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  • Jennifer M Mueller-Phillips
    Capital Market Consequences of Audit Partner Quality.
    research summary posted January 19, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Capital Market Consequences of Audit Partner Quality.
    Practical Implications:

    The study responds to the call for more academic research on the individuals that perform audits by examining a jurisdiction where audit partner identification is mandatory. Using the Taiwan market, the results show that engagement partner identification provides informational value to capital market participants. From a regulatory perspective, regulators believe that providing information that allows for investor evaluation of the audit partner’s past engagement performance is helpful for investment decision-making. This study provides support for the regulators’ views.

    Citation:

    Aobdia, D., C. Lin, and R. Petacchi. 2015. Capital Market Consequences of Audit Partner Quality. The Accounting Review 90 (6): 21432176.

    Keywords:
    individual auditors, audit quality, capital market consequences
    Purpose of the Study:

    This study examines whether disclosing audit partner names provides information to the capital markets incremental to the disclosure of audit firms. Prior audit literature has shown that the hiring of a high quality audit firm is a positive signal to investors about firm value. However, there is limited empirical evidence on the individuals performing the audit. The purpose of this study is to address this knowledge gap by assessing the informational value of audit partners in the capital markets. To assess informational value, the authors first determine the audit partner’s quality based on their client’s discretionary accruals. Using the assessed quality level, the authors evaluate the following questions:

    • Do capital markets respond positively to a switch from a low quality audit partner to a high quality audit partner?
    • Are earnings more informative when audited by a high quality audit partner?
    • Do firms audited by high quality audit partners have lower IPO underpricing and obtain better debt contracts?

    This study is the first large-sample study to address whether audit partners provide information to investors above their audit firm affiliation. This is of high importance because of recent regulatory proposals in the European Union and United States that call for audit partner disclosure. The results from this study provide an understanding of the consequences of audit partner quality and show how investors value differences in audit partner quality. In addition, the study also expands the audit quality literature by providing evidence at a level below the audit firm.  

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study. They obtain financial and audit-related data from the Taiwan Economic Journal (TEJ) for all public companies in Taiwan. The authors obtain audit partner changes, names of current and former partners, and other financial-related announcements from the Market Observation Post System (MOPS). The sample period is from 1995-2010. For the audit partner quality tests, the data is from the 1995-2005 period. For the capital market tests, the data is from the 2006-2010 period.

    Findings:
    • Audit partner quality is positively associated with earnings response coefficients indicating that investors perceive earnings as more informative when audited by a high quality audit partner.
    • In addition, capital markets react positively to a switch from a low quality engagement partner to a high quality engagement partner. A change to an audit partner with quality one quartile higher is associated with a positive abnormal returns of 0.7  1.2%.
    • Using the IPO setting, the authors find that firms going public experience lower IPO underpricing when audited by high quality audit partners.
    • In the debt setting, high quality audit partners contribute to reducing the information asymmetry between firms and their lenders. Firms audited by high quality engagement partners have debt contracts with lower interest rates, higher loan values, and fewer securitized collateral requirements.  
    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Audit Partner Identification by Name
  • The Auditing Section
    Client Importance, Institutional Improvements, and Audit...
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Client Importance, Institutional Improvements, and Audit Quality in China: An Office and Individual Auditor Level Analysis
    Practical Implications:

    This study uses engagement-level audit partner data, to analyze whether audit quality is driven by client importance at the office- or partner-level.  Overall, the results contribute to evidence showing that investor protection rules and laws at the country-level are associated with engagement-level audit quality.  This indicates the importance of strong investor protection regulations.  These results may be of interest to shareholders and securities market regulators, especially in developing economies, transitional economies, or economies where such regulations are weak.  Additionally, these results may be of interests to auditors in countries with such economies.  Finally, to the extent that audit firms serve clients with investors that receive varying levels of protection (i.e. public vs. private or a “well-known seasoned issuer”), these results may indicate opportunities for such firms to enhance audit requirements for certain non-public engagements. 

