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  • Jennifer M Mueller-Phillips
    Hybridized professional groups and institutional work: COSO...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Hybridized professional groups and institutional work: COSO and the rise of enterprise risk management
    Practical Implications:

    The results of this study provide insights into the rise of COSO’s ERM framework.  More broadly, it highlights key features that enabled the ERM framework to successfully diffuse internationally.

    Practitioners looking to “popularize” an idea or new business tool in their organization might benefit by considering a wide variety of activities to (1) disrupt the use of existing organizational practices; (2) create (or adopt) a tool with characteristics that are more likely to pique organizational members’ interest and encourage their actual use of the tool; and (3) maintain and provide guidance to address problem areas that might affect adoption.  The use of groups that span multiple functional domains – either within an organization or beyond an organization’s boundaries – might also be strategically used to further the creation, adoption and implementation of ideas and business tools in an organization.

    For more information on this study, please contact Christie Hayne.

    Citation:

    Hayne, C. and C. Free. 2014. Hybridized professional groups and institutional work:  COSO and the rise of enterprise risk management. Accounting, Organizations and Society 39 (5): 309-330.

    Keywords:
    Risk management; COSO; Hybridized professional groups; Diffusion; Institutional work
    Purpose of the Study:

    In 2004, the Committee of Sponsoring Organizations (COSO) released a framework purporting to help organizations manage risk (titled “Enterprise Risk Management – Integrated Framework”). The purpose of this study is to understand how and why COSO’s framework emerged as the dominant standard in the field.  Not only has COSO’s enterprise risk management (ERM) framework been criticized for being especially challenging for organizations to successfully implement but it has also been seen to be not markedly different from other competing frameworks. Despite this, COSO’s ERM framework has been consistently named as a world-level template for best practice and thus has received attention from organizations across the world.

    This study is important because though a significant collection of research has examined the diffusion of important management tools, it has focused on the features of the tool or the characteristics of adopting organizations to explain their dominance.  Instead, we focus on an under-explored perspective by examining the “supply side” such that COSO (which we conceive of as a hybridized professional group) performed a number of activities (what we call institutional work) to create, distribute and promote their ERM framework. 

    Design/Method/ Approach:

    Between May 2010 and September 2012, the authors conducted field research by interviewing key individuals holding authorship, guidance or oversight roles throughout the creation of COSO’s Enterprise Risk Management – Integrated Framework.  Many of the interview participants had prior or current relationships with COSO, but some individuals had no formal connections to COSO and were instead drawn from industry and/or practice.  The authors consulted a variety of COSO’s “thought papers” and guidance including the Enterprise Risk Management – Integrated Framework, Internal Control – Integrated Framework and more recent ERM-related guidance.  The authors also reviewed four practitioner focused magazines in order to trace and understand the growing prevalence of key risk terminology.

    Findings:
    • The authors find that COSO employed a comprehensive collection of political, cultural and technical activities to facilitate the diffusion of their ERM framework. This institutional work included activities such as (1) highlighting deficiencies in organizations’ existing ways of mitigating risk, (2) designing a risk framework with the same look and feel of COSO’s previously successful internal control framework, (3) designing an abstract and flexible framework that would appear relevant to a wide group of potential adopters, (4) leveraging a large network of supporters through the five professional accounting bodies associated with COSO, and (5) continuing to develop accessible how-to guides and conducting other promotional activities aimed at generating mass market awareness. Indeed, the popularization of COSO’s ERM framework is explained through varied and overlapping types of institutional work.
    • Unlike other management tools that are created by one group of individuals and then popularized by another, the authors identify COSO as a unique group that was able to traverse both the creation and dissemination role.  Presented as a “hybridized professional group”, COSO brought together consultants that understood organizations’ challenges with risk management, university professors that were familiar with emerging research, and members from industry that spoke to the needs and preferences of key corporates. COSO’s composition not only benefited from members drawn from diverse industries but they also held a range of job positions and functional expertise (e.g., internal control, risk, financial management).
    Category:
    Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Cost of Equity Capital
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 05.0 Audit Team Composition, 05.03 Partner Rotation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Partner Tenure and Cost of Equity Capital
    Practical Implications:

    Prior research suggests that the length of auditor-client relationship affects audit quality, and, therefore, the integrity and information risk associated with a clients’ financial reporting. This study attempts to examine the effects of audit engagement partner tenure and rotation on investors’ perceptions. The results of this study raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner’s identity or pay attention to audit partner tenure. If investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure.  

