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  • Jennifer M Mueller-Phillips
    Management Influence on Auditor Selection and Subsequent...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Management Influence on Auditor Selection and Subsequent Impairments of Auditor Independence during the Post-SOX Period.
    Practical Implications:

    This paper documents that management still have significant influence over auditor selection in the post-SOX Act period. The quality of audit committee seems not to reduce management influence in auditor selection. The findings call into question the effectiveness of Section 301 of SOX Act that requires the audit committee be directly responsible for choosing auditors. The study also shows the assumption that hiring auditors affiliated with the management would harm auditor independence is unwarranted. The findings of this paper are primarily informative to the standard setters and regulators.     

    Citation:

    Dhaliwal, D. S., P. T. Lamoreaux, C. S. Lennox, and L. M. Mauler. 2015. Management influence on auditor selection and subsequent impairments of auditor independence during the postSOX period. Contemporary Accounting Research 32 (2): 575607.

    Keywords:
    auditor independence, auditor selection, Sarbanes-Oxley Act, affiliations
    Purpose of the Study:

    Section 301 of the Sarbanes-Oxley Act (SOX) requires the audit committee be directly responsible for appointing the external auditors. One of the purposes of this section is to eliminate client management influence over auditor selection and thus enhance auditor independence. Recent surveys and case study find conflicting results on how this rule is implemented by the U.S. public companies. However, no archival study has been done to provide direct evidence on the effectiveness of this rule. The assumption that auditor selection influenced by management will reduce auditor independence also needs to be tested. A prior study finds that, in pre-SOX period, an audit firm is more likely to be appointed if client management has personnel once worked in the firm. The authors use management affiliation with the audit firm as a measure for management influence over auditor selection. If the SOX Section 301 works, the probability of hiring affiliated auditors should decrease. The authors conduct a rigorous study using objective data to examine whether this is the case. The authors further look at whether hiring affiliated auditors impairs auditor independence as claimed by the supporters of this rule. They also investigate the effect of audit committee quality on appointing affiliated auditors and the relationship with audit quality.   

    Design/Method/ Approach:

    The sample comprises all Big 4 auditor appointments by the U.S. public companies from 1995 to 2009. The authors identify management affiliation with Big 4 by reading the executive biographies in the companies’ proxy statements. They first test whether management affiliation increases the chance that the company selects the affiliated firm as its auditor. For this test, they compare the pre-SOX sample with the post-SOX sample to see if the SOX Act weakens the relationship. They further check how audit committee quality affects the relationship. At the end, they examine whether the company that hires the affiliated auditor in deed experience lower quality audits.

    Findings:
    • The probability that an audit firm is selected by the company significantly increases if one of the top management is affiliated with the firm. This positive relationship is not reduced by the passage of the SOX Act.
    • There is mixed evidence that audit committee quality lowers the probability of selecting affiliated auditors in the pre-SOX period and no evidence that audit committee quality has an effect on affiliated auditor hiring during the post-SOX period.
    • There is inconsistent evidence that hiring affiliated auditor affects auditor independence. In the post-SOX period, affiliated auditors are less likely to issue going concern opinions than unaffiliated auditors. But affiliated auditors are not less likely to constrain earnings management.
    • The lower propensity of affiliated auditors to issue going concern opinions is offset by the high quality audit committees. But audit committee quality seems not to impact the relationship between affiliated auditors and earnings management.
    Category:
    Auditor Selection and Auditor Changes, Independence & Ethics
    Sub-category:
    Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Audit Market Concentration and Auditor Tolerance for...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Market Concentration and Auditor Tolerance for Earnings Management.
    Practical Implications:

    Given that auditor concentration is an important topic that has seen relatively little empirical research, this study contributes to the literature by providing more complete evidence on the relation between auditor concentration and audit quality. Concentration reduced the opportunity for Big 4 clients to switch auditors particularly given the new auditor independence requirements following the 2002 Sarbanes-Oxley Act. Reduced choice is seen as increasing auditor entrenchment and complacency, and potentially contributing to a more lenient and less skeptical audit for clients.