    The results of this study also suggest that audit accountability at the individual level makes auditors more sensitive to the costs of audit failure.  This result may have implications for auditor accountability from a regulatory standpoint, as well as an audit firm policy standpoint.

    Citation:

    Chen, S., S. Y. J. Sun, and D. Wu. 2010. Client Importance, Institutional Improvements, and Audit Quality in China: An Office and Individual Auditor Level Analysis. The Accounting Review 85 (1): 127-158.

    Keywords:
    international matters, audit quality, quality control, client importance, litigation, audit-reporting decision
    Purpose of the Study:

    This study addresses the broad question of whether the economic importance of a client impairs audit quality.  The authors use Chinese data to: 

    • Investigate whether institutional improvements in a country's investor protection environment affect engagement-level audit quality.
    • Examine the relationship between client economic importance to the individual auditor (individual engagement partners) and audit quality in China.
    Design/Method/ Approach:

    The authors use a sample of 8,917 client firm-year observations from 1995 to 2004 where 1995 to 2000 is the low investor protection period and 2001 to 2004 is the high investor protection environment following changes by the Chinese Supreme Court to heighten investor protection rules. Audit quality is measured using the probability of the auditor issuing a modified audit opinion.  Client importance is measured using the ratio of individual client assets to the total client assets audited at both the office level and partner level.

    Findings:
    • Client importance at the partner level impaired audit quality during a period when investor protection was weak (1995-2000).
    • Auditors appear to have become more conservative after improvements were made to investor protection rules and laws.  This is evidenced by a positive correlation between audit quality and client importance at the partner level from 2001-2004.
    • Client importance at the office level is not significantly associated with audit quality in either period (1995-2004).
    • Audits that received a sanction by the Chinese government as an audit failure were more likely to be for clients of high importance to the auditor in the pre 2001 period and were more likely to be for clients of low importance to the auditor in the post 2001 period.
    Category:
    Independence & Ethics, Accountants' Reporting, International Matters
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent, Going Concern Decisions, Going Concern Decisions, Audit Partner Identification by Name
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  • Jennifer M Mueller-Phillips
    Costs and Benefits of Requiring an Engagement Partner...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Costs and Benefits of Requiring an Engagement Partner Signature: Recent Experience in the United Kingdom
    Practical Implications:

    Requiring engagement partners to sign their names to audit reports appears to result in increased audit quality, earnings informativeness, and audit fees, suggesting that the signature requirement emphasizes personal accountability for engagement partners. Requiring the identification of engagement partners in audit reports would likely have similar effects. Thus, there are both costs and benefits that the PCAOB should consider in making its decision regarding partner identification.

    For more information on this study, please contact Chan Li: chanli@katz.pitt.edu.

    Citation:

    Carcello, J. V. and C. Li. 2013. Costs and benefits of requiring an engagement partner signature: Recent experience in the United Kingdom. The Accounting Review 88 (5): 1511-1546.

    Keywords:
    PCAOB; engagement partner signature; United Kingdom; audit quality; audit fees; costs and benefits.
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is considering requiring the identification of the engagement partner in audit reports. Proponents of the proposal argue that it will increase accountability and transparency, which will result in improved audit quality. Opponents argue that engagement partner identification is unnecessary, as audit firms’ quality control systems and the threats of sanctions by regulators and private litigation are sufficient to hold partners accountable. Identifying engagement partners is similar to them signing audit reports in their own name, which the U.K. began requiring in 2009. Because of the similarities between the U.K. and the U.S., it is likely that the effects of requiring engagement partner identification in the U.S. will be similar to the effects of requiring the engagement partner to sign the audit report in the U.K. Therefore, the authors investigate the benefits and costs of requiring partner signatures in the U.K. in the form of changes in audit quality and audit fees. The results are likely informative of the benefits and costs of requiring partner identification in the U.S.