    Citation:

    Azizkhani, M., G. S. Monroe, and G. Shailer. 2013. Audit Partner Tenure and Cost of Equity Capital. Auditing 32 (1).

    Keywords:
    audit partner rotation; audit partner tenure; cost of capital; financial reporting credibility
    Purpose of the Study:

    Recent proposals by the PCAOB suggest that audit firms should be required to identify the name of the engagement partner in the audit report. The proposals suggest that this provides useful information to investors by allowing investors to identify audit partner tenure and rotation. Professional accounting bodies and regulators have long been concerned that long auditor-client relationships impair audit quality. The PCAOB, however, has noted that other commenters do not believe disclosure of partner identity will provide meaningful information to investors. This study investigates the usefulness of disclosing partner identity by exploring whether audit partner tenure and partner rotation are informative to investors, as indicated by the ex ante cost of equity capital.

    Design/Method/ Approach:

    The authors tested the relationship between client-specific ex ante cost of equity capital and audit partner tenure using two models. The client-specific ex ante cost of equity capital was estimated using the price-earnings ratio divided by the short-term earnings growth rate. Auditor tenure was tested using raw, long transform, and quadratic terms. The authors also used two-stage regressions to address the potential for Big 4 selection bias. The sample was selected for all Australian-domiciled companies listed on the Australian Stock Exchange during the 1995-2005 time period. 

    Findings:
    • Partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements.
    • Imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor.
    • Partner rotation is associated with increased ex ante cost of equity capital.  
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Changes in Audit Standards, Partner Rotation
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  • Jennifer M Mueller-Phillips
    Does Mandatory IFRS Adoption Improve the Information...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Does Mandatory IFRS Adoption Improve the Information Environment?
    Practical Implications:

    The results of this study have important implications for the debate on the globalization of accounting standards and for regulators that are considering a transition towards IFRS. Although the effects of IFRS adoption are not homogenous for all firms, the adoption of one set of accounting standards is likely to generate both information and comparability effects and improve the quality of information intermediation in capital markets.

    For more information on this study, please contact Joanne Horton.
     

    Citation:

    Horton, J., G. Serafeim, and I. Serafeim. 2013. Does Mandatory IFRS Adoption Improve the Information Environment? Contemporary Accounting Research 30 (1).

    Keywords:
    international financial reporting standards; impact analysis; earnings forecasting; quality.
    Purpose of the Study:

    With over 120 countries requiring or permitting the use of IFRS by publicly listed companies, the idea of pushing for mandatory IFRS adoption has become a popular topic. Mandatory IFRS adoption has the potential to improve worldwide financial reporting quality and contribute to better functioning capital markets. Potential benefits includes facilitating cross-border comparability, increase reporting transparency, decreasing information costs, and improving the efficiency of the markets. The idea relies on the presumption that mandatory IFRS adoption provides superior information to market participants and/or increased accounting comparability compared to previous accounting regimes. This study examines whether such a global transition towards a single set of accounting standards has been met by these presumed benefits. Based on prior research the authors derived these three hypotheses to test:

    1.    Mandatory IFRS adoption provides comparability benefits and as a result affects analyst earnings forecast accuracy for firms adopting IFRS mandatorily.
    2.    Mandatory IFRS adoption provides information quality benefits and as a result affects analyst earnings forecast accuracy for firms adopting IFRS mandatorily.
    3.    The increase in forecast accuracy following mandatory IFRS is associated with increased opportunities for firms to manage earnings towards a target.
     

    Design/Method/ Approach:

    To test the three hypotheses above, the authors first needed to verify that adoption of IFRS improves the information environment for the firms in the sample. Specifically, the authors tested for difference in forecast errors before and after mandatory IFRS compliance for nonadaptors, mandatory adaptors, and voluntary adaptors. To test for the effect of IFRS adoption, several models were developed to analyze firm data and forecasting information. Other analysis is conducted to determine whether improvements in information environment could be driven by factors outside of IFRS adoption.   

