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    Threats to Auditor Independence: The Impact of Relationship...
    research summary posted December 3, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
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    Title:
    Threats to Auditor Independence: The Impact of Relationship and Economic Bonds
    Practical Implications:

    The results of the study suggest that establishing close auditor-client relationships can reward audit firms with higher NAS revenues from clients. In particular, longer audit firm tenure and audit firm alumni directors benefit the audit firms with higher NAS provision. This indicates that a successful strategy for audit firms may be to develop long-term associations with clients at the firm level (rather than at the partner level) and to establish active alumni networks. At the same time audit firms should ensure that adequate procedures are in place to ensure that appropriate audit reports are issued, most particularly when strong auditor-client relationships are present.

    For more information on this study, please contact Elizabeth Carson.

    Citation:

    Ye, P., E. Carson, and R. Simnett. 2011. Threats to auditor independence: The impact of relationship and economic bonds. Auditing: A Journal of Practice & Theory 30 (1): 121-148.

    Keywords:
    Independence and ethics; non-audit services; going concern decisions; alumni
    Purpose of the Study:

    Auditor independence is the foundation of high quality audit services and a crucial component in the statutory corporate reporting process. The cases of high-profile corporate failure associated with auditing scandals in early 2000s have cast doubts over auditor independence and the value of auditing. Most regulatory concerns regarding auditor independence have centered on three alleged independence threats:

    • Auditor’s economic dependence on the client due to the provision of non-audit services (NAS)
    • Auditor’s familiarity with the client due to lengthy audit tenure
    • The personal relationships between the audit engagement partner and client’s directors

    Relevant regulatory reforms have taken place in both the U.S. (SOX, 2002) and Australia (CLERP 9, 2004) to mitigate such concerns. However, empirical evidence only provides limited support to the regulations, and two fundamental questions underlying the independence issue remain unanswered:

    • What factors influence a company’s decision to purchase NAS from its incumbent auditor?
    • How do the economic and social bonds between auditors and clients affect auditor independence?

    This paper addresses the questions to inform regulation by examining:

    • Whether client’s NAS purchase from the incumbent auditor is affected by four identified auditor-client relationships: (1) audit firm tenure, (2) audit partner tenure, (3) relationship tenure (ongoing personal interactions between audit engagement partner and client’s director), and (4) client’s director being an alumnus of the audit firm. 
    • Whether auditor’s propensity to issue a going-concern opinion (as the manifestation of auditor independence) is affected by the provision of NAS and the four identified auditor-client relationships.
    Design/Method/ Approach:

    The study uses 2002 Australian data on publicly-traded companies. 2002 is chosen as a period when the audit environment was still relatively unregulated. Data was hand-collected from companies’ annual reports. The impacts of various factors on auditor independence are examined using statistical analysis.

    Findings:

    The study finds:

    • Some evidence that increased audit firm tenure and the presence of directors with alumni connections to the incumbent audit firm is associated with an increased likelihood of clients’ NAS purchase from the incumbent audit firm. Such impact is stronger in companies with lower leverage and higher ownership concentration.
    • No evidence that audit partner tenure or relationship tenure (between audit partner and client director) impacts client’s NAS purchasing decisions.
    • Evidence that higher levels of NAS provision and longer audit partner tenure are associated with a lower propensity in auditor’s issuance of going-concern opinions.
    • No evidence that audit firm tenure, relationship tenure or the presence of client director’s alumnus status impacts on auditor’s propensity to issue going-concern opinions.
    • Evidence that auditors are less likely to issue a going-concern opinion when there is a high-level NAS provision to the client and the client has an incumbent audit firm alumni director.
    Category:
    Auditor Judgment, Independence & Ethics
    Sub-category:
    Going Concern Decisions, Non-audit Services