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  • Jennifer M Mueller-Phillips
    Corporate Governance Research in Accounting and Auditing:...
    research summary posted October 27, 2014 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.03 Board/Audit Committee Tenure, 13.04 Board/Audit Committee Compensation, 13.05 Board/Audit Committee Oversight, 13.06 Board/Audit Committee Processes 
    Title:
    Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions
    Practical Implications:

    First, the weight of evidence suggests that weak governance is associated with an increased likelihood of adverse financial reporting outcomes (in particular, fraud and restatements). Thus, perhaps the most fundamental practice implication is that the governance research findings to date are, on an overall basis, consistent with the focus on improved corporate governance (e.g., board independence, audit committee expertise) found in SOX and related regulatory reforms.

    Second, since the board and the audit committee are primary mechanisms for the internal monitoring of top management’s financial reporting behavior, and given that the CEO and/or CFO is involved in 89 percent of all public company accounting frauds (Beasley et al. 2010), external auditors need to very carefully examine corporate governance characteristics and processes in assessing the control environment.

    Third, research finds that auditor changes/dismissals are less problematic in the presence of good governance. That is, in the presence of good governance, the auditor change/dismissal may be justified by poor auditor performance or excessive fees. Since regulators do not have the resources to examine all auditor changes, even if limited to dismissals, regulators might want to consider the client firm’s governance characteristics when deciding whether to investigate an auditor dismissal.

    Fourth, research indicates that external auditors assess risk higher and plan more audit hours for firms with weak governance. However, whether auditors adequately adjust for weak governance has not been examined. In other words, adjustments of risk assessments and audit hours occur, but is there enough adjustment in light of the higher risk?

    Fifth, strong governance and strong auditing appear to be complements rather than substitutes—stronger boards and audit committees are associated with stronger auditing. Therefore, monitoring (both internal monitoring by the board and audit committee, and external monitoring by the auditor) is likely to be especially weak in firms with weak governance, for the quality of auditing is likely to be lower in the presence of weak governance.

    Sixth, a number of studies have demonstrated the importance of audit committee accounting expertise, as well as auditing expertise and industry expertise. Firms should strive to appoint audit committee members with specific accounting and auditing expertise given their apparently greater effectiveness and the positive stock market reaction to the appointment of accounting experts.

    Seventh, a growing line of research indicates that audit committee compensation methods can influence audit committee members’ judgments, and audit committee compensation methods are associated with the risk of restatement and with the handling of auditor adjustments. We encourage auditors, analysts, and shareholders to be cognizant of the potential risks involved if audit committee members are compensated primarily with short-term, incentive-based pay.

    Eighth, some audit committees appear to take their monitoring roles seriously, while others appear to be primarily ceremonial in nature. Auditors are in a unique position to evaluate the effectiveness of the audit committee process. Auditors should explicitly evaluate the effectiveness of the audit committee’s processes, and adjust their risk assessments, budgeted hours, and the nature, extent, and timing of audit testing, especially if effective audit committee processes seem to be attenuated by the intervention of a dominant CEO.

    Finally, given the severe reputational damage experienced by directors, especially audit committee members, in cases of financial reporting failures, and given the difficulty of monitoring a large entity on a part-time basis, audit committees might want to consider retaining permanent staff or consultants to the audit committee.

    For more information on this study, please contact Dana Hermanson.

    Citation:

    Carcello J. V., D. R. Hermanson, and Z. Ye. 2011. Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions. Auditing: A Journal of Practice & Theory 30 (3): 1-31. 

    Keywords:
    Corporate governance; board; audit committee; literature review.
    Purpose of the Study:

    Over the past two decades, the corporate governance literature in accounting and auditing has grown rapidly. We review this literature, primarily focusing on corporate board and audit committee issues.

    Design/Method/ Approach:

    We discuss 12 recent literature review or meta-analysis papers and summarize selected results (i.e., clusters of papers with new and interesting results) from recent empirical research papers, after reviewing the findings of over 250 studies. 

