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  • Jennifer M Mueller-Phillips
    Non-Big 4 Local Market Leadership and its Effect on...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Non-Big 4 Local Market Leadership and its Effect on Competition
    Practical Implications:

    The results of this study are important to audit policymakers, academics, and practitioners. Though Non-Big 4 firms audit fewer publicly traded companies, the results indicate that they are still able to develop a reputation on their full book of business that enables them to become market leaders. In addition, policymakers’ efforts to increase Non-Big 4 market share may not work nationwide. The authors show that certain local characteristics impact the likelihood of Non-Big 4 local leadership, which suggests that targeted efforts may be more beneficial than nationwide efforts. Finally, the results imply that though the presence of a Non-Big 4 local market leader creates downward fee pressure on audit firms, Big 4 and Non-Big 4 firms are not substitutes as Big 4 firms still earn a fee premium in these markets. 

    Citation:

    Keune, M.B., B.W. Mayhew, and J.J. Schmidt. 2016. Non-Big 4 local market leadership and its effect on competition. The Accounting Review. 91(3): 907-931.

    Keywords:
    local audit market; Big 4 market competition; audit fee premium
    Purpose of the Study:

    Non-Big 4 public accounting firms in many major metropolitan areas are as large as or larger than the Big 4 firms present in the market. However, prior academic research has assumed that little competition exists between Big 4 and Non-Big 4 public accounting firms. As a result of this supposed lack of competition, policymakers in the U.S. and Europe have suggested that they step in to grow Non-Big 4 firms. Regulatory intervention may be unwarranted though given a Government Accountability Office study from 2008 that shows that though large publicly traded companies are limited in their choice of auditor, they still obtain competitive fees. This paper investigates whether and how these seemingly contradictory findings can be accurate. Specifically, the authors:

     

    • Examine the local factors associated with Non-Big 4 local market leadership from both the demand and supply sides.

     

    • Examine the relationship between Non-Big 4 local market leadership and competition.

     

    The authors also introduce a new measure of market leadership based on overall office size. 

    Design/Method/ Approach:

    The authors collected the accounting firm rankings from local business publications for the top 50 largest U.S. Metropolitan Statistical Areas. The accounting firm rankings are based on the number of employees, professional staff, or CPAs in the local office. Audit fees, local market characteristics, and other variables were obtained from the Audit Analytics database and Compustat. The information collected on these firms was for years 2005-2010. 

    Findings:
    • The authors find that Non-Big 4 market leadership is less likely in markets that have more Fortune 1000 clients and more initial public offerings.

     

    • The authors find that Non-Big 4 market leadership is more likely in markets without a large airport hub, with lower litigation costs, and with lower average educational attainment of the labor pool.

     

    • The authors find that, on average, audit fees are 18% lower in markets with Non-Big 4 firm leadership. Fees are lower the closer the Non-Big 4 leaders are in size to the Big 4 firms in the market.

     

    • The authors find that the Non-Big 4 leader firms are able to earn a fee premium, but that the Big 4 firms in those markets still earn a fee premium above and beyond the Non-Big 4 leader’s fee premium. 
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
  • Jennifer M Mueller-Phillips
    Small Audit Firm Membership in Associations, Networks, and...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.0 Audit Team Composition, 05.08 Impact of Office Size in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees
    Practical Implications:

    The results of this study are important for regulators concerned about the lack of competition in the audit market for large publicly-traded companies.  These data indicate that audit firm associations can increase competition in this sector of the market by providing small firms with the necessary resources to adequately audit large, global, and complex audit clients.  These findings should also be of interest to small audit firms interested in better serving larger audit clients.  Lastly, these results should be of interest to corporate governance bodies and investors interested in the relationship between audit firm type and audit quality.

    Citation:

    Bills, K. L., L. M. Cunningham, and L. A. Byers. 2016. Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees. The Accounting Review 91 (3): 767-792.

    Keywords:
    associations; networks; small audit firms; audit fees
    Purpose of the Study:

    Small audit firms are often restricted in their ability to audit large public companies because these companies often have global operations and complex business and financial reporting environments which demand a level of resources difficult for smaller firms to provide.  Many of these small firms seek membership in accounting firm associations in an effort to overcome these barriers.  Accounting firm associations are autonomous organizations in which all firm members are independent in legal name and structure, but membership affords participating firms access to resources provided by the association itself as well as fellow association members.