    Citation:

    Boone, J. P., I. K. Khurana, and K.K. Raman. 2012. Audit Market Concentration and Auditor Tolerance for Earnings Management* Audit Market Concentration and Auditor Tolerance for Earnings Management. Contemporary Accounting Research 29 (4): 1171-1203. 

    Keywords:
    industrial concentration, earning management, auditor independence, auditing-quality control
    Purpose of the Study:

    The relation between market concentration and audit quality remains an important public policy issue. This study examines whether concentration in U.S. local audit markets affects the auditor’s tolerance for earnings management by audit clients. In recent years, policy makers have expressed concern about the risks posed by auditor concentration (i.e., the market dominance of the Big 4 audit firms) for audit quality. The concern is that market concentration limits a company’s choice of auditory, particularly if they are a large company. Having only four large auditors reduces a client’s opportunity to switch auditors and thereby entrenches the incumbent auditor. To the extent that auditor entrenchment contributes to auditory complacency and a more lenient and less skeptical approach to audits, auditor concentration could lower service quality. To the extent that audit entrenchment strengthens auditor independence and allows for greater “pushback” by the auditor, concentration could have a beneficial effect on audit quality. The authors examined a restrictive sample of observations based on clients that have the incentive and means to manage earnings to meet or beat earning benchmarks.

    Design/Method/ Approach:

    The sample is formed from the merged COMPUSTAT annual industrial files, including the primary, secondary, tertiary, and full coverage research files. The sample consists of 4,779 observations for which client’s nondiscretionary earnings fell short of analysts’ consensus earnings forecast from 2003-2009. The authors also examine a reduced sample of 2,988 observations where they exclude clients with nondiscretionary earnings that fall short of the analysts’ consensus earnings forecast by more than 5 percent of total assets.

    Findings:

    The results indicate that higher concentration (as measured by the Herfindahl index) is associated with an increased likelihood of the client having sufficient positive discretionary accruals that together with the nondiscretionary earnings is equal to or greater than the analysts’ consensus earnings forecast. Utilizing a more focused definition of earnings management, thefindings suggest that higher concentration is associated with lower audit quality. The results hold across alternative measures of the Herfindahl index based on all auditors or Big 4 auditors only, and based on audit fees, client size, or number of clients. However, the authors are unable to detect a relation between Big 4 market share and auditor tolerance for earnings management to meet or beat the earnings forecast. In a separate analysis the authors find evidence that clients in more concentrated audit markets are more likely to just beat (rather than just miss) the earnings benchmarks. Overall, the evidence is consistent with auditor concentration manifesting itself in increased auditor tolerance for earnings management by clients.

    Category:
    Independence & Ethics, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management, Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    The Sarbanes-Oxley Act and Exit Strategies of Private Firms.
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Sarbanes-Oxley Act and Exit Strategies of Private Firms.
    Practical Implications:

    While there are ex ante societal benefits to SOX-type reforms, in terms of reduced fraud, better financial reporting, and the resulting reduction of negative externalities, the regulator must consider the total societal costs of SOX-type reforms, including real costs to society resulting from smaller private firms opting to be acquired rather than going public. The authors leave a consideration of the costs and benefits of SOX-type regulations up to the global regulatory community, with the hope that the stylized facts presented in this study inform the ongoing debate about the socially optimal level of mandatory investment in internal and external monitoring.

    Citation:

    Bova, F., M. Minutti-Meza, G. Richardson, and D. Vyas. 2014. The Sarbanes-Oxley Act and Exit Strategies of Private Firms. Contemporary Accounting Research 31 (3): 818-850.

    Keywords:
    auditing, Sarbanes-Oxley, government policy, consolidation & merger of corporations, compliance
    Purpose of the Study:

    There may be real costs to society if private firms opt to be acquired rather than pursue an IPO. The authors assess whether SOX has had an impact on both the exit strategy preferences of private firms and the deal proceeds achieved by private firms when selling to a public buyer. The authors assess SOX’s impact on the decision of private firms to either be acquired by a public firm or to pursue an IPO. SOX’s implementation has forced publicly traded firms to incur costly new layers of financial reporting controls to monitor internal transactions. These costs have proven to be one of the more controversial elements of SOX’s implementation. As the evidence suggests that there are larger SOX-related costs for IPO firms, fewer firms should meet the threshold over which the benefits of going public outweigh the benefits of being acquired, and as a result fewer U.S. private firms should choose the U.S. IPO option as an exit strategy, post-SOX. SOX might limit private firms’ options for financing in general, and stifle opportunities for private companies to grow.