    Findings:

    We discuss the major insights from this literature and the practice implications of these findings. In addition, we identify a number of opportunities for future research. In particular, we make suggestions for: (1) improved research paradigms in corporate governance, (2) extensions of existing research, and (3) new or emerging lines of research.

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Compensation, Board/Audit Committee Composition, Board/Audit Committee Oversight, Board/Audit Committee Processes, Board/Audit Committee Tenure
  • Jennifer M Mueller-Phillips
    Bringing Darkness to Light: The Influence of Auditor Quality...
    research summary posted June 2, 2014 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    Bringing Darkness to Light: The Influence of Auditor Quality and Audit Committee Expertise on the Timeliness of Financial Statement Restatement Disclosures
    Practical Implications:

    This objective of this study is to determine whether auditor quality and audit committee financial expertise are associated with improved restatement disclosure timeliness as reflected in reduced dark periods. Recent actions by regulatory agencies suggest that the timeliness of financial reporting remains a top priority of investors and regulators. This study finds evidence that both the auditors and audit committees can provide significant value to clients and improve timely disclosure of restatement details. 

    Citation:

    Schmidt, J., and M. S. Wilkins. 2013. Bringing Darkness to Light: The Influence of Auditor Quality and Audit Committee Expertise on the Timeliness of Financial Statement Restatement Disclosures. Auditing 32 (1).

    Keywords:
    accounting expertise; audit committees; audit quality; financial expertise; financial reporting timeliness; financial statement restatements
    Purpose of the Study:

    Several recent regulatory actions suggest that the timely reporting of financial data is a top priority of investors and regulators. This study investigates whether auditor quality and audit committee expertise are associated with improved financial reporting timeliness as measured by the duration of a financial statement’s “dark period.” The restatement dark period represents the length of time between a company’s discovery that it will need to restate financial data and the subsequent disclosure of the restatement’s effect on earnings. This dark period restatement setting helps to address the fundamental question of whether better governance helps companies resolve financial reporting problems. 

    Design/Method/ Approach:

    The authors selected a sample of 154 firms announcing dark restatements disclosed between 2004 and 2009. This sample was used to test the following hypotheses:

    • H1: Restatement dark periods are shorter for clients of Big 4 auditors. 
    • H2a: Restatement dark periods are shorter when the audit committee contains a larger proportion of financial experts. 
    • H2b: Restatement dark periods are shorter when the audit committee contains a larger proportion of accounting financial experts.
    • H3: Restatement dark periods are shorter when the audit committee chair has accounting financial expertise. 

    A multivariate model was then used to investigate the determinants of the length of restatement dark periods of the selected sample. 

     

    Findings:
    • Dark periods are shorter in the presence of Big 4 auditors.
    • Restatement dark periods are shorter among clients that have audit committees with more financial accounting experts. 
    • The relationship between the audit committee financial expertise and restatement dark periods is primarily attributable to the presence of an audit committee chair who is an accounting financial expert. 
    • With these factors present, restatement disclosures are provided up to 38 percent faster
    Category:
    Accountants' Reporting, Auditor Selection and Auditor Changes, Governance
    Sub-category:
    Board/Audit Committee Composition, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Restatements
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  • Jennifer M Mueller-Phillips
    The Impact on Auditor Judgments of CEO Influence on Audit...
    research summary posted May 25, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 09.0 Auditor Judgment, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    The Impact on Auditor Judgments of CEO Influence on Audit Committee Independence
    Practical Implications:

    The results of this study show that auditors consider the influence that the CEO has over the audit committee in determining whether the audit committee is likely to support the audit team when resolving issues with management. To the extent that auditors feel that CEO influence decreases audit committee support of the external auditor this undermines the independent reporting line that the audit committee should provide. Current audit standards do not address this situation.

    Citation:

    Cohen, J.R., L.M. Gaynor, G. Krishnamoorthy, and A.M. Wright. 2011. The Impact on Auditors Judgments of CEO Influence on Audit Committee Independence. Auditing: A Journal of Practice and Theory 30 (4): 129-147.