    Design/Method/ Approach:

    Using publicly-disclosed data on companies listed on the London Stock Exchange (LSE) between 2008 and 2010 (the years surrounding the implementation of the signature requirement), the authors examine audit quality changes using the following measures:

    • Abnormal accruals
    • Likelihood of meeting earnings thresholds
    • Earnings informativeness
    • Likelihood of qualified opinions

    The authors also examine the change in audit fees following the implementation of the signature requirement.

    Findings:

    The authors find that following the implementation of the signature requirement, abnormal accruals and the likelihood of meeting earnings thresholds decrease in the U.K. These results suggest that audit clients’ earnings management declines due to the signature requirement. Further, the association between return on assets and stock market returns increases following the signature requirement, implying that reported earnings becomes more informative of firm value to investors following the implementation of the signature requirement. The likelihood of audit clients receiving a qualified audit opinion following the signature requirement also increases, suggesting that audit reporting becomes more conservative with the signature requirement. Finally, audit fees increase with signature requirement. Thus, signature requirement appears to result in higher fees for audit clients. These changes do not occur for U.S. firms or other European firms during the same period and do not occur for the U.K. in the period prior to the introduction of the signature requirement, providing evidence that the changes in the U.K. are the result of the signature requirement.

    Category:
    Accountants' Reporting, International Matters
    Sub-category:
    Audit Partner Identification by Name, Changes in Reporting Formats
  • Jennifer M Mueller-Phillips
    Discussion of “Does the Identity of Engagement Partners M...
    research summary posted January 20, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.03 Impact of New Accounting Pronouncements, 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Discussion of “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions”.
    Practical Implications:

    This discussion emphasizes significant caution when interpreting the results of the study. Mainly, it is unclear if results of the study can generalize to the broader public company market in the US. Furthermore, if the results are misinterpreted (i.e., individual auditors are not systematically aggressive but, instead, high quality auditors are systematically assigned the riskiest clients) then regulation requiring audit partner identification could actually have overall negative effects on overall audit quality.

    Citation:

    Kinney, W.R. 2015. Discussion of “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions”. Contemporary Accounting Research 32 (4):1479-1488.

    Keywords:
    auditor attributes, reporting style, auditor identification, audit quality, going concern opinion, Type I error, Type II error, credit risk, insolvency risks, statutory audits
    Purpose of the Study:

    The author reviews the paper's content, analyzes its predictive validity, and discusses its multiple implications. He provides constructive suggestions for improvements. Based on predictive validity analysis, the author concludes that engagement partner assignment strategy is an important and acknowledged omitted variable that affects the study's internal validity via both the independent variable (partner's prior performance measure) and the dependent variable (borrower's cost of debt capital). The omission also affects construct validities and, if audit firms are applying a plausible assignment strategy, then interpretation of the study's main results would be reversed. Finally, the lack of a standards intervention noted by the authors and the extreme size and other differences between audits of Swedish private companies and U.S. public companies impair external validity and generalization to the U.S. intervention.

    Design/Method/ Approach:

    This article is a discussion.

    Findings:

    The discussion emphasizes the following points:

    • KVZ (the reviewed paper’s authors Knechel, Vanstraelen and Zerni) main analyses are for statutory (not financial statement) audits of small, private, Swedish companies. Therefore, these results may have more limited generalizability. 
    • KVZ use publically available data for private companies without considering the significant amount of private information available to private lenders and audit firms.
    • KVZ acknowledge and cannot rule out a potential competing hypothesis whereby audit firms follow a “best partner to riskiest engagements” strategy. In this case, the highest quality partners may appear to have the most aggressive reporting strategy because that partner serves riskier clients with harder to predict bankruptcy risk. To confirm/disconfirm this competing hypothesis occurs, KVZ could ask audit firm management to describe their audit partner assignment strategies and rank a sample of partners accordingly. This information could be correlated with KVZ’s reporting style measures.    
    • Regulators, academics, and popular/business press articles may be similarly over-generalizing KVZ’s results. Furthermore, misinterpretation of results could have the ill-effects of high quality audit partners being assessed as low quality. This false characterization may lead high quality auditors to refuse to audit riskier clients where their skills are most needed. As such, any interpretations of KVZ’s results should proceed with much caution.
    Category:
    Accountants' Reporting, Audit Team Composition, International Matters, Standard Setting
    Sub-category:
    Audit Partner Identification by Name, Changes in Audit Standards, Diversity of Skill Sets (e.g. Tenure & Experience), Going Concern Decisions, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    Do Audit Clients Successfully Engage in Opinion Shopping?...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 15.0 International Matters, 15.01 Audit Partner Identification by Name, 15.03 Audit Partner Rotation 
    Title:
    Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence
    Practical Implications:

     These findings should be of interest to policy makers in China because, among other implications, the results suggest that Chinese regulators should pay attention to the switching of audit partners before they reach tenure limit for mandatory rotation. Partner-level opinion shopping could be more difficult to detect in markets in which the identity of the engagement partner is not disclosed, and it may therefore be prevalent in those markets, such as the United States.

    Citation:

     Chen, F., A. Peng, S. Xue, Z. Yang, and F. Ye. 2016. Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence. Journal of Accounting Research 54 (1): 79-112.

    Purpose of the Study:

    Opinion shopping refers to the practice by which audit clients seek alternative auditors willing to give a clean audit opinion when the incumbent auditor is likely to issue an unclean opinion. Existing studies examine whether companies successfully engage in opinion shopping through switching audit firms using data from such countries as China, the United Kingdom, and the United States. In this study, the authors examine evidence of switching audit partners within the same firm rather than switching to another firm for clean audit opinions, which they term “partner-level opinion shopping.” Statements from the PCAOB suggest that partner-level rotation shopping has become a regulatory concern and the regulators believe that this practice may be more prevalent if the names of engagement partners are not publicly disclosed; however, there is no empirical evidence on the existence and extent of partner-level opinion shopping to the best of the authors’ knowledge. Consequently, the authors attempt to fill this gap in the auditing literature by testing whether companies successfully engage in partner-level opinion shopping.

    Design/Method/ Approach:

    The authors decided to use data from China because engagement partners in China are required to sign the audit report, which enables the authors to identify partner switches before partners reach their mandatory rotation limit. The sample consists of observations from 1998 to 2012. They use an audit reporting model to determine a company’s probability of receiving a modified audit opinion (MAO) with and without a partner switch. 

    Findings:
    • The authors find consistent results for partner-level opinion shopping for both field partner and review partner switching.
    • The authors’ findings support the notion that partner-level opinion shopping is less likely to be successful for companies audited by firms organized as partnerships.
    • The authors find no evidence suggesting that outgoing audit partners are overly conservative compared with an average audit partner with an expected conservatism score of zero; the authors do not find evidence that incoming partners are less conservative than outgoing partners.
    • The authors find evidence that Chinese companies successfully engage in partner-level opinion shopping.
    • The authors find that the extent of success in opinion shopping is affected by client importance and the organizational forms of audit firms.
    • The authors’ results show that companies that successfully engage in opinion shopping report significantly lower-quality earnings, as indicated by higher discretionary accruals and a higher likelihood of reporting small profits.
    • The authors find direct evidence that incoming audit partners, for companies that obtain more favorable audit opinions after a partner switch, have a higher propensity to issue clean opinions than outgoing partners.
    Category:
    International Matters
    Sub-category:
    Audit Partner Identification by Name, Audit Partner Rotation
  • Jennifer M Mueller-Phillips
    Does Mandatory Rotation of Audit Partners Improve Audit...
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name, 15.03 Audit Partner Rotation 
    Title:
    Does Mandatory Rotation of Audit Partners Improve Audit Quality?
    Practical Implications:

    The authors contribute to the literature on mandatory partner rotation by showing that it has a beneficial impact on audit quality even in the absence of mandatory audit firm rotation. The findings are important given that many countries currently require partner rotation, but not audit firm rotation. The authors infer how mandatory rotation affects audit quality by examining the impact on audit adjustments. The authors contribute to the existing literature on the determinants of audit adjustments by showing that mandatory partner rotation increases the frequency of adjustments during the partner’s final year of tenure and during the replacement partner’s first year of tenure.

