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  • 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
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder...
    research summary posted June 22, 2014 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.11 Impact of Firm and External Inspection Programs 
    Title:
    When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors.
    Practical Implications:

    The objective of this study is to determine whether PCAOB inspection reports of triennially inspected auditors are used as audit quality signals. The study was based upon the premise that the reports may serve as a publicly-available proxy of perceived audit quality. Clients were found to react differently to the PCAOB inspection reports contingent upon their severity with GAAP-deficient reports are more likely to trigger an auditor dismissal than a clean or GAAS-deficient report. The results suggest that clients of non-Big 4/non-national auditors are using certain PCAOB inspection reports as a publicly-available signal of audit quality and not as a means of procuring more favorable audit reporting or audit fees. 

    Citation:

    Abbott, L., 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 32 (2).

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

    The PCAOB conducts inspections of registered public accounting firms that provide audits for publicly traded companies. The results of the inspection process are summarized in publicly available reports at the PCAOB website. Using these reports, this study categorizes the inspection reports into three levels of increasing severity: clean, GAAS-deficient, and GAAP-deficient. GAAP-deficient PCAOB inspection reports are examined for potential use as perceived audit quality signals for the clients of GAAP-deficient auditors that are inspected on a triennial basis by the PCAOB. The investigation is predicated on the notion that audit quality is generally not directly observable. Thus the clients of these auditors may seek to signal their desire for audit quality by dismissing their GAAP-deficient auditors.

    Design/Method/ Approach:

    The authors obtained all inspection reports from the PCAOB from January 21, 2005, to December 31, 2007. The sample chosen included 54 GAAP-deficient, triennially inspected auditors with complete data for 379 of the auditors’ reported clients. This sample was used to test the following hypotheses:

    • H1: There is a positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient auditor.
    • H2: Greater agency conflict values magnify the positive relation between the receipt of GAAP-deficient PCAOB inspection reports and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.  
    • H3: Independent and expert audit committees magnify the positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor. 
    • H4: Outside blockholdings magnify the positive relation between the receipt of a GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.
    • H5: Securities issuance magnify the positive relation between the receipt of GAAP-deficient PCAOB inspection report and the likelihood of dismissing a triennially inspected auditor in favor of a non-GAAP-deficient, triennially inspected auditor.
    Findings:
    • Dismissal rate is high for GAAP-deficient auditors
    • A majority of the clients also received a going-concern modification
    • The subsequent auditor is virtually always a triennially inspected auditor that is not GAAP-deficient
    • Agency conflict and audit committee effectiveness are helpful in predicting which GAAP-deficient auditors are more likely to be dismissed.
    Category:
    Audit Quality & Quality Control, Auditor Selection and Auditor Changes
    Sub-category:
    Attempts to Measure Audit Quality, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Impact of Firm & External Inspection Programs
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  • 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

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