    Keywords:
    Audit committee; audit judgments; independence corporate governance; CEO influence; management incentives
    Purpose of the Study:

    Although an audit committee meets regulatory requirements of independence, it is still possible that the CEO of a company has influenced the appointment of its members. This study investigates whether knowledge of the CEO’s prior relationships with audit committee members, either professional or personal, influences the magnitude of an audit adjustment that they anticipate will be waived.

    Design/Method/ Approach:

    Evidence was collected prior to September of 2010. This study is an experiment that was distributed via email. Participants consisted of 65 auditors with ranks ranging from manager to partner. The case materials provided a brief case related to inventory obsolescence and asked participants to determine the audit adjustment they believed should be recorded as well as the audit adjustment they believed would actually be recorded by the hypothetical client

    Findings:

    This study examined jointly the effects of management incentives for earnings management and CEO relationship with the audit committee on waived audit differences, which was measured as the difference between what participants thought the adjustment should be ideally versus what it would be after negotiations with the client.

    • Auditors estimated smaller amounts of the proposed adjustment would be waived if posting the full adjustment would cause the company to miss EPS targets. In other words, auditors are more conservative and waive smaller amounts of proposed adjustments when management has a high incentive to manage earnings.
    • When incentives to manage earnings are low (adjustment would not cause the company to miss EPS targets) then the relationship of the CEO with the audit committee does not influence the amount of the adjustment that is waived.
    • When incentives to manager earnings are high (adjustment would cause the company to miss EPS targets) and the CEO has a relationship with audit committee member(s) auditors anticipate less of the adjustment being waived than when the CEO has no relationship with audit committee member(s). The study attributes this effect to the auditors perceiving greater bargaining power when the CEO has no relationship because the audit committee is more independent and therefore more likely to support the auditor.
    Category:
    Auditor Judgment, Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Board/Audit Committee Composition, Earnings Management, Earnings Management
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  • Jennifer M Mueller-Phillips
    Do Former Audit Firm Partners on Audit Committees Procure...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor?
    Practical Implications:

    This study presents new evidence that suggests the presence of AFAPs and UFAPs on the audit committee has the potential to reduce threats to auditor independence by pre-approving the purchase of less NAS form the auditor. The findings of this study are consistent with the view that AFAPs serving as independent audit committee members appear not to make economic decisions in favor of their former audit firm, and, thus, may be exercising objective and independent oversight to enhance auditor independence. This evidence is also in line with the goal of SOX to reduce actual or perceived threats to auditor independence. From a regulatory perspective, the findings suggests that concerns about audit firm alumni on client’s audit committees may not be warranted in the post-SOX environment and the three-year cooling period rule may be unnecessary. However, further research in other contexts is needed.

    For more information on this study, please contact Vic Naiker.
     

    Citation:

    Naiker, V., D. S. Sharma, and V. D. Sharma. 2013. Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor? The Accounting Review 88 (1): 297–326.

    Keywords:
    alumni; audit committee; cooling-off period; former partner; independence; nonaudit; revolving-door
    Purpose of the Study:

    This study focuses on how the presence of a former audit firm partner (FAP) on the audit committee is related to nonaudit services (NAS) procured from the external auditor. The Sarbanes-Oxley Act of 2002 requires the audit committee to pre-approve nonaudit services procured from the auditor to prevent potential independence issues. The presence of a FAP affiliated with the current auditor on the audit committee could undermine the audit committee’s due diligence over the NAS pre-approval process. To alleviate these concerns, the SEC implemented a three-year cooling-off period for appointing audit form alumni as independent directors. This study analyzes the effects of these relationships on auditor independence.

    Design/Method/ Approach:

    A sample of 2,748 firm-year observations with available corporate governance, director, and CFO biographical data for fiscal years ending in 2004 and 2005 was selected. The sample was tested using regression models to investigate the association between affiliated former audit partners (AFAPs) and unaffiliated audit partners (UFAPs) on the audit committee and nonaudit services purchased from the auditor.