    Citation:

     Lennox, C. S., Wu, X., & Zhang, T. 2014. Does Mandatory Rotation of Audit Partners Improve Audit Quality? Accounting Review 89 (5): 1775-1803.

    Keywords:
    audit adjustment, audit partners, audit quality, mandatory rotation
    Purpose of the Study:

    Many jurisdictions impose limitations on the length of audit partner tenure, but they impose no limitations on the length of audit firm tenure. Despite the widespread prevalence of this practice, there is very little evidence on the consequences of mandatory partner rotation when audit firms do not have to be rotated. This is primarily because most countries do not require partners’ names to be disclosed and so researchers are unable to identify when partner rotation occurs.

    When only the audit partner is rotated and the audit firm remains the same, the audit methodology, procedures, and other engagement personnel do not necessarily change. Therefore, it is an open question whether mandatory partner rotation can really improve audit quality. This question is important because if mandatory partner rotation does not help to improve audit quality, then regulators are likely to call for alternative and more restrictive policies, such as mandatory rotation of the entire audit firm.

    The authors choose China as the empirical setting for two reasons. First, just as in the U.S., in China, the engagement and review partners have to be rotated every five years. Audit reports in China disclose the names of both partners. This allows the authors to identify cases in which one or both of the partners are switched due to the mandatory rotation requirements. Second, since 2006, audit firms in China must report the pre-audit annual profits of all publicly traded clients to the Ministry of Finance. The Ministry provided these proprietary data to the authors for the purposes of academic research.

    Design/Method/ Approach:

    The authors use a logistic model to test their hypotheses. The authors use a final sample of 6,341 company-year observations from the Inspection Bureau’s audit adjustments database for the period 20062010. All the partner rotations in the sample occur on audit firms’ continuing engagements.

    Findings:

    1) Audit adjustments occur more often when the engagement partner is scheduled for mandatory rotation at the end of the year. Consistent with a beneficial peer review effect, this suggests that the departing partner anticipates the arrival of a new partner in year t+1 and this motivates the departing partner to conduct a higher quality audit in year t.

    2) Audit adjustments occur more often during the incoming partner’s first year of tenure than in other years. This is consistent with mandatory rotation generating a fresh perspective, such that a newly appointed partner is more likely to detect and correct financial reporting problems during the first year of tenure.

    Overall, the results suggest that mandatory partner rotation has a beneficial effect in the partner’s final year of tenure before rotation occurs and in the subsequent year when the new partner is appointed. The results are found to be statistically significant for: (1) large and small adjustments, and (2) downward and upward adjustments. The results are statistically significant for engagement partners, but not for review partners, which makes sense given that the engagement partner has a more important role in the audit fieldwork.

    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Audit Partner Identification by Name, Audit Partner Rotation
  • Jennifer M Mueller-Phillips
    Does the Identity of Engagement Partners Matter? An Analysis...
    research summary posted January 20, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.03 Impact of New Accounting Pronouncements, 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions.
    Practical Implications:

    Auditor aggressive/conservative reporting style may be a systematic audit partner attribute and non-randomly distributed across engagements. Particular market participants (in this case, lenders) appear to recognize and price these differences in reporting style. While the particular mechanism through which these different reporting styles occur is not possible to determine, the results suggest the importance of individual audit partners in influencing audit reporting decisions. Therefore, current regulations in both the US and EU to identify the individual partner’s identity could potentially offer valuable information to market participants.