    Because accounting firm associations can pre-screen affiliate members and provide access to resources that would otherwise be more difficult or costly for small audit firms to obtain, audit quality for the clients of these affiliate members is likely to be higher than the clients of unaffiliated small audit firms.  Addressing this issue is important because over half of all publicly traded companies are audited by small audit firms and little accounting research to date examines differences in audit quality across the clients of small audit firms.  Below are three objectives the authors address in their study:

    • Examine whether audit quality is higher for clients of affiliated audit firms relative to the level of quality provided by nonmember firms.  The pre-screening process and access to additional resources is expected to result in higher quality for affiliated small audit firms relative to unaffiliated small audit firms.
    • Examine whether clients who choose to engage an affiliated small audit firm pay a fee premium.  If membership in an accounting firm association is associated with a perceived reputation for higher audit quality, then audit fees for affiliated small audit firms should be higher relative to unaffiliated small firms.
    • Examine whether the potential increase in audit quality associated with membership in an accounting firm association affects the extent to which audit quality differs between Big 4 firms and small, but affiliated audit firms. While prior research indicates audit quality is lower for small audit firms relative to Big 4 firms, affiliation in an accounting firm association may provide small firms with the additional resources necessary to close this gap.
    Design/Method/ Approach:

    The authors use hand-collected audit firm association membership data from 2010-2013, along with financial statement data for publicly traded firms, to examine whether audit quality and audit fees for publicly traded clients differs between small audit firms affiliated with an audit firm association and small firms with no such affiliation.  Audit quality was measured using PCAOB inspection findings, financial statement misstatement rates, and differences in levels of client discretionary accruals.

    Findings:
    • Affiliated small audit firms provide on average higher quality audits to their publicly traded clients relative to small, un-affiliated audit firms.  In particular affiliated small audit firms are less likely to receive accounting related deficiencies, or audit related deficiencies in their PCAOB inspection reports.  In addition, the clients of affiliated members report fewer annual financial statement misstatements, and less extreme discretionary accruals.  In addition, the findings indicate that when a small audit firm joins an accounting firm association, audit quality increases in subsequent years.  Lastly audit quality is increasing in the size of the audit firm association.  This indicates that the increase in audit quality is driven by an increased access to valuable resources provided by the affiliation.
    • Affiliated small audit firms receive an audit fee premium from their clients relative to unaffiliated small audit firms and this premium is increasing in the size of the audit firm association. 
    • The researchers observe no significant differences in audit quality between affiliated small audit firms and Big 4 firms.  This indicates that affiliated small audit firms provide high-quality audits to large publicly-traded companies.  In addition, while affiliated small audit firms experience a fee premium relative to unaffiliated firms, these fee premiums remain lower than those experienced by Big 4 firms.
    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Impact of Office Size
  • Jennifer M Mueller-Phillips
    The Contagion Effect of Low-Quality Audits at the Level of...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 03.01 Auditor Qualifications, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Contagion Effect of Low-Quality Audits at the Level of Individual Auditors
    Practical Implications:

    This study highlights the importance of individual auditor identification in audit reports. The results are also useful for financial information users, regulators, and policymakers to help them understand the impact of an auditor’s characteristics on an audit. The results are especially helpful for firms trying to understand the reasons behind audit failures and subsequently, to mitigate audit failures in the future.

    Citation:

    Li Baolei Qi Gaoliang Tian, Liuchuang, and G. Zhang. 2017. “The Contagion Effect of Low-Quality Audits at the Level of Individual Auditors”. The Accounting Review 92.1 (2017): 137.

    Keywords:
    contagion effect; individual auditors; audit failures; audit quality; auditors’ personal characteristics
    Purpose of the Study:

    This study examines whether there is a relation between audit failure by an individual auditor and the quality of other audits performed by this individual, and if the audit failure creates a rippling effect onto the rest of the office’s audit quality. In China, unlike most other countries, the identity and personal profile of signing auditors are disclosed in the public domain. This allows for the authors to determine the role of an individual auditor in an audit failure. The authors also consider whether or not qualitative characteristics (experience, gender, education) of an auditor can decrease the contagion effect of audit failure within an office location.