    Design/Method/ Approach:

    The study was conducted using data collected during the 1994-2009 time period. The combination of U.S. IPO and takeover firms results in a sample of 3,738 observations. The combination of U.K. IPO and takeover firms results in a sample of 1,515 observations. Data from COMPUSTAT and the Center for Research and Public Securities (CRSP) was used to calculate the industry-related factors in the model.

    Findings:
    • SOX appears to have shifted U.S. private companies’ exit strategy preferences from pursuing an IPO to being acquired by a public firm. This shift in preferences is particularly prominent for smaller U.S. firms.
    • In over 85% of the cases, the IPO firms discuss concerns over the substantial costs to becoming SOX compliant, prior to going public.
    • The findings imply that the adoption of SOX has both changed the propensity for firms to choose an IPO relative to being acquired and negatively impacted the proceeds obtained by acquired targets.
    • Private deal proceeds are lower in the post-SOX era if a seller is not fully SOX compliant. The target either incurs the SOX compliance costs or the proceeds are reduced to reflect the fact that the public buyer has to incur these costs. Either way, the private target is forced to incur SOX compliance costs.
    • The authors rerun the tests in a U.K. setting. As the United Kingdom did not adopt concurrent SOX-like regulations with the United States, they find no evidence that SOX affected U.K. private companies’ exit strategy preferences.
    Category:
    Independence & Ethics
    Sub-category:
    Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    A Test of the Auditor Reliability Framework Using Lenders’ J...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    A Test of the Auditor Reliability Framework Using Lenders’ Judgments
    Practical Implications:

    The results of this study indicate that banning the provision of both non-audit and audit services by a single firm likely increased perceptions of auditor independence, but did not significantly effect overall judgments of reliability or the extent to which financial statement users incorporate financial statement information into their decision process. Additionally, results of this study indicate that companies who have audits performed by auditors who are perceived to possess greater integrity, expertise and independence likely enjoy reduced costs of borrowing.

    For more information on this study, please contact F. Todd DeZoort.

    Citation:

    DeZoort, F.T., T. Holt, and M.H. Taylor. 2012. A test of the auditor reliability framework using lenders’ judgments. Accounting, Organizations and Society 37 (8): 519-533.

    Purpose of the Study:

    The purpose of this study is to test the relationship between financial statement users’ perceptions of auditor expertise, integrity, independence and objectivity and overall assessments of auditor reliability. Previous research suggests that perceptions of auditor reliability are critical to perceptions of financial statement reliability. This study directly tests that assertion and also investigates the relationship between perceptions of financial statement reliability and subsequent reliance on disclosed financial information. 

    Design/Method/ Approach:

    Data for this study was collected via a survey of commercial lenders belonging to the Risk Management Association prior to 2012. The survey yielded 187 responses and required participants to review financial information for a hypothetical company. Participants responded to several questions about their perceptions of the company’s auditors, the financial statements and overall risk as a potential applicant for a commercial loan.

    Findings:

    This study investigates the relationship between financial statement users’ perceptions of auditor expertise, integrity, independence and objectivity and makes the following observations:

    • Perceptions of auditor integrity are positively correlated with perceptions of auditor independence, expertise, objectivity and reliability
    • Perceptions of auditor expertise are positively correlated with perceptions of auditor objectivity
    • Perceptions of auditor independence are positively correlated with perceptions of objectivity
    • Perceptions of auditor objectivity are positively correlated with perceptions of auditor reliability.

    This study also investigates how perceptions of auditor reliability influence financial statement users’ interpretation and use of financial statement information.

    • Perceptions of auditor reliability are positively correlated with perceptions of financial statement reliability
    • Perceptions of financial statement reliability are negatively correlated with judged risk of default on a