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    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 
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    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