    Design/Method/ Approach:

    The sample consists of 11,706 audit decisions and 3,357 of which were audited by failed auditors from 1999-2011. The China Securities Markets and Accounting Research (CSMAR) database was used to find financial information and information about the financial restatement reports were found on the China Information website. The qualitative characteristics of auditors used were age, gender, education level, major, CCP membership, and experience. This data was gathered from the CICPA website.

    Findings:

    The authors find the following:

    • Auditors who experience audit failure are more likely to have further failures in the subsequent four years. Additionally these auditors are more likely to have higher levels of abnormal accruals in other audits as well, indicating an overall lower audit quality. This combination suggests that there is a contagion effect between individual audit failure and future audit quality.
    • Offices that experience audit failures and offices that do not have no significant differences in failed audits in subsequent years or audit quality. This suggests that contagion does not seem to occur across different auditors in the same office.
    • The contagion effect can be decreased based on certain qualitative characteristics of the auditor. Specifically, it is decreased for female auditors, auditors holding a master’s degree, and auditors with more auditing experience.
    Category:
    Audit Quality & Quality Control, Auditor Selection and Auditor Changes
    Sub-category:
    Attempts to Measure Audit Quality, Auditor Qualifications (e.g. size - industry expertise)
    Home:

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  • The Auditing Section
    The Pricing of National and City-Specific Reputations for...
    research summary posted May 7, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market
    Practical Implications:

    This study has practical audit client portfolio management implications for audit firms seeking to earn audit fee premiums for reputations of industry expertise. For example, auditors’ reputations for industry expertise are neither strictly national nor strictly local.  One interpretation with practical implications for such firms is that national level or city level reputations for industry expertise are not individually sufficient to maximize fee premiums.  Rather, auditors can most effectively earn fee premiums when they establish both city-level and national-level reputations for industry expertise.

    Citation:

    Francis, J. R., K. Reichelt, and D. Wang.  2005.  The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market.  The Accounting Review 80 (1): 113-136.

    Keywords:
    Auditor industry expertise, Big 5 accounting firms, audit fees
    Purpose of the Study:

    The purpose of this study is to examine the pricing of Big 5 industry expertise in the United States based on national and city level reputations for industry expertise.  

    Industry knowledge and expertise help auditors build reputations that auditors can use to negotiate fee premiums.  Prior research suggests that industry knowledge and expertise is developed by investments in accounting professionals and their experiences in serving clients out of city-based practice offices.  However, auditors can build national reputations for industry expertise that may enable them to negotiate audit fee premiums as well.  The authors argue that the central issue in the “national” vs. “city” perspective on industry expertise is the degree to which office-specific expertise is transferrable throughout a firm. Specifically, the national perspective assumes accounting firms capture the industry expertise of its office-based professionals and distribute it throughout the entire firm.  Conversely, the city perspective assumes that auditor expertise is indelibly tied to individual professionals and cannot be distributed throughout the firm.  This study examines industry specialization audit fee premiums at the city level and national level to analyze how auditor reputations for industry expertise are viewed.  Specifically, the authors use U.S. fee disclosures to investigate audit pricing in the U.S.  audit market in order to determine: 

    • whether there is evidence that Big 5 auditor industry expertise is priced in the U.S. audit market 
    • whether the market for audit fees prices a Big 5 firm’s national (firm-wide) reputation or city-specific (local-office) reputations for industry expertise
    Design/Method/ Approach:

    The study uses data on U.S. non-financial publicly-traded companies with Big 5 auditors during the fiscal years 2000 and 2001.  The authors investigate audit fee premiums resulting from:

    • National specialization only,
    • City specialization only, and
    • Combined city and national specialization.
    Findings:
    • There is evidence of a fee premium of 19% on engagements where Big 5 auditors are both the nationally top-ranked auditor and the city-level industry leader in the city where the client is headquartered. The authors argue this indicates that national and city-specific industry leadership jointly impact auditor reputation and pricing. 
    • The magnitude of the premium for joint national-city leadership is bigger for larger clients (22 percent) than for smaller clients (7 percent).  
    • There is evidence of a fee premium of 8% on engagements where Big 5 auditors are the city-specific industry leader but not the national industry leader.  The authors argue this may indicate that auditor industry expertise is tied to individual professionals. However, the result is sensitive to test methods so the evidence is inconclusive on this point. 
    • There is no evidence of a fee premium for auditors that are national industry leaders alone without also being city-specific industry leaders.  The authors argue this indicates that national leadership alone does not result in a premium. 