    Findings:
    • The information environment improves for mandatory adopters.
    • The larger the difference between IFRS earnings and local GAAP earnings the larger is the improvement in the information environment.
    • Forecast accuracy improves more for analyst-firm pairs that are affected by either information or comparability benefits.
    • There is no evidence suggesting that the increase in forecast accuracy is driven by earnings manipulation.
       
    Category:
    International Matters, Standard Setting
    Sub-category:
    Changes in Audit Standards, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    An Examination of the Credence Attributes of an Audit
    research summary posted October 15, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    An Examination of the Credence Attributes of an Audit
    Practical Implications:

    At its core, the theory proposed by the authors assumes that auditors are economic agents who provide a valuable service and can be expected to behave rationally to maximize their profits. Strategic behaviors such as under-auditing, over-auditing, or overbilling would be unobservable by an auditee in many instances. The possibility of such behaviors has important implications for the level of assurance over financial reports and can potentially affect the efficient allocation of capital resources. One of the goals of this study was to analyze how the credence aspect of audits could influence important policy decisions. Regulation may play a powerful role in mitigating the credence nature of auditing, e.g., PCAOB inspections. However, regulation can be a double-edged sword if it increases the incentive or opportunity for auditors to behave strategically. Therefore, auditors can take the theories and models presented in this study to evaluate their firms for potential profit maximizing biases that may negatively impact audit quality and efficiency. Policy makers could also use these theories and models to evaluate how new auditing policies might influence auditors’ incentives and behaviors.

    For more information on this study, please contact W. Robert Knechel.
     

    Citation:

    Causholli, M., and W. R. Knechel. 2012. An Examination of the Credence Attributes of an Audit. Accounting Horizons 26(4): 631-656.

    Keywords:
    Credence attributes; audit quality; audit efficiency.
    Purpose of the Study:

    The purpose of this study was to expand the understanding of the economics of auditing and audit markets by using the theory of credence goods as the basis for explaining auditors’ incentives. The idea of a credence good or service is that (1) the seller of the good or service is an expert who both recommends and provides a level of service to the buyer; (2) buyers of credence goods or services cannot assess how a service is a delivered and must rely on a seller’s recommendation; and (3) buyers cannot assess how well the service was performed. The authors suggest that the external audit is a credence good which provides auditors with incentives to under-audit, over-audit or overcharge their clients.

    Design/Method/ Approach:

    The authors take a purely theoretical approach to study the perspective of an audit as a credence good. The authors rely on prior research of credence goods and on the principles of Game Theory to help explain auditors’ incentives to under-audit, over-audit or overcharge clients and predict auditors’ behaviors under certain scenarios. The authors use theoretical decision trees to describe an auditor’s possible strategies for bidding for an audit, and for executing the audit. The authors also describe examples of prior auditing research that present results that support the author’s credence theory.

    Findings:

        The authors propose that if an audit is a credence good, the auditee cannot determine any of the levels of audit effort that define the auditor’s decisions. This creates information asymmetry between the auditor and auditee both before and after the audit because the auditee cannot be sure of the true level of assurance that is necessary before the audit, and the auditee cannot be sure of the true level of assurance that is gained as a consequence of the audit. The information asymmetry goes in favor of the auditor, who can act strategically to under-audit and earn greater profits because the auditee has imperfect information about the auditor’s work and the level of assurance gained by the auditor’s efforts.

     The authors also propose that there are disciplining mechanisms in the market for audit services that are in place to mitigate an auditor’s incentive to behave strategically such as an auditee’s direct knowledge, audit firm reputation and size, professional regulation, legal liability, and competition between audit firms. However, while these mechanisms may be in place, an auditor facing low penalties or risk of detection may be more likely to consider strategic actions. In environments with weak courts or regulation, auditors have more incentives to act strategically and expect to reap superior profits as a result. Similarly, changes in regulations or other structural changes in the audit market can induce changes in the incentives for auditors to behave strategically. Overall, disciplining mechanisms facilitate the operation of audit markets even though they may not completely resolve the information (credence) problem.
     

