Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • Jennifer M Mueller-Phillips
    Auditor Communications with the Audit Committee and the...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.02 Board/Financial Experts, 13.05 Board/Audit Committee Oversight 
    Title:
    Auditor Communications with the Audit Committee and the Board of Directors: Policy Recommendations and Opportunities for Future Research.
    Practical Implications:

    The review identifies insights for practice and opportunities for research on communication issues between the auditor, the audit committee, and the board. The authors strongly believe that the academic and the practice communities must have a continual dialogue so that standards reflect research, and research is directed to issues with the greatest potential to positively affect public policy. These implications should interest the PCAOB, the SEC, other standard-setters, and regulators that focus on issues related to corporate governance and financial reporting quality.

    Citation:

    Cohen, J., L. M. Gaynor, G. Krishnamoorthy, and A. M. Wright. 2007. Auditor Communications with the Audit Committee and the Board of Directors: Policy Recommendations and Opportunities for Future Research. Accounting Horizons 21 (2): 165-187.

    Keywords:
    board of directors, communication between audit committees and external auditors, corporate governance, financial reporting quality, internal control reports
    Purpose of the Study:

    In 2004 the Public Company Accounting Oversight Board (PCAOB) began considering a standard to improve guidance on the communication process between external auditors and audit committees. The Sarbanes-Oxley Act of 2002 expands and emphasizes the role of audit committees in ensuring the quality of reported financial results. This increased responsibility requires improved and expanded dialogue between audit committees and external auditors.

    In this paper, the authors review the extant academic literature to address relevant issues pertaining to communications between external auditors and audit committees on matters relevant to the integrity of the financial reporting process as well as to the PCAOB-developed discussion questions (DQs). Specifically, they examine literature regarding communications pertaining to overall financial reporting quality, internal controls, the external auditor’s job performance, the form of communications (oral or written), and communications pertaining to the Management’s Discussion and Analysis (MD&A) section of the annual report. For each major area, they discuss the implications of the academic research for standard-setters and identify future research opportunities for the academic community.  

    Design/Method/ Approach:

    The literature review primarily features research published in academic accounting and auditing journals. In an effort to capture the latest research availableas well as research on emerging topics, such as many of those precipitated by the passage of SOXthe authors also include working papers submitted to major archiving services. The authors searched electronic databases such as Ingenta, ABI/Inform, and American Accounting Association (AAA) Electronic Publications using keywords or combinations of keywords related to the various topics and subtopics discussed in this paper. They also searched Social Science Research Network (SSRN) and scholar.google.com to identify relevant working papers.

    Findings:
    • Financial Reporting Quality:
      • Frequent communications with a well-informed, financially sophisticated audit committee and communications among the audit committee, the auditor, and the full board improve financial reporting quality.
    • Internal Controls:
      • The nature and the extent of communications between the auditor and the audit committee should be sensitive to whether a control weakness or deficiency relates to entity level controls or account-level controls, given the differentially serious implications of these two types of weaknesses.
      • Firm-specific factors (e.g., financial distress, company size) should influence communications and may require the auditor to report directly with the board on matters related to internal control.
      • The audit committee and the external auditor should discuss the quality of the internal audit function and the extent to which the external auditor is able to rely on the work performed by internal audit.
      • The audit committee should discuss with external auditors their policy to protect whistle-blowers.
    • External Auditor Performance:
      • It it is important for the auditor to communicate to the audit committee all relationships with the client, the fees and nature of all services provided, and the extent to which any nonaudit services are beneficial to the audit.
      • The auditor should report all issues and proposed adjustments to the audit committee and the process used for resolving contentious issues.
      • The auditor should also report to the board its evaluation of the quality, effectiveness, and authority of the audit committee in discharging its responsibilities.
    • Other Issues:
      • A review of the literature suggests that the MD&A should be more emphasized in the discussions between the audit committee and the auditors.
    Category:
    Governance
    Sub-category:
    Board/Audit Committee Oversight, Board/Financial Experts
  • Jennifer M Mueller-Phillips
    Board Interlocks and Earnings Management Contagion.
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.05 Board/Audit Committee Oversight 
    Title:
    Board Interlocks and Earnings Management Contagion.
    Practical Implications:

    The evidence on the firm-to-firm spread of financial reporting behavior via board networks contributes to a little-studied area in accounting that should be important. The authors contribute to the corporate governance literature by offering evidence that contagion effects vary with board positions. They show that board supervision of management is important for ensuring high-quality financial reporting and that board linkages affect the success of this supervision. Regulators concerned about improving financial reporting quality should consider the board connectivity of companies.

    Citation:

    Chiu, P. C., S. H. Teoh, and F. Tian. 2013. Board Interlocks and Earnings Management Contagion. Accounting Review 88 (3): 915-944.

    Keywords:
    board interlocks, board networks, contagion, earnings management, governance, restatements, social networks
    Purpose of the Study:

    In the corporate world, behavior may spread through board of director networks. A board link exists between two firms whenever a director sits on both firms’ boards. A typical board in the sample has nine directors, and the median number of interlocks with other boards is approximately five. In this way, firms are widely connected by their board networks, which potentially serve as conduits for spreading behaviors from firm to firm.

    In this study, the authors investigate whether financial reporting behavior spreads through interlocking corporate boards. The test design emphasizes contagion of bad financial reporting choices, specifically, earnings management that results in a subsequent earnings restatement, although it also allows for inferences about good reporting contagion. The authors use restatements to identify firms that have managed earnings and the period when the manipulation occurred. They refer to a firm that later restates earnings as contagious. The authors define the contagious period as starting in the first year for which earnings are restated and ending two years after. Any firm that shares an interlocked director with the contagious firm during the contagious period is therefore exposed to an earnings management infection via the board network. They consider a multiyear contagious period to allow the earnings management infection to incubate, which is analogous to an epidemiological setting for viral infections. The key test investigates whether an exposed firm is more likely to manage earnings during the contagious period as compared to an unexposed firm.

    Design/Method/ Approach:

    The authors use the U.S. Government Accountability Office’s (GAO) first release of restatements between January 1, 1997 to June 30, 2002 to identify contagious firms and their contagious periods. They keep only the earliest restatement within the sample period when a firm has multiple restatements. The authors obtain director names from Risk Metrics. In the 19972001 sample period the authors identify a sample of 118 observations.

    Findings:
    • The authors find strong evidence that a firm is more likely to manage earnings when exposed within a three-year period to earnings management from a common director with an earnings manipulator. The contagion effect is economically substantial.
    • The regression odds ratio suggests that a board link to a manipulator doubles the likelihood that the firm will manage earnings.
    • The authors also find evidence for good financial reporting contagion. A board link to a non-manipulator significantly decreases the likelihood of the firm being a manipulator.
    • Both bad and good accounting behaviors are contagious across board networks.
    • Earnings management contagion is stronger when the shared director has a leadership position as board chair or audit committee chair, or an accounting-relevant position as an audit committee member, in the exposed firm.
    • The contagion is also stronger when the linked director is the board chair or CEO of the contagious firm, but not when the linked director is the CEO of the exposed firm.
    • Earnings management contagion is exacerbated when the exposed firm is located within 100 miles of the contagious firm and shares a common auditor with the contagious firm.
    • The evidence supports the proposition that earnings manipulation spreads through board networks.
    Category:
    Accountants' Reporting, Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Board/Audit Committee Composition, Board/Audit Committee Oversight, Earnings Management, Earnings Management, Restatements
  • Jennifer M Mueller-Phillips
    Board Monitoring and Endogenous Information Asymmetry.
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience, 14.10 CEO Compensation 
    Title:
    Board Monitoring and Endogenous Information Asymmetry.
    Practical Implications:

    The author claims that motivating the CEO to reveal information may or may not be beneficial. The disconnection between compensation and outcomes results from active monitoring. Compensation contracts rely on board evaluation, not on the final outcomes, to provide incentives. The proactive board activity can result in poor firm performance. This proactive activity requires extra care to reign in an expert: the CEO.