    The authors argue these findings suggest that an auditor’s reputation is priced into audit fees as if both firm-wide (national) and city-specific (local) reputations are jointly relevant.

    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Audit fee decisions, Auditor Qualifications (e.g. size - industry expertise)
    Home:
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  • Jennifer M Mueller-Phillips
    The Value of Big N Target Auditors in Corporate Takeovers.
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Value of Big N Target Auditors in Corporate Takeovers.
    Practical Implications:

    The findings provide new evidence confirming the role of Big N auditors in corporate takeovers. In addition, the evidence suggests a positive association between deal completion and Big N target auditors. This information is critical to acquirer managers and investors, as ex ante acquirers can expect a lower deadweight loss associated with a failed M&A deal if the target firm employs a Big N auditor. Fund managers may find the discovery of the positive association between the target likelihood and engaging a Big N target auditor to be useful. Given recent evidence recommending a portfolio selection strategy based on the probability that a firm becoming a target in an M&A generates premium returns, auditor information might be utilized to screen a low cost M&A.

    Citation:

    Xie, Y., H. S. Yi, and Y. Zhang. 2013. The Value of Big N Target Auditors in Corporate Takeovers. Auditing: A Journal of Practice & Theory 32 (3): 141-169.

    Keywords:
    Big N auditors, M&A targets, mergers and acquisitions, auditor selection
    Purpose of the Study:

    While prior literature examines the value of Big N auditors in various corporate financing activities, there is only limited evidence documenting the value of Big N auditors in one of the biggest investment decisions a company ever makesmergers and acquisitions (M&As). This paper documents the value of Big N target auditors by examining whether acquirers screen target firms based on, and whether subsequent M&A deal completion depends upon, the target firm’s auditor reputation (i.e., proxied by Big N auditor).

    The authors argue that acquirers have at least two reasons to value Big N target auditors in corporate takeovers. First, an acquirer’s ex ante assessment of the viability of M&As critically hinges on the quality of the target’s firm-specific information. Acquirers are more likely to appreciate high-quality assurance provided by Big N auditors for target firms (the assurance value perspective). Second, it is not uncommon for acquirers to charge target auditors with misrepresenting the viability of the business being sold. Given this litigation risk, acquirers are likely to prefer target firms with Big N auditors due to their deep pockets. This insurance value of target auditors also likely motivates acquirers to value Big N auditors of potential target firms (the insurance value perspective).

    Design/Method/ Approach:

    The authors identify firms being targeted in M&As from the Securities Data Corporation’s (SDC) data ranging from 1987 to 2006. They retain observations for both takeover targets and non-takeover targets, and there are 96,902 firm-year observations with complete data on variables for the first test. Among them, 3,000 observations are takeover targets. Note that the sample only includes public bidder/target companies. The final sample used for the second test consists of 2,130 firm-year observations.

    Findings:
    • The likelihood of a company becoming an M&A target is higher when it engages Big N auditors.
    • Conditioning on being targeted, the likelihood of a target being eventually acquired is higher when it engages a Big N auditor.
    • To provide further evidence of the assurance and insurance values of Big N auditors in M&As, the authors examine whether the main findings are more pronounced for firms with higher information risk. The results of these cross-sectional tests reveal that the effects of Big N target auditors on the likelihood of companies becoming targets and on deal completion rates are more pronounced for firms with low accruals quality (the proxy for high information risk).
    • The results indicate that Big N target auditors facilitate M&A deals by lowering a target’s information risk and expected litigation costs.
    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Industry Expertise – Firm and Individual