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  • Jennifer M Mueller-Phillips
    Auditor Resignation and Firm Ownership Structure
    research summary posted October 29, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.06 Resignation Decisions, 13.0 Governance, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience 
    Title:
    Auditor Resignation and Firm Ownership Structure
    Practical Implications:

    The audit profession operates in a highly legal environment, and because of this, audit firms must find ways to manage their risk exposure. One way to reduce the risk of litigation against the firm is to manage the client portfolio and resigning from high risk clients. According to the study, family owned firms are less of a litigation risk to the auditor than non-family owned firms, especially when the CEO of the family-owned firm is not a family member. However, if an auditor does resign from auditing a family-owned firm managed by a non-family CEO, the investing public reacts less negatively to this than if the firm were not family owned.


    For more information on this study, please contact Samer K. Khalil.
     

    Citation:

    Khalil, S., J. Cohen, and G. Trompeter. Auditor resignation and firm ownership structure. Accounting Horizons 24 (4): 703-727.

    Keywords:
    family firms; auditor resignations; corporate governance; market reactions
    Purpose of the Study:

    In order to manage risk exposure, audit firms can choose to resign from high risk clients. Auditor resignations can bring very negative outcomes to the discharged client because of the audit search and startup costs incurred and the investors’ interpretation in the information signaled by the auditor resignation. This study investigates whether the likelihood of auditor resignations and the subsequent stock market reaction in family firms differs significantly from that in non-family firms. Additionally, this study examines whether the identity of the CEO that manages the family firms has an effect on the aforementioned associations. The identity of the CEO refers to whether the CEO is a founder, a descendant, or a non-family CEO.

    Design/Method/ Approach:

    The evidence for this study was gathered using auditor resignations reported on the Audit Analytics database in the U.S over five calendar years, 2004-2008. Sample firms were matched with control firms that did not switch their auditors using four different attributes: firm size, firm industry, auditor type, and auditor tenure to serve as one benchmark.  A random sample of control firms that did not switch their auditors and had publicly available data on their corporate governance was used as a second benchmark.

    Findings:
    • The primary findings of this study were that: 1) auditors of family firms are less likely to resign than those of non-family firms and that 2) auditor resignations are less likely to occur in family firms managed by a founder or non-family CEO. These imply that auditors appear to attribute lower litigation risk to family firms because the family’s concern to preserve their reputation and contribute family wealth to future generations reduces the risk of misappropriation of assets and/or earnings management.
    • Another primary finding was that abnormal return following auditor resignations in family firms are significantly less negative than those in non-family firms. Furthermore, the findings suggest that the investing public places a lower weight on the bad news associated with auditor resignation in family firms managed by a non-family CEO as opposed to non-family firms. The public’s reaction to a resignation did not vary based on whether a family firm was managed by a founder or descendant CEO.
    • Secondary finding indicate that the following variables also have an impact on auditor resignation:
      • Firm audit reports modified for going concern reasons
      • Firms that report weaknesses in internal control over financial reporting
      • Firms that report a loss in the year preceding auditor resignation
      • The presence of an auditor-client mismatch
      • Firms with large variance in abnormal returns
      • Firms with higher likelihoods of bankruptcy and acquisition
      • Corporate governance mechanisms such as number of audit committee meetings, percentage of financial experts serving on the audit committee, and one or more institutional block holders.
         
    Category:
    Client Acceptance and Continuance, Corporate Matters, Governance
    Sub-category:
    CEO Tenure & Experience, Resignation Decisions
  • 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
    CEO Financial Background and Audit Pricing
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience 
    Title:
    CEO Financial Background and Audit Pricing
    Practical Implications:

     The findings of this study suggest that the training and functional expertise of the CEO can affect the auditor’s perception of engagement risk, observed through a reduction in audit fees. They add to the growing literature of CEO characteristics which highlight how top managers influence firm outcomes.

    Citation:

     Kalelkar, R., S. Khan. 2016. CEO Financial Background and Audit Pricing. Accounting Horizons 30 (3): 325-339.

    Keywords:
    CEO financial expertise; audit fees
    Purpose of the Study:

     Theory suggests that the audit pricing decision is a function of a client’s audit risk and business risk. Recent literature has suggested that CEO characteristics can affect how auditor’s perceive the firm’s audit risk and the resulting audit pricing decision. This paper addresses how the financial expertise of Chief Executive Officer influences audit fees. The authors hypothesize that a CEO’s financial expertise can affect the level of audit fees through two channels:

    • Reducing the firm’s business risk through greater performance and profitability and

    • Reducing the firm’s audit risk by improving the quality of the firm’s financial reporting.

    Specifically, they suggest that a CEO’s financial expertise will lower both the firm’s audit risk and business risk resulting in lower audit effort and a corresponding reduction in audit fees.

    Design/Method/ Approach:

    The authors use a sample of firms with changes in CEO financial expertise between 2004 and 2013.  Specifically, they look at firms that switched from a CEO with financial expertise to a CEO with no financial expertise and vice versa, resulting in a sample of 77 firms and 81 changes in financial expertise.

     

    Alternatively, to address the unobservable characteristics of the firm which may influence both accounting outcomes and CEO selection, the authors utilize an instrumental variables two-stage model.  They use the local density of financial firms as an instrument for the financial expertise of the focal firm.  The location of the firm can influence the financial expertise of the board of directors.  When the board holds greater financial expertise this can limit the demand for a CEO with similar functional expertise within the firm.

    Findings:
    • The authors find that audit fees for firms with a financial expert CEO are lower by 8.5 percent, or $310,000.  The results are robust to controlling for CEO voluntary turnover, the simultaneous turnover of the CFO, firm fixed effects, as well as an instrumental variables approach.
    • Consistent with their predictions, results suggest that a CEO’s financial expertise results in lower audit fees, potentially due to decreased audit risk and lower audit effort.
    Category:
    Corporate Matters, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, CEO Tenure & Experience

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