    Findings:
    • Firms with FAPs purchase significantly less NAS compared to firms without and FAP.
    • The capacity of the audit committee to reduce dependency on auditor-provided NAS in the post-SOX era may be enhanced when committee members possess partner-level experience.
    • AFAPs on the audit committee adopt a more conservative NAS pre-approval strategy by reducing NAS purchased from the auditor.
    • Audit committees including AFAPs not meeting the mandatory three-year cooling off periods are equally conservative when pre-approving NAS purchased for the auditor relative to audit committees that include AFAPs satisfying this rule and UFAPs.
       
    Category:
    Governance, Independence & Ethics, Standard Setting
    Sub-category:
    Board/Audit Committee Composition, Impact of SOX, Non-audit Services
  • Jennifer M Mueller-Phillips
    Female Board Presence and the Likelihood of Financial...
    research summary posted October 31, 2013 by Jennifer M Mueller-Phillips, tagged 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    Female Board Presence and the Likelihood of Financial Restatement
    Practical Implications:

    Female board presence has a beneficial impact on a board of director’s governance function and is negatively associated with financial restatements, a costly ordeal for any company. Increasing board diversity through many characteristics (culture, age, etc.) helps avoid the pitfalls of groupthink and leads to better corporate governance.

    For more information on this study, please contact Lawrence J. Abbott at the University of Wisconsin-Milwaukee (abbotl@uwm.edu).
     

    Citation:

    Abbott, L. J., S. Parker, and T. J. Presley. 2012. Female Board Presence and the Likelihood of Financial Restatement. Accounting Horizons 26 (4): 607-629

    Keywords:
    board gender diversity; corporate governance; restatement.
    Purpose of the Study:

    A large amount of research has been devoted to understanding the relationship between board member independence and financial restatements. However, the overall results have been mixed with evidence for and against the idea that director independence leads to better governance. The study tests whether a more diverse board leads to greater independence and therefore a lower likelihood of restatement. The measure the authors use for diversity is the presence of a female board director.

    The authors motivate their study based on the idea of “group-think,” which is a mode of thinking group members engage in when seeking consensus rather than pursuing other, possibly better courses of action. Gender diversity has been shown to decrease this tendency in groups and this paper tests whether that leads to better corporate governance when at least one board member is female.
     

    Design/Method/ Approach:

    The results of this study are based on firm restatements included in the GAO report from 1997 through 2002. All firms in the study were non-Fortune 1000 firms. The authors believe larger firms may have more pressure to have a “token” female board member and so this sample of smaller firms better represents the true effect of having a female present on the board. The authors matched a sample of firms with restatements with a control sample of firms that did not restate during the same period. The control firms were matched with a firm in the restatement sample as best as possible using characteristics such as market value of equity and industry code to ensure that they represented the best possible match for a similar firm that did not have to restate during the same time period.

    Findings:

    About 65 percent of firms in the sample had boards that did not include a single female director. Results from the study show a significant reduction in the likelihood of a financial restatement when the board contains at least one female board member. However, the authors admit that it may not actually be the female presence on the board that leads to a lower likelihood of restatements. For example, firms with better overall corporate governance may be more likely to appoint female board members for real or perceived benefits. Better corporate governance could drive both likelihood for restatement and the presence of a female board member.

    Category:
    Accountants' Reporting, Governance
    Sub-category:
    Board/Audit Committee Composition, Restatements
  • Jennifer M Mueller-Phillips
    A Post-SOX Examination of Factors Associated with the Size...
    research summary posted October 31, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 05.0 Audit Team Composition, 05.04 Staff Hiring, Turnover and Morale, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    A Post-SOX Examination of Factors Associated with the Size of Internal Audit Functions
    Practical Implications:

    This study provides insights that should be useful for CAEs and boards of directors (or audit committees) in discussions related to (1) internal audit philosophy regarding its potential contributions to an organization, (2) alternative staffing models, (3) resource allocation, and (4) embracement of audit technology. The study could also help guide external auditors’ evaluation of client internal audit functions. The authors find that the mission of internal audit functions differs from organization to organization. Additionally, the results suggest that internal audit functions used for leadership development purposes (i.e., a rotational staffing strategy) are larger, presumably because the staff have less experience and staff are rotating in and out of the department more frequently. Finally, these findings help illustrate the importance of internal audit proving that it is ‘‘value added’’ to the organization. Management and audit committees are often looking for more than financial statement compliance, and those internal audit functions that have responded to these greater needs are rewarded with more resources, likely because they are perceived to deliver more value.