    Citation:

    Tian, J. J. 2014. Board Monitoring and Endogenous Information Asymmetry. Contemporary Accounting Research 31 (1): 136-151.

    Keywords:
    boarding monitoring, information acquisition, information asymmetry, project decision, executive compensation, CEO compensation
    Purpose of the Study:

    Boards of directors are frequently questioned pertaining to their monitoring role in executive decision making and compensation. The sequence of financial fraud in the early 2000s called public attention that boards have not done enough to align executive incentives with shareholders’ interests. Since shareholders do not normally observe executives’ actions and may not even know what actions executives should have taken to maximize shareholder value, increasing board effort to reduce such information asymmetry is commonly viewed as desirable.

    The present study challenges this common view that increasing board effort in monitoring is always desirable. This view neglects a key fact in corporate decision making: the information asymmetry between the CEO and shareholders is a result of the CEOs expertise. This study highlights the fact that CEOs are hired for their superior ability to make strategic decisions, particularly for their unique skills to acquire, process and interpret information relevant to these decisions.

    Design/Method/ Approach:

    The authors uses analytical modeling to conclude on the questions of interest.

    Findings:

    If board monitoring eliminates all information asymmetry, the board can easily ensure that decisions are made in the best interest of shareholders. It resolves all uncertainty in the remaining decision problems. However, preserving uncertainty is crucial ex ante in order to motivate a risk-averse CEO to acquire information, as effort need not be expended if there is no concern for uncertainty. Thus, board monitoring creates a time consistency problem for the CEO to acquire information.

    The board should actively engage in monitoring activities only when the board is able to evaluate the information provided by the CEO with high accuracy. That is, when board monitoring is able to produce enough information about the CEO’s effort directly, preserving uncertainty to incentivize the CEO to acquire information is a second-order concern. However, if a project requires special skills for implementation and board evaluation may not be accurate enough, it is better for the board to remain passive and not interfere with the CEO’s decisions.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Board/Audit Committee Oversight, CEO Compensation, CEO Tenure & Experience
  • Jennifer M Mueller-Phillips
    Busyness, Expertise, and Financial Reporting Quality of...
    research summary posted July 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.02 Board/Financial Experts, 13.05 Board/Audit Committee Oversight 
    Title:
    Busyness, Expertise, and Financial Reporting Quality of Audit Committee Chairs and Financial Experts
    Practical Implications:

    This research makes important contributions to understanding the factors associated with audit committee monitoring effectiveness in the post-SOX period. This study provides additional support for already existing research that both busy audit committee chairs and busy audit committee financial experts may result in overall lower financial reporting quality. These results are important for firms to consider in order to understand how the effectiveness of the audit committee can be affected by these key roles.

    For more information on this study, please contact Paul Tanyi.

    Citation:

    Tanyi, P. N. and D. B. Smith. 2015. Busyness, expertise, and financial reporting quality of audit committee chairs and financial experts. Auditing: A Journal of Practice and Theory 34 (2): 59-89.

    Keywords:
    Audit committee chairs, audit committee financial experts, audit committees, financial reporting quality
    Purpose of the Study:

    The audit committee chairman and financial experts hold important roles for audit committee oversight. This study investigates whether the number of other chairman or expert positions held by the individuals (“busyness”) negatively influences their ability to properly oversee financial reporting.  Previous research has shown that before the Sarbanes-Oxley Act there was a positive relationship between multiple audit committee directorships and monitoring quality. This study seeks to support the alternative hypotheses that financial reporting quality post-SOX is negatively associated with the number of audit committee chair positions and other audit committee financial expertise positions held by the audit committee chairman/financial experts.