    Citation:

    Knechel, W. R., A. Vanstaelen, and M. Zerni. 2015. Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions. Contemporary Accounting Research 32 (4):1443-1478.

    Keywords:
    auditor attributes, reporting style, auditor identification, audit quality, going concern opinion, Type I error, Type II error, credit risk, insolvency risks, statutory audits
    Purpose of the Study:

    Current debate exists as to whether requiring individual auditor identification would enhance audit quality and, if so, whether investors understand and respond to these differences. This study provides empirical evidence to support the assertions that:

    1. Reporting style (i.e. consistently conservative or aggressive reporting) is an individual partner attribute that systematically differs between partners.  
    2. Investors understand and respond to these differences when assessing a company’s risk.

    This study is especially relevant given both the EU’s decade old requirement to disclosure of audit engagement partner and the recent, similar PCAOB requirement that US audit partners do the same.

    Design/Method/ Approach:

    The authors use archival methods. They acquired panel data between 2001  2008 of the total clienteles of individual Big 4 audit partners of statutory audits for small, private companies in Sweden. This excludes non-Big 4 auditors and joint auditors.

    Findings:

    In general, the frequency of Type I and II reporting errors is correlated over time for an individual partner both (1) across time for the same client and (2) between clients. As such, aggressive or conservative accounting appears to be a systematic partner attribute. Regarding investors, they appear to understand that partner reporting style is systematic across time and between clients and penalize firms audited by partners with a history of aggressive reporting via higher interest rates, lower credit ratings, and higher credit/insolvency risk. These results are, generally, economically significant.

    More specific results include:  

    • Predictive ability of both accruals and cash flows on future OCFs are lower when prior reporting errors of either Type have previously occurred.
    • Prior aggressive reporting results in lower persistence of current accrual estimates.  
    • Type I (Type II) reporting errors are negatively (positively) associated with abnormal accruals.
    • Conservative accrual reporting is positively (negatively) associated with Type I (Type II) reporting errors in all settings. Aggressive accrual reporting is positively (negatively) associated with Type II (Type I) reporting errors in low-risk settings.  
    • Clients of partners with aggressive reporting style have higher implicit interest rates, lower credit ratings, higher assessed insolvency risk, and lower Tobin’s Q. Conservative reporting styles has no effect on these credit measures.  
    • Past partner reporting style differentially affects market reaction to a new Going Concern Opinion.
    • Past partner Type II reporting errors has an economically marginally-significant effect on insolvency risk.
    Category:
    Accountants' Reporting, Audit Team Composition, International Matters, Standard Setting
    Sub-category:
    Audit Partner Identification by Name, Changes in Audit Standards, Diversity of Skill Sets (e.g. Tenure & Experience), Going Concern Decisions, Going Concern Decisions, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    Engagement partner identification: A theoretical analysis.
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Engagement partner identification: A theoretical analysis.
    Practical Implications:

    The conclusions in this paper are relevant to audit firms and audit partners, as both are directly affected by the PCAOB’s proposal to identify partners on the audit report. The paper models the impact of partner identification on the choices of partners on engagements with inconclusive audit evidence, showing that partners are more likely to make decisions that decrease firm profitability in order to reduce the risk of reputational damage. They suggest that this will be more detrimental to large audit firms since the difference between the partner’s share of firm risk and overall firm risk is greater relative to small firms.

    Citation:

    Carcello, J., and R. Santore. 2015. Engagement partner identification: A theoretical analysis. Accounting Horizons 29 (2): 297-311.

    Keywords:
    PCAOB, audit partner identification
    Purpose of the Study:

    The PCAOB has proposed regulation requiring disclosure of the audit engagement partner’s name within the audit report. This proposal has been met with much resistance from the audit community. The authors establish a model to determine the audit partner reaction to inconclusive evidence under each regime: no partner identification and partner identification. The authors aim to determine which partythe firm or the partnerbears the risk associated with the audit report for an inconclusive set of audit evidence and, in doing so, identify if requiring the partner signature incentivizes the partner to act in a manner inconsistent with the firm’s incentives. The authors also address how this misalignment of incentives differs for small and large audit firms.