    Category:
    Audit Quality & Quality Control, Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    The Impact of PCAOB Auditing Standard No. 5 on Audit Fees...
    research summary posted October 3, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of PCAOB Auditing Standard No. 5 on Audit Fees and Audit Quality
    Practical Implications:

    This study provides an analysis of the effect of PCAOB Auditing Standard No. 5 (AS5) on internal control audit efficiency. The authors interpret their results as indicating that AS5 improved internal control audit efficiency by reducing audit fees without harming audit quality. The results of this study provide insight into the consequences of PCAOB standard setting, which is of interest to standard setters and businesses subject to their rules.


    For more information on this study, please contact Dechun Wang.
     

    Citation:

    Wang, D. and J. Zhou. 2012. The Impact of PCAOB Auditing Standard No. 5 on Audit Fees and Audit Quality. Accounting Horizons 26 (3): 493-511.

    Keywords:
    PCAOB Auditing Standard No. 5, audit fee, audit quality, internal control.
    Purpose of the Study:

    Due to strong complaints to the SEC and PCAOB about high audit costs associated with PCAOB Auditing Standard No. 2 (AS2) which governed internal controls audits, the PCAOB amended AS2 and proposed Auditing Standard No. 5 (AS5) in 2007. AS5 was aimed at reducing unnecessary costs and providing a more efficient audit of internal controls. It provides auditors a “top-down, risk-based” approach which allows them to tailor the audit to client size, complexity and specific critical risk areas. Furthermore, it provides auditors more flexibility in relying on the work of management and internal auditors.
        This study’s aim is to understand whether the PCAOB has accomplished its goal of making internal audits more efficient. The authors make a point to say that this requires not only audit fee reduction but also no drop in audit quality. The authors make and test the following hypotheses:

    H1: Audit fees are significantly lower after the adoption of AS5 for accelerated filers, but not non-accelerated filers (Note: AS5 does not apply to non-accelerated filers because the requirement of an audit of internal controls for these firms was initially deferred and eventually exempted by the Dodd-Frank Act of 2010)

    H2: Ceterus Paribus, audit quality does not change after the adoption of AS5
     

    Design/Method/ Approach:

    The authors utilize data on public companies around the 2007 implementation of AS5. They classify accelerated filers that had FYEs between November 15, 2007 (the AS5 implementation date) and November 14, 2008 as AS5 firms. They compare changes in audit fees for these firms to changes in audit fees in the previous year. They then compare changes in audit fees for AS5 firms to changes in audit fees for firms not subject to AS5 during the same period (non-accelerated filers). Finally they compare audit quality for AS5 firms in the year after AS5 implementation to the year immediately preceding AS5 implementation.

    Findings:
    • The authors provide evidence of a decrease in audit fees for the AS5 sample while audit fees increased for the pre-AS5 sample and the contemporaneous non-accelerated filing sample. 
    • The authors do not find a significant change in audit quality for the AS5 sample. This failure to find a significant result is robust to different measures of audit quality (Abnormal accruals, meeting or beating earnings forecasts and the probability of issuing an internal control weakness opinion).

    Taken together, the authors claim that these results are indicative of AS5 providing more efficient audits of internal controls. They argue that this result is confirmation that AS5 has accomplished the PCAOB’s objective of providing the same benefits of Sarbanes Oxley at a more reasonable cost to companies.

    Category:
    Internal Control, Standard Setting
    Sub-category:
    Changes in Audit Standards, Impact of 404 on Fees and Financial Reporting Quality
  • The Auditing Section
    The Global Audit Profession and the International Financial...
    research summary posted May 4, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.06 Impact of PCAOB in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Global Audit Profession and the International Financial Architecture: Understanding Regulatory Relationships at a Time of Financial Crisis
    Practical Implications:

    This paper provides insight into the effect of the global financial crisis on auditors and the relationships between large international accounting firms, regulators, and standard setters. The paper summarizes a variety of reports and policy proposals related to the global financial crisis, including the number of times auditors are mentioned in each of the reports. The paper discusses issues related to bank audits, including discussion of fair value issues and going concern reports.