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

    Citation:

    Anderson, U. L., M. H. Christ, K. M. Johnstone, and L. E. Rittenberg. 2012. A Post-SOX Examination of Factors Associated with the Size of Internal Audit Functions. Accounting Horizons 26(2): 167-191

    Keywords:
    Internal Audit; resource allocation; budgeting; staffing.
    Purpose of the Study:

    Internal auditing is a key element of an organization’s governance, risk management, and internal control structure. However, many organizations struggle to know if the investments they make in the internal audit function are appropriate and use size benchmarking data (e.g., firm assets, revenues, number of employees) to determine if internal audit is appropriately sized. However, benchmark data fails to incorporate other factors that influence internal audit size such as the effectiveness and efficiency of an internal audit function, the scope of the internal audit mission, or internal audit objectives and staffing strategies. Therefore, the objectives of the study include the following:

    • Develop and test a conceptual model that articulates the factors associated with internal audit size in the contemporary post-SOX era. The model includes four determinants of internal audit size: (1) audit committee characteristics, (2) internal audit characteristics and mission, (3) assurance activities performed by others (including internal audit outsourcing providers and assurance provided by other functions within the organization), and (4) organization characteristics.
    • Conduct an examination using contemporary post-SOX data in order to extend earlier related research on internal audit sizing by considering a variety of previously unexamined characteristics that differentiate internal audit functions from one another.
    • Examine the state of internal audit staffing in the post-SOX environment.
       
    Design/Method/ Approach:

    The authors collected data with which to test their model by first conducting field interviews with a variety of chief audit executives across a broad range of industries. The authors then distributed a survey to chief audit executives that are members of the Institute of Internal Auditors. The survey includes questions related to each of the four determinants of internal audit size (as mentioned above), as well as internal audit size based on number of internal audit personnel. The field interviews were conducted between August 2006 to November 2006 and the survey was conducted from August 2007 and October 2008.

    Findings:

    The authors find that internal audit size is positively associated with:

    Audit Committee Characteristics:

    • the size of the audit committee;
    • the frequency of audit committee meetings with the CAE
    • audit committee review and approval of the internal audit budget.

    Internal Audit Characteristics and Mission:

    • CAE tenure in the organization;
    • performance of IT auditing;
    • the use of a staffing model in which internal audit is used for rotational leadership development
    • the use of sophisticated audit technology.

    Organization Characteristics:

    • the total assets of the organization
    • the number of foreign subsidiaries that the organization possesses.


    Further, the authors find that internal audit size is inversely associated with:

    Internal Audit Characteristics and Mission:

    • the percent of audit staff designated as Certified Internal Auditors.

    Internal Audit Activities Performed by Others:

    • the extent of internal audit activities outsourced to a third party.
    Category:
    Audit Team Composition, Governance, Standard Setting
    Sub-category:
    Board/Audit Committee Composition, Impact of SOX, Staff Hiring - Turnover & Morale
  • Jennifer M Mueller-Phillips
    Changes in Corporate Governance Associated with the...
    research summary posted October 24, 2013 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 07.04 Assessing Remediation of Weaknesses, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    Changes in Corporate Governance Associated with the Revelation of Internal Control Material Weaknesses and Their Subsequent Remediation
    Practical Implications:

    The results of this study support the audit committee regulations under SOX and the board independence regulations of the listing exchanges. These results are important to regulators as they show that improvements in audit committee influence, competence, and incentives are each positively associated with ICMW remediation. In addition, the results reveal that improvements in these audit committee characteristics are most strongly associated with the remediation of ICMWs relating to control activities and monitoring, but not to ICMWs across the other COSO categories. Lastly, the results are important to management as they highlight the importance of hands-on day-to-day leadership by management in addressing situations involving the revelation and remediation of material negative events.