    Design/Method/ Approach:

    The authors develop an analytical model, which abstracts away from actual data. The model predicts aggressive/conservative reporting decisions of the partner when audit evidence is inconclusive and accounts for the influence of:

    • Number of partners
    • Partner’s share of the firm and salary
    • Partner’s portfolio revenue
    • Quality of the financial statements
    • Cost of conducting additional audit work
    • Non-audit fees
    • Firm and Partner reputation damages, including litigation risk
    Findings:

    The reporting decision for an audit partner on an audit with inconclusive audit evidence is shown to be influenced by requiring partner identification. This occurs as identification creates a risk of reputational damage to the partner, adding to the partner’s consequences of lost future fees and share of litigation risk which exist absent partner identification. The authors show that audit firm profitability is decreased as partners make decisions to reduce their own reputational damage at the cost of increased costs to the firm, even when extra audit effort may not be merited. They also show that larger firms are more likely to be affected by partner identification since partners have a smaller relative ownership stake in large firms and therefore more readily act against the best interest of the firm (on the other extreme, a sole practitioner will always act in the best interest of the firm since there is no difference between her incentives and the firm’s incentives).

    Category:
    International Matters, Standard Setting
    Sub-category:
    Audit Partner Identification by Name, Impact of PCAOB
  • Jennifer M Mueller-Phillips
    Fee Discounting and Audit Quality Following Audit Firm and...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence.
    Practical Implications:

    The study results are important to regulators and audit practitioners as they show the consequences of initial year audit fee low-balling on the performance of the audit. Lower audit quality occurs when an audit firm change includes a change to both audit partners along with a reduction in audit fees. This indicates that retaining one or both of the former audit partners in the new audit firm can offset the reduced audit quality effect in the initial years of the audit engagement. 

    Citation:

    Huang, H.-W., K. Raghunandan, T.-C. Huang, and J.-R. Chiou. 2015. Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence. The Accounting Review 90 (4): 15171546.

    Keywords:
    audit fees, auditor changes, audit quality
    Purpose of the Study:

    Global regulators have voiced concerns regarding the low-balling of initial audit fees and the effect on audit quality. Although prior studies in the United States provide evidence of the low-balling effect, the emergence of China as a global economic power provides motivation to examine the low-balling effect in the Chinese audit market. In addition, there is limited evidence on the audit quality effects of low-balling the initial audit fee.  

    This paper addresses whether: 1) the low-balling of initial audit fees occurs in China; 2) there is an association between the low-balling of initial audit fees and the type of audit partner change related to an audit firm change; and 3) the reduction of the initial audit fees influences low quality audits.

    The Chinese audit market expanded in the late 1990s primarily through mergers. In some cases, audit partners changed firms but retained their audit client base. With the public disclosure of audit partner names in China, the authors can determine if the audit firm change results in an audit partner change.  For this study, a normal audit firm change occurs when both of the audit partners are new to the audit engagement. For this normal change, the authors expect a higher instance of low-balling of initial year audit fees. Alternatively, if one or both of the audit partners continue on the audit engagement after an audit firm change, the authors expect a reduced low-balling effect.

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study. They obtain audit fees, financial data, return data, and corporate governance information from the China Center for Economic Research (CCER) database. Audit partner and audit firm information is from the Taiwan Economic Journal (TEJ) database. The sample period is from 2002-2012. All data is for clients listed on the Shanghai and Shenzhen stock exchanges.

    Findings:
    • The authors find evidence of the low-balling of initial audit fees in the Chinese audit market. Specifically, they show the greatest reduction in initial audit fees when the audit client engages a new firm and both of the audit partners are new to the engagement. Using an audit fee changes model, the initial audit fee discount is approximately 4% when both audit partners are new to the client. 
    • When evaluating audit quality, the authors find that audit sanctions from the Chinese regulator are more likely when there is an audit firm change with two new audit partners and an initial audit fee discount. Using discretionary accruals, they find consistent results with the sanctions results of lower audit quality. Using modified audit opinions, the results provide weaker evidence of lower audit quality than when using sanctions or discretionary accruals. 
    • The authors noted no evidence that audit partner changes, without a related audit firm change, result in lower audit quality.
    • Interestingly, the authors find that initial audit fee reductions become smaller over time and the association between fee reductions and lower audit quality is insignificant after the first two years of the audit.   
    Category:
    Audit Quality & Quality Control, Independence & Ethics, International Matters
    Sub-category:
    Audit Partner Identification by Name, Impact of Fees on Decisions by Auditors & Management
  • Jennifer M Mueller-Phillips
    The Association between Audit-Partner Quality and Engagement...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.02 Engagement Quality Review – Processes and Effectiveness, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    The Association between Audit-Partner Quality and Engagement Quality: Evidence from Financial Report Misstatements
    Practical Implications:

     This study provides useful insights into how audit-partner quality affects engagement-level quality and underscores the importance of audit-partner identification; furthermore, this study could lead to future research which can explore whether audit-partner quality affects the cost of equity and debt capital above and beyond audit-firm and audit-client characteristics with the hopes of deepening the understanding of auditor performance and the market perception of auditor reputation at the audit-partner level.

    Citation:

    Wang, Yanyan, Lisheng Yu, and Yuping Zhao. 2015. The Association between Audit-Partner Quality and Engagement Quality: Evidence from Financial Report Misstatements. Auditing: A Journal of Practice and Theory 34 (3): 81-111.

    Keywords:
    Audit-partner quality, audit failure rate, audit quality control, restatements
    Purpose of the Study:

    This paper attempts to address two specific research questions in this paper:

     

    • Does audit-partner quality affect engagement-level audit quality?
    • How do engagement-team-level and audit-firm-level quality reviews moderate the influence of audit-partner on engagement-level quality?

    Most of the research that has been done on this subject focuses on firm-level or office-level audit quality; however, it is the opinion of the authors that both firm-level and office-level audit quality is driven by the quality of the engagements supervised by individual audit partners.  As a result, the authors decided to investigate just how integral of a role audit partners actually play in the engagement quality equation.  This research is especially interesting for the following reasons:

     

    • The complex nature of auditing implies that it is a judgment and decision-making process which is heavily affected by the characteristics of the person making the decisions.
    • Some insight will be shared on the current debate regarding mandatory disclosure of the engagement partner in the audit report.
    Design/Method/ Approach:

               The authors collected their evidence by merging data from the following sources for the period 2004-2009:

     

    • All available firm-year observations from the China Stock Market and Accounting Research database (CSMAR), which included financial and stock market data, audit opinions, and names of audit firms
    • All identities of the signing audit partners, obtained from CSMAR
    • All restatement announcements collected from annual report disclosures
    Findings:
    • The authors find that the probability of future restatements is higher for annual reports audited by audit partners with higher past-audit failure rates.
    • The authors find that engagement partners who actually conduct the audit have significantly greater influence on future restatement probability than review partners
    • The authors find that clients audited by high-quality audit firms are less likely to restate; however, older firms and firms with higher book-to-market ratio are more likely to restate current year annual reports.
    • The authors find that audit-firm-level quality control slightly attenuates the influence of review partners, but no quality control effectively weakens the influence of engagement partners.  Given that engagement partners play much more of a ro0le in the audit than the review partners, the findings fail to substantiate the mitigating effects of quality control.
    • The authors find that economic incentives amplify engagement partner’s influence on audit quality.
    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Audit Partner Identification by Name, Engagement Quality Review – Processes & Effectiveness

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