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    The Effect of Lame Duck Auditors on Management Discretion:...
    research summary posted August 30, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 14.0 Corporate Matters, 14.01 Earnings Management 
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    Title:
    The Effect of Lame Duck Auditors on Management Discretion: An Empirical Analysis
    Practical Implications:

    These results should be of specific interest to regulators who have proposed rules to increase the accountability of auditors by more clearly aligning their reputations with assurance quality, as well as to regulators who have expressed concerns that pressures associated with future audit fee dependence could influence the extent to which auditors behave independently. This study is not meant to be used to influence discussion surrounding mandatory audit firm rotation, as the study focused on voluntary, not mandatory, terminations of the audit-client relationship.

    Citation:

    Cassell, C., L. Myers, T. Seidel, and J. Zhou. 2016. The Effect of Lame Duck Auditors on Management Discretion: An Empirical Analysis. Auditing: A Journal of Practice and Theory 35 (3): 51-73.

    Keywords:
    auditor independence, earnings management, discretionary accruals, management discretion, and mandatory audit rotation
    Purpose of the Study:

    This study focuses on the unique situation in which the auditor-client bond is severed for future reporting periods but continues for the current reporting period. The authors label the auditors in this situation “lame duck auditors,” borrowing the expression from the political realm. In the context of politics, lame duck politicians frequently act with greater freedom because they are not concerned about how their actions will affect their chances of re-election. This could mean a politician would vote for measures that are better for his constituents no matter the consequences, or he could more easily succumb to pressures from outside influences like lobbyists. Just like in the political setting, the term “lame duck”” should not necessarily convey a negative connotation; the term simply refers to a situation that could alter an auditor’s responsibilities and incentive structures, which could lead to a change in behavior. The authors believe that financial reporting quality is higher in lame duck situations and completed this study to test that hypothesis. 

    Design/Method/ Approach:

    The authors use data from 2000-2010 and focus their investigation on the effect of lame duck auditors on the quality of the quarterly financial statements. Interim quarterly reporting is the primary focus because it allows the authors to focus on the effect of reputation concerns rather than litigation risk.

    Findings:
    • The authors find that auditor independence and/or reputation concerns are strengthened in lame duck situations because financial reporting quality is higher when a lame duck auditor performs the quality review.
    • The authors find that lame duck auditors are more likely among older companies, accelerated filers, companies with a material weakness in internal control, and companies announcing a restatement during the current or prior year.
    • The authors find that lame duck auditors are less likely among larger companies, companies audited by a Big N auditor, and companies with higher leverage and higher revenue volatility.
    • The authors’ findings verify that the main results of the study are not attributable to systematic differences between lame duck and non-lame duck auditor observations. 
    • The authors’ findings suggest that creating more uncertainty regarding the present value of expected future cash flows or increasing potential reputational concerns has the potential to improve assurance quality.
    Category:
    Corporate Matters, Independence & Ethics
    Sub-category:
    Audit Firm Rotation, Earnings Management