    Design/Method/ Approach:

    The final data sample consisted of 6,535 firm-year observations from the period 2004 to 2008. The authors compare the busyness of the audit committee chairman and financial expert(s) to the quality of the public companies’ financial reporting. The authors determine the busyness of the chairman and financial experts using the number of other chair and financial expertise positions that they hold.  Financial reporting quality is measured by evaluating certain characteristics of the firms’ earnings and indicators of managerial earnings manipulation. The authors controlled for certain firm characteristics that might influence financial reporting quality—other governance characteristics, the nature of the firm’s business, the strength of internal controls over financial reporting, and auditor characteristics.

    Findings:
    • The number of audit committee chair positions and other audit committee financial expertise positions held by the audit committee chairman is significantly negatively associated with financial reporting quality.           
    • The number of audit committee chair positions and other audit committee financial expertise positions held by the audit committee financial expert is significantly negatively associated with financial reporting quality.
    • Because the audit committee chairs and financial experts serve on multiple audit committees where they are considered audit committee chairpersons and financial experts, respectively, their over-commitment appears to limit the average amount of time they can devote to each audit committee, resulting in the previously stated negative associations.
    • Multiple audit committee directorships do not appear to be problematic for members who are not audit committee chairs or financial experts, likely because they face fewer burdens and expectations.
    Category:
    Governance
    Sub-category:
    Board/Audit Committee Composition, Board/Audit Committee Oversight, Board/Financial Experts
  • Jennifer M Mueller-Phillips
    Client Importance and Earnings Management: The Moderating...
    research summary posted October 24, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    Client Importance and Earnings Management: The Moderating Role of Audit Committees
    Practical Implications:

    The results of this study have implications to both New Zealand and the United States. Regulators in New Zealand should assess these results as possible indications that the profession’s self-regulated status may need to be revised in light of the existence of lower financial reporting quality for clients that have weak audit committee oversight and are economically important clients to the auditor. Additionally, these results provide evidence to contribute to the ongoing debate in the United States regarding the merits and the intended and unintended consequences of independent auditor oversight through regulatory bodies such as the PCAOB.

    For more information on this study, please contact Vineeta D. Sharma.
     

    Citation:

    Sharma, V., D.S. Divesh, and U. Ananthanarayanan. 2011. Client importance and earnings management: the moderating role of audit committees. Auditing: A Journal of Practice and Theory 30 (1): 125-156.

    Keywords:
    audit committee; auditor independence; accruals; corporate governance; fees, earnings management; non-audit
    Purpose of the Study:

    As a result of declining investor confidence in the quality of financial information due to financial scandals, many countries have implemented corporate governance reforms that specifically identify the audit committee as the primary mechanism for the oversight of auditor independence and financial statement quality. This study investigates how the association between the economic importance of a client to the auditor and earnings management is moderated by the audit committee. Client importance is a potential threat to auditor independence and thus is a potential threat to audit quality. The authors suggest that the possibility exists that auditors may view the audit wealth provided from a client as more important than maintaining independence which is determinant of the audit quality; therefore, the authors examine if there is a positive correlation between client importance and earnings management. Certain circumstances, such as management ownership, leverage, high growth, and firm size, could potentially promote an environment that is conducive to earnings management independent of the external audit. In consideration of these circumstances, the auditors studied whether the association between client importance and earnings management was effected by these firm environmental factors. The audit committee’s response and efforts to mitigate these factors were also examined, specifically in light of the best practices recommendations. 

    Design/Method/ Approach:

    The authors conducted this study by gathering empirical evidence from firms listed on the New Zealand Stock Exchange in the fiscal years 2004 and 2005. The NZSE was chosen as a proper natural laboratory because there is no ban or limit on non-audit services, no mandate on the roles and composition of the audit committee exists, the audit profession is self-regulated, it is a less litigious environment, and it is geographically and economically small.