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

    Citation:

    Johnstone, K., C. Li, and K. H. Rupley. 2011. Changes in Corporate Governance Associated with the Revelation of Internal Control Material Weaknesses and Their Subsequent Remediation.  Contemporary Accounting Research 28 (1):  331-383. 

    Keywords:
    internal controls; material weaknesses; corporate governance; materiality; remediation.
    Purpose of the Study:

    Section 404 of the SOX requires public firms and their external auditors to report on the effectiveness of firms’ internal controls over financial reporting (ICOFR) or to reveal the presence of internal control material weaknesses (ICMWs). Other sections in SOX and listing requirements of the NYSE and NASDAQ also contain regulations intended to improve the conduct and oversight of boards of directors, audit committees, and top management. The purpose of this paper is to propose and test a conceptual model of the process that firms use to remediate negative events in general, and ICMWs specifically, with a focus on the role of governance structure changes (including turnover of and improvements in the characteristics of boards of directors, audit committees, and top management). Specifically, the authors examine what actions companies take in changing corporate governance in an attempt to regain equilibrium upon occurrence of a negative event and how do these changes impact the likelihood that a material weakness is remediated.

    Design/Method/ Approach:

    The authors utilize a conceptual model which includes two primary phases, the first of which concerns the association between the disclosure of ICMWs and turnover of boards of directors, audit committees, and top management. The second phase of the model concerns the association between the remediation of ICMWs and both outright turnover of and changes in the particular characteristics of boards of directors, audit committees, and top management. The first phase utilizes an ICMW sample of firms with December fiscal year ends from 2004 through 2007 that report ICMWs in their SOX Section 404 reports and a control sample which received unqualified SOX 404 Reports and examines the association between ICMW disclosure and governance changes. The second model utilizes a similar sample, but only includes firms which disclose ICMWs in 2004-2006 as it is required that firms need a year to remediate.  This second model estimates the association between ICMW and governance structure changes.

    Findings:
    • The authors find that that the disclosure of ICMWs is positively associated with subsequent turnover of members of boards of directors, audit committees, and top management, including both CEOs and CFOs. As such, the authors infer that the incentives to make significant structural changes in governance following the revelation of an ICMW appear to outweigh the disincentives, and firms revealing an ICMW act in a similar manner to firms revealing other material negative events such as fraud or restatements.
    • Furthermore, the authors show that remediation is positively associated with turnover of audit committee members, but not turnover of board members, CEOs, or CFOs.
    • Additionally, the results reveal that ICMW remediation is positively associated with an increase in the proportion of independent directors on the board, an increase in the percentage of independent directors who also serve on other boards, changes involving having an audit committee member chairing the board, improvements in audit committee member financial expertise, an increase in the percentage of shareholdings of audit committee members, changes toward CFOs with greater accounting expertise, greater CFO-specific work experience, and improvements in CEO reputation.
    • Lastly, the results reveal that ICMW remediation is negatively associated with a greater number of ICMWs and the presence of general ICMWs (those having pervasive effects on financial reporting) rather than specific ICMWs.
       
    Category:
    Governance, Internal Control
    Sub-category:
    Assessing Remediation of Weaknesses, Board/Audit Committee Composition, Reporting Material Weaknesses
  • Jennifer M Mueller-Phillips
    The Association between Audit Committee...
    research summary posted September 10, 2013 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    The Association between Audit Committee Multiple-Directorships, Tenure, and Financial Misstatements
    Practical Implications:

    Auditors should be interested in these findings both for designing an effective engagement and for properly considering risk and liability during the client acceptance stage of the audit. Firms wherein the board contains multiple directors with long tenure are riskier, and auditors should consider that fact when deciding whether to accept the client and when designing the audit.

