form of the compensation received by different audit committees to see if their decisions varied. This experiment was conducted on Executive M.BA.s serving as audit committee members. 

    Findings:
    • Participants receiving primarily short-term options for compensation with a high likelihood of PCAOB inspection voiced greater support for requiring an audit adjustment be made.
    • Participants receiving primarily short-term options for compensation with a low likelihood of PCAOB inspection were not as vocal in calling for an audit adjustment.
    • Participants receiving cash for compensation were not at all phased by the likelihood of a PCAOB inspection.

    The results regarding the audit committee were not surprising overall with the majority claiming to agree to adjust their financials due to the experience of the auditor; however, some claimed that they agreed to the adjustment primarily because of how a regulatory agency, like the PCAOB, might view their decision not to require an audit adjustment be recorded. This supports the hypothesis that PCAOB risk, as opposed to client risk, is driving the results of an audit. The few audit committee members who decided not to adjust the financials cited management expertise as their primary reason for this decision. 

    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Impact of Quality Reviewers, Interactions with Audit Committee Members
  • Jennifer M Mueller-Phillips
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control, 11.10 Impact of Quality Reviewers, 11.11 Impact of Firm and External Inspection Programs, 12.0 Accountants’ Reports and Reporting, 12.04 Investigations 
    Title:
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors.
    Practical Implications:

    The authors provide initial empirical evidence that Securities and Exchange Commission (SEC) registrants found GAAP-deficient PCAOB inspection reports to be a useful signal of audit quality for triennially inspected auditors. This evidence indicates that PCAOB inspection reports created heterogeneity in auditor brand name that did not previously exist. Also, this paper is the first to empirically link audit committee characteristics to PCAOB inspection report severity and auditor choice. The authors believe this is an increasingly relevant finding as audit committees have been granted much greater auditor dismissal and hiring authority due to SOX. This study indicates that a PCAOB inspection report may serve as an audit quality signal for auditors of broker-dealers, who were previously exempt from the inspection process. Such a finding has current relevance given the PCAOB has recently sought to expand the inspection program to foreign auditors, such as those based in China whose clients are cross-listed on U.S. security exchanges or are listed due to a reverse merger.

    Citation:

    Abbott, L. J., K. A. Gunny, and T. C. Zhang. 2013. When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors. Auditing: A Journal of Practice & Theory 32 (2): 1-31.

    Keywords:
    audit quality signals, PCAOB inspection process
    Purpose of the Study:

    The PCAOB is a private regulatory agency, independent of the accounting industry. Congress bestowed upon the PCAOB the ability to inspect the work of all accounting firms that audit publicly traded companies. Inspections are conducted annually for Big 4 and national auditors with greater than 100 publicly held registrants (annually inspected auditors). The inspection process is conducted every three years for auditors with fewer than 100 publicly held clients (triennially inspected auditors). The authors classify inspection reports into three categories according to severity. In a clean report, the PCAOB finds no audit deficiencies. In a GAAS-deficient report, the PCAOB notes that the financial statements audited by the auditor are free of material error, but that the audit process did not fully follow GAAS-recommended audit procedures. In a GAAP-deficient report, the PCAOB states that the auditor “failed to identify a material departure from GAAP” or that the audited company “restated certain of its financial statements to make changes relating to” matters/audit deficiencies uncovered by the PCAOB inspection.

    The current study examines the PCAOB in the context of whether GAAP-deficient PCAOB inspection reports of triennially inspected auditors are enough of a deleterious audit-quality signal to prompt dismissals of these auditors. This study then identifies the successor triennially inspected auditor and uses the three-tiered categorization scheme to denote an increase in auditor quality. Specifically, the authors create a dichotomous dismissal-based dependent variable coded “1” in cases where the dismissal results in a higher-quality triennially inspected successor auditor, and “0” otherwise.

    Design/Method/ Approach:

    The authors obtain all inspection reports from the PCAOB website from January 21, 2005 to December 31, 2007. A total of 521 triennially inspected nonforeign accounting firm PCAOB inspection reports were filed, of which 256 (49.1 percent) were clean, and 61 (11.7 percent) were GAAP-deficient. The 54 GAAP-deficient, triennially inspected auditors are included in the sample. The 54 GAAP-deficient auditors report 525 publicly held clients per their PCAOB inspection reports.

    Findings:
    • The authors find that GAAP-deficient, triennially inspected auditors are more likely to be dismissed by their clients and are overwhelmingly replaced by a triennially inspected successor that has not received a GAAP-deficient inspection report.
    • They also document that the dismissal rate for the clean PCAOB inspection report sample is 17.9 percent, while the dismissal rate for the GAAP-deficient sample is a significantly higher 44.3 percent.
    • The authors find that greater agency conflicts, the presence of an independent and expert audit committee, and blockholdings magnify the likelihood of dismissing a GAAP-deficient, triennially inspected auditor in favor of a triennially inspected auditor that is not GAAP-deficient.
    • Interestingly, the authors find that opinion shopping or fee shopping does not differentially impact the likelihood of dismissing a GAAP-deficient, triennially inspected auditor in favor of a triennially inspected auditor that is not GAAP-deficient.
    • The authors link the use of PCAOB inspection reports to an agency-based demand for audit quality signals.
    Category:
    Accountants' Reporting, Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of Firm & External Inspection Programs, Impact of PCAOB, Impact of Quality Reviewers, Investigations

Filter by Type

Filter by Tag