    Findings:
    • A positive correlation was observed between client importance and the observed proxies for earnings management, which included both performance-adjusted discretionary total and current accruals. This implies that as client importance, as related to the wealth production to the external auditors, increases the possibility of the existence of earnings management in the financial statements also increases.
    • The association became more pronounced for income-increasing accruals that potentially diminish the quality of earnings and are of greater concern to regulators; however, this was moderated by the audit committee.
    • The association between client importance and earnings management is conditional on other firm characteristics such as inside ownership, growth, leverage, and firm size. These factors could create potential agency conflicts but are moderated by the audit committee.
    • Accounting expertise on the audit committee and committees composed completely of outside directors explain the moderating effects of the audit committee.
    • The association with earnings management became more pronounced when the audit committee did not meet the best practices outlined by the NZSEC. These practice suggestions from the NZSEC are merely recommendations, not requirements, as the auditing profession is self- regulated in New Zealand.
       
    Category:
    Governance, Independence & Ethics
    Sub-category:
    Board/Audit Committee Oversight, Impact of Fees on Decisions by Auditors & Management, Non-audit Services
  • The Auditing Section
    Corporate Board Governance and Voluntary Disclosure of...
    research summary posted May 7, 2012 by The Auditing Section, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    Corporate Board Governance and Voluntary Disclosure of Executive Compensation Practices
    Practical Implications:

    Consistent with prior corporate governance research, this study concludes that more independent boards of directors are associated with better shareholder representation in disagreements with management.  Moreover, the results highlight the importance of the board governance process for effective decision making. This study documents that having less time to meet as a group and having fewer directors serving on the board can lead to reduced transparency. Frequent board meetings would facilitate greater information sharing among directors and more directors serving on boards would allow better workload distribution and committee assignments.

    Citation:

    Laksmana, I. 2008. Corporate board governance and voluntary disclosure of executive compensation practices.  Contemporary Accounting Research 25 (4): 1147-1182.

    Keywords:
    Board of directors, corporate governance, executive compensation, voluntary disclosure
    Purpose of the Study:

    Recent corporate scandals focused considerable public attention on the role of boards of directors in corporate governance. The purpose of this study is to assess whether higher quality boards voluntarily disclose more information about their compensation practices. The U.S. SEC requires a report justifying the compensation policies, but does not specify the items to be disclosed or the reporting format to be followed. Compensation-related disclosures are particularly important because boards of directors have a responsibility to report the basis of their actions for determining executive compensation in the companies’ proxy statements.

    Unlike other disclosure studies, the present study examines disclosures as the outcomes of board decisions rather than the assumed effect of boards on management decisions. Below are the two primary objectives that the author addresses in this study:

    • Examine whether boards of directors’ time and resource commitments are associated with the extent of compensation practice disclosures.
    • Examine whether more independent boards and compensation committees are more likely to make objective decisions by supporting greater disclosures.
    Design/Method/ Approach:

    This study selects publicly traded firms in nonregulated industries listed on the Standard & Poor’s (S&P) 500 as of December 31, 1992. The author examines the compensation disclosures in proxy statements of those firms filed in 1993 and in 2002. 

    Findings:
    • Boards reported more compensation-related disclosures in 2002 (most recent year) than they did in 1993 (first response to new SEC rules). 
    • More independent boards and compensation committees have more transparent compensation practice disclosures.
    • Meeting frequency and board size are both important factors for increased compensation disclosures.  The board/committee must be of adequate size to distribute workload and meet frequently enough to make decisions. 
    Category:
    Governance
    Sub-category:
    Board/Audit Committee Oversight
    Home:
    home button
  • 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
  • The Auditing Section
    Financial Restatements and Shareholder Ratifications of the...
    research summary posted April 23, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    Financial Restatements and Shareholder Ratifications of the Auditor
    Practical Implications:

    The authors’ results show that restatements are viewed by investors as audit failures and restatements reflect negatively on investor perceptions of the external auditor. The study also suggests that audit committees’ decisions to change auditors are not influenced by shareholder ratification voting.  The authors state that the results support “efforts to require SEC registrants to submit auditor selection for a shareholder ratification vote.”