    Citation:

    Sharma, V.D. and E.R. Iselin.  2012. The Association between Audit Committee Multiple-Directorships, Tenure, and Financial Misstatements. Auditing: A Journal of Practice and Theory. (31) 3: 149–175.

    Keywords:
    audit committee, multiple-directorships, tenure, restatement, misstatement, financial reporting quality
    Purpose of the Study:

    This study seeks to answer questions about whether multiple-directorships and length of tenure on an audit committee have any impact on financial reporting quality as measured by financial restatements.

    Design/Method/ Approach:

    The study uses restatement announcements from the General Accounting Office as well as data on audit committee composition for 1999 to 2001 and 2004 to 2006. It then runs econometric tests on the data to ascertain what relationships exist between restatements and audit committee composition.

    Findings:

    The authors find that (1) multiple-directorships lead to decreased financial reporting quality indicated by an increased number of restatements because directors are "spread too thin" and (2) length of tenure is also positively associated with financial restatements.

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Composition
  • The Auditing Section
    The Impact of Roles of the Board on Auditors’ Risk A...
    research summary posted April 16, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    The Impact of Roles of the Board on Auditors’ Risk Assessments and Program Planning Decisions
    Practical Implications:

    The results of this study suggest that auditors do take into consideration board roles in their control risk assessments.  In addition, both dimensions of board structure are suggested to affect assigned audit hours. These findings provide additional insights into whether auditors are able to integrate adequately the board roles into their audit planning.  The results have implications for audit firms in better understanding how auditors incorporate the board roles into their risk assessments and audit planning.  Further, the results suggest that, in line with PCAOB AS 2, auditors rely on a more complex set of factors than simply the monitoring role of boards. 

    Citation:

    Cohen, J.C., G. Krishnamoorthy, and A.M. Wright. 2007.  The Impact of Roles of the Board on Auditors’ Risk Assessments and Program Planning Decisions.  Auditing: A Journal of Practice and Theory 26 (1): 91-112.

    Keywords:
    corporate governance; board role; resource dependence; risk assessment; audit planning judgments.
    Purpose of the Study:

    The current study expands our knowledge of the impact of governance structure, by focusing on how two attributes of boards influence the auditors’ risk assessment and program planning decisions. Specifically, the authors examine the influence of resource dependence and agency board roles, both defined below.  

    • A resource dependence role is described as one where the board member has specific experience with either the company or industry that is advantageous to their ability to provide relevant guidance. 
    • An agency role is described as one that provides a strong management monitoring function.  The current study examines whether inherent and control risk assessments are lower when these roles are stronger.  

    Below are the primary objectives that the authors address in this study: 

    • Examine the extent to which resource dependence and agency board roles affect auditors’ inherent risk assessment, control risk assessment, and planned audit hours (used as a proxy for extent of audit testing).
    Design/Method/ Approach:

    The investigation used an experimental questionnaire to obtain data. The questionnaire solicited voluntary responses from audit partners and managers at two large Northeast offices of one Big 4 auditing firm, prior to 2004.  Participants read a case-based experiment concerning a high-tech company, where the board related facts were varied between higher and lower resource dependence and higher and lower agency roles.  The participants then answered questions related to inherent and control risks, resource allocations and personal information.

    Findings:
    • Evidence suggests that auditors do respond to the roles of the board.  Specifically, auditors increase their control risk assessment when the board structure reflects weaker agency or resource dependence.
    • Evidence suggests that auditors do not respond to roles of the board when making inherent risk assessments. Specifically, the strength or weakness of either board characteristic has no impact on auditors’ inherent risk assessment. 
    • When auditors were presented with a board where resource dependence and agency roles were both higher, they decreased the amount of planned audit hours recommended.  Overall then, the evidence suggests that when both resource dependence and agency roles were higher, the control risk assessment and audit effort (i.e., planned audit hours) were lower. In all other combinations of the two board structure characteristics (i.e., high resource dependence-low agency, low resource dependence high agency, and low resource dependence-low agency), planned audit hours were higher.
    Category:
    Risk & Risk Management - Including Fraud Risk, Governance
    Sub-category:
    Assessing Risk of Material Misstatement, Board/Audit Committee Composition
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  • The Auditing Section
    Restoring Trust after Fraud: Does Corporate Governance...
    research summary posted May 7, 2012 by The Auditing Section, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.05 Board/Audit Committee Oversight 
    Title:
    Restoring Trust after Fraud: Does Corporate Governance Matter?
    Practical Implications:

    The results of this study suggests that the economic costs firms incur to improve their governance environment are effective in helping to restore some of the firm’s credibility after a fraudulent reporting event.  The study supports prior research that associates weak governance structures with fraudulent financial reporting.  Just as important, the results indicate that fraud firms receive some positive economic benefits from this recovery strategy, at least in terms of abnormal market returns. 

    Citation:

    Farber, D. 2005. Restoring Trust after Fraud: Does Corporate Governance Matter? The Accounting Review 80 (2): 539-561.

    Keywords:
    fraud; corporate governance; credible financial reporting; investor trust; agency costs; independent directors; audit committee
    Purpose of the Study:

    Given the fraud-related scandals of the early 2000’s, regulators recognized the impact that a high quality corporate governance environment can have on firms’ financial reporting quality and enacted several provisions to strengthen or enhance firms’ governance structures.  Academic studies support this perception and show an association between weak corporate governance structures and fraudulent financial reporting.  However, while the academic evidence supports regulators’ belief that strong corporate governance helps prevent fraudulent financial reporting, there is little evidence regarding what steps are actually taken by firms to improve their governance environments after these firms have committed acts of fraudulent financial reporting.  In addition, there is little evidence regarding the effectiveness of these acts in restoring the firm’s credibility with capital market participants.  Therefore, this paper addresses these concerns through the following two specific objectives:

    • Examine whether an association exists between the revelation of fraudulent financial reporting and subsequent steps taken to improve the firm’s corporate governance environment.  The corporate governance steps examined in this paper relate to the characteristics of the board of directors and audit committee, as well as other governance mechanisms such as a Big 4/non Big 4 auditor as the external audit provider and the CEO serving the dual role of Chairman of the Board.
    • Examine whether the firm’s improvements in corporate governance are rewarded by informed capital market participants.  The informed capital market participants examined in this study include analysts, institutional owners, and short-sellers.
    Design/Method/ Approach:

    The author examines a sample of U.S. publicly traded firms cited by the SEC in Accounting and Auditing Enforcement Releases (AAERs) for SEC Rule 10b-5 of the Exchange Act of 1934 violations during the period of 1982 - 1997.  The author further limits his sample to financial statement-related fraud violations.

    The author tests changes in corporate governance by matching fraud firms with a control firm based upon industry, stock exchange listing and comparable sales.  Using the combined sample of fraudulent and control firms, the author examines the stated objectives using changes in univariate statistics for up to three years subsequent to the fraud revelation and regression analysis methods.

    Findings:
    • In the year prior to fraud detection, the author finds that fraud firms have a weaker governance environment as measured by outside director percentage, the number of outside directors, the number of audit committee meetings, the number of financial experts on the audit committee, the quality of the external audit firm, the proportion of firms with the combined CEO/Chairman position, and the percentage of blockholder ownership.
    • Fraud firms, at the end of three years following the fraud detection, are statistically similar to the control firms on many governance characteristics, including outsider director percentage and the proportion with the combined CEO/Chairman position.  Fraud firms even appear to exceed the control firms in terms of the number of audit committee meetings, although control firms have a larger number of financial experts and are more likely audited by Big 4 auditors.
    • Although the author finds that analyst following and institutional ownership do not increase in fraud firms, increasing the board’s independence does appear associated with long-run buy-and-hold abnormal returns.
    Category:
    Governance
    Sub-category:
    Board/Audit Committee Composition, Board/Audit Committee Oversight
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