    Citation:

    Humphrey, C., A. Loft and M. Woods. 2009. The Global Audit Profession and the International Financial Architecture: Understanding Regulatory Relationships at a Time of Financial Crisis. Accounting, Organizations and Society 34 (6-7): 810-825.

    Keywords:
    International auditing, standard setting, auditing interpretations, global audit regulation, audit committees, accountant independence, global financial crisis, and international federation of accountants
    Purpose of the Study:

    The global financial crisis of 2008 resulted in multiple bank failings, some with little to no warning from auditors. However, auditors have largely stayed out of the discussions of what went wrong to cause the global financial crisis. This paper takes a look at the potential effects the global financial crisis could have on the auditing profession. Specifically, the paper notes: 

    • The importance of viewing auditing from a global context Regulatory response to the global financial crisis and how new regulations affect auditing
    • The potential future of bank auditing 

    This paper also explores the relationships between the international audit firms, regulators, and standard setters.

    Design/Method/ Approach:

    This paper provides the authors’ commentary on the global financial crisis and discusses some reports and policy proposals that resulted from the financial crisis.

    Findings:
    • The paper notes that although auditors have not been questioned extensively regarding their role in the global financial crisis, some new policy initiatives and reports have mentioned the auditing profession.
    • The paper suggests that in solving the global financial crisis, it is important for auditors, regulators, standard setters, and others to work together.
    • The paper notes that it is important to consider the audit profession on a global basis.
    • The authors challenge the industry to make the knowledge related to international audit practice, regulatory networks and the forces driving the same more accessible.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards, Impact of PCAOB
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  • The Auditing Section
    From Inspection to Auditing: Audit and Markets as Linked...
    research summary posted May 4, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    From Inspection to Auditing: Audit and Markets as Linked Ecologies
    Practical Implications:

    This study provides insight into the way the auditing market has evolved in Russia and how modern-day audits differ from Soviet-era  inspections. The author also focus on what services (i.e., consulting, tax) Russian businesses feel their auditors should provide, and how prestige is gained in the Russian audit markets. The results of this study should be of interest to accounting firms considering either initial entry into Russia or expanding current services in Russia.

    Citation:

    Mennicken, A. 2010. From Inspection to Auditing: Audit and Markets as Linked Ecologies. Accounting, Organizations and Society 35 (3): 334-359.

    Keywords:
    International matters, business and politics, markets, auditing procedures, consulting firms, professionalization, auditing, Russia (federation), other management consulting services, marketing consulting services, administrative management and general management consulting services, neoliberalism, and Russia (federation) – economic conditions 1991-
    Purpose of the Study:

    This study examines the transition from Soviet government inspections to capitalist auditing in Russia over the period 1985 to 2005. The author discusses how auditors marketed their services – including consulting and tax advising services. Additionally, the study includes some discussion of what constitutes “audit quality” in Russia (e.g. firm size and similarities in approach with Big Four accounting firms). The author notes that in Russia, audits are merely “tolerated” while consulting and tax services are marketed as the “value added” services auditors can provide.

    Design/Method/ Approach:

    The author analyzed legal documents, accounting and audit journals, accounting and audit textbooks, newspapers and business magazines dating from 1985 to 2008. Additionally, the author carried out 48 in-depth interviews in Moscow between 2001 and 2002 with former Soviet financial inspectors, Russian auditors, state regulators, representatives of new professional associations, academics, and other professionals. In addition, the author observed employees of two large Russian audit firms (one for two months and the other for 2.5 months) and observed employees of the International Center for Accounting Reform for one month.

    Findings:
    • The audit profession in Russia has transitioned from Soviet-era inspections where they merely reported exceptions to external users to an environment where they focus more on adding value by providing reports directly to company management.
    • Modern day auditing in Russia consists of providing value added services to the client, such as consulting services and tax advice. However, the financial statement audit remains secondary to these services.
    • Rankings of audit firms by the popular business press in Russia are seen as a way to gain exposure, market services, and acquire new clients. These rankings are often dependent upon audit firm size and similarities to the Big Four international      accounting firms.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
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