    Citation:

    Liu, L., K. Raghunandan, and D. Rama. 2009. Financial Restatements and Shareholder Ratifications of the Auditor. Auditing: A Journal of Practice & Theory 28 (1): 225-240.

    Keywords:
    restatements; shareholder voting; auditor ratification
    Purpose of the Study:

    The purpose of this study is to examine the impact that client restatements have on shareholder ratification votes for the external auditor.  Restatements have been widely recognized as an indicator of low audit quality and as such may influence shareholder perceptions of the external auditor.  Shareholder ratification of the external auditor is not required by state or federal laws; however, many firms maintain the practice as a measure of good governance.  This ratification vote is the only opportunity shareholders have to comment on their approval/disapproval of the audit firm and/or audit quality.  Furthermore, some investor advocate groups (e.g., CalPERS) have withheld votes against audit committee directors of firms that did not offer shareholders an opportunity to vote on auditor ratification.                                                                                                                           

    The authors expect that firms will have a higher proportion of shareholders not voting for the appointment of the auditor following a restatement.

    Design/Method/ Approach:

    The authors collect data on firms that restate 2004 or 2005 financial statements and compare shareholder ratification votes for the restating firms to shareholder ratification votes for a control sample of firms that did not restate their 2004 or 2005 financial statements.

    Findings:
    • The authors find that shareholders are more likely to vote against auditor ratification after a client restatement relative to firms that do not restate their financial statements and relative to shareholder voting prior to the restatement.
    • There were 19 of 97 restatement firms that had more than 5 percent of shareholder votes not in favor of ratifying the auditor; only 2 of these 19 firms subsequently changed auditors the following year.
    Category:
    Auditor Selection and Auditor Changes, Governance
    Sub-category:
    Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Board/Audit Committee Oversight
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Internal Control Quality: The Role of Auditor-Provided Tax...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    Internal Control Quality: The Role of Auditor-Provided Tax Services.
    Practical Implications:

    The results of this study are important to audit regulators as they make decisions regarding policies, and to corporate governance officials as they make decisions regarding the audit firms they engage to provide tax nonaudit services. The evidence indicates that tax nonaudit services accelerate audit firm awareness of material transactions as these services are associated with a lower likelihood of a material weakness in internal controls. In addition, further evidence supports that this finding is not simply due to impaired auditor independence. Overall, this suggests that tax nonaudit services provided by the audit firm improve internal control quality. As regulators and companies evaluate the consequences of tax nonaudit services, the findings in this paper may impact their conclusions.

    Citation:

    De Simone, L., M.S. Ege, and B. Stomberg. 2015. Internal Control Quality: The Role of Auditor-Provided Tax Services. The Accounting Review. 90(4): 1469-1496.

    Keywords:
    auditor fees, nonaudit services, auditor independence, internal controls, tax, financial reporting quality
    Purpose of the Study:

    Audit regulators and companies’ corporate governance officials are charged with understanding and creating policies for auditor provided nonaudit services. To make informed decisions, it is important for these groups to know the benefits and costs of auditor provided nonaudit services. Previous research has reported a positive association between tax nonaudit services and financial reporting quality and audit quality. This paper investigates the relationship between tax nonaudit services and a specific component of financial reporting quality: internal control quality. Specifically, the authors:

    • Examine the relationship between tax nonaudit services and the probability of a material weakness in internal controls (i.e. internal control quality).
    • Examine whether tax nonaudit services are beneficial to companies experiencing a shock to their internal control environment.
    • Examine how the relationship between tax nonaudit services and internal control quality is affected by audit firm tenure.

    The authors also explain the process through which they propose tax nonaudit services affects non-tax financial reporting quality.

    Design/Method/ Approach:

    The authors collected auditor internal control opinions and data necessary to calculate control variables on publicly-traded companies that are subject to SOX Section 404(b). The information collected on these companies was for years 2004-2012.

