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    How Do Regulatory Reforms to Enhance Auditor Independence...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.07 Audit Firm Rotation, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
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    Title:
    How Do Regulatory Reforms to Enhance Auditor Independence Work in Practice?
    Practical Implications:

    This study sheds light on what underlies decision making in the imperative audit committee responsibility of auditor appointment: nuanced interactions and power asymmetry among management, the audit committee, and auditors. The auditors viewed the CFO as the client and tailored the proposal accordingly. The audit committee will not be effective unless both auditors and audit committee members fundamentally change their mindsets about their respective roles in relation to client management. As large public companies employ multiple Big 4 firm, the viability of severing existing relationships to bring in a truly independent auditor mindset through audit firm rotation is questionable.

    Citation:

    Fiolleau, K., Hoang, K., Jamal, K., & Sunder, S. 2013. How Do Regulatory Reforms to Enhance Auditor Independence Work in Practice? Contemporary Accounting Research 30 (3): 864-890.

    Keywords:
    audit committees, reforms, auditor independence, audit firm rotation, independence
    Purpose of the Study:

    This article presents a study on regulatory reforms that aim to enhance auditor independence work. In order to achieve the right balance between the auditors serving commercial versus professional interests, regulators implemented a set of alternative remedies that include mandatory audit partner rotation and enhanced audit committee responsibilities, expertise and independence. As of September 2013, regulators based in Europe and the U.S. are considering to extend rotation requirement to encompass audit firm rotation rather than partner rotation. In this paper, the authors conduct a field study to investigate how regulatory reforms designed to promote auditor independence (specifically audit committee reforms and proposed audit firm rotation requirements) may actually work in the context of auditor change. This study of auditor change also yields insights into the potential consequences of increasing the frequency of auditorclient courtships through mandatory audit firm rotation, which has recently been proposed by regulators as a way of reinforcing auditor independence. The underlying premise is that audit quality would be enhanced by weakening the economic and relationship bonds between auditors and their clients. The authors investigate how the audit committee interprets and executes its legislative mandate in appointing an independent external auditor.

    Design/Method/ Approach:

    The authors collected data six months after the company’s RFP process and new auditor appointment. The authors obtained a copy of the company’s RFP document from the CFO, and copies of the bid documents directly from all Big 4 audit firms who bid for this audit. They interviewed the company’s CFO and the chair of the audit committee. The authors interviewed each of the four proposed engagement audit partners for 60-90 minutes.

    Findings:
    • Management controlled access to documents and people, and played a powerful role in making the auditor appointment decision.
    • Management engaged the audit firm that offered the least senior level expertise and the lowest fee.
    • The audit committee adopted management’s priorities in encouraging prospective auditors to demonstrate responsiveness to management.
    • Prospective auditors were reticent to probe the client for information that would have helped them identify risks before accepting the engagement.
    • The auditors were focused on winning the client and were willing to cut fees, move partners to the client’s head office city, and curtail quality control.
    • If management, with private information and interests, continues to have substantial influence over hiring the auditor, then regulatory reforms for audit firm rotation and/or audit committee empowerment are likely to be ineffective.
    • Auditor change puts pressure on audit fees, and requires auditors to demonstrate commitment and responsiveness to the management of both prospective clients and current ones used as referees.
    • Instead of strengthening independence and providing a fresh auditor perspective, the authors find that the auditor change process is dominated by management and is characterized by gestures from prospective auditors to win client favor during the courtship, potentially rendering proposed audit firm rotation ineffective.
    Category:
    Corporate Matters, Independence & Ethics
    Sub-category:
    Audit Committee Effectiveness, Audit Firm Rotation, Audit Firm Rotation, Impact of Fees on Decisions by Auditors & Management