    Findings:
    • The authors find that companies that purchase tax nonaudit services are significantly less likely to disclose a material weakness. A one standard-deviation increase in tax nonaudit services is associated with approximately a 13% decrease in the rate of material weaknesses relative to the base rate. Further analysis indicates that impaired auditor independence does not account for this result.
    • The authors find that when companies experience a significant shock to their internal control environment, tax nonaudit services incrementally benefit internal control quality relative to other companies.
    • The authors find that the benefits of tax nonaudit services on internal control quality are greater in the early years of audit firm tenure.
    Category:
    Governance, Independence & Ethics, Internal Control
    Sub-category:
    Board/Audit Committee Oversight, Non-audit Services, Reporting Material Weaknesses
  • Jennifer M Mueller-Phillips
    Managers’ Strategic Reporting Judgments in Audit N...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.04 Interactions with Client Management, 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Managers’ Strategic Reporting Judgments in Audit Negotiations
    Practical Implications:

     The results of this study are important to consider when examining the effects of the audit committee on managers’ judgments. This study identifies the changes to the reporting environment stemming from the implementation of SOX, particularly with respect to communications between auditors and the audit committee and the authority and responsibility of the audit committee. This study adds insight to prior archival research that suggests that audit committees considered to be effective are associated with greater financial reporting quality. Further, these findings suggest that managers act as if auditors and audit committees that jointly resist management pressures to engage in aggressive reporting play important roles in ensuring high financial reporting quality.

    Citation:

     Brown-Liburd, H., A. Wright and V. Zamora. 2016. Managers’ Strategic Reporting Judgments in Audit Negotiations. Auditing, A Journal of Practice and Theory 35 (2): 47-64.

    Keywords:
    Audit negotiation, past counterpart relationship, audit committee oversight
    Purpose of the Study:

     Prior research has largely characterized audit issue negotiations as a dyadic relationship between auditors and managers. However, the Sarbanes Oxley Act (SOX) substantially enhanced the audit committee’s oversight responsibilities for the financial reporting and auditing process. Thus, negotiations post-SOX may be viewed as a triadic relationship involving managers, auditors, and the audit committee. Differing judgments between auditors during negotiations and managers during financial reporting exist because they have different perspectives and incentives. Whereas managers’ incentives relate to maximizing financial reporting outcomes while maintaining the firm’s reporting reputation, auditors’ incentives relate to fostering a functioning working relationship with the client while appropriately attesting to the financial statements. These differences in perspectives and incentives yield contrasting expectations of negotiation judgments for auditors and managers. This study seeks to examine the joint effects of past auditor-client negotiations and audit committee strength on management’s strategic reporting judgments.

    Design/Method/ Approach:

     The authors recruited participants from an executive training session attended by CFOs/controllers and held at a large public university in the southeastern U.S. During a controlled experiment, participants completed the hard copy experimental case. Participants engaged in planning for an upcoming audit negotiation involving a subjective estimate for an inventory write down due to obsolescence. The authors asked participants to identify their initial offer and their perception of the negotiated ultimate final outcome. Audit committee strength was manipulated as either weak or strong. The nature of past auditor-client negotiations over “grey” misstatements was manipulated as either contentious or cooperative.

    Findings:

    The results are consistent with a strong combined effect of the roles of both the auditor and the audit committee in managers’ pre-negotiation judgments.

    • The presence of both strong audit committee oversight and an auditor that has been contentious in past negotiations together significantly constrain managers’ aggressive reporting.
    • The presence of weak audit committee oversight and an auditor that has been cooperative in past negotiations jointly provide the opportunity for managers to engage in more aggressive reporting.
    • Managers report less aggressively in the presence of a contentious auditor and strong oversight by the audit committee to ensure timely resolution and protect the firm’s financial reporting reputation, and to minimize the risk that the audit committee will intervene against the managers’ favor.
    • Managers report more aggressively in consideration of his/her relative bargaining power against a cooperative auditor who appears to have high relationship concerns, along with weak oversight by the audit committee that is passive/persuadable. 
    Category:
    Corporate Matters, Engagement Management, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight, Interactions with Client Management

Filter by Type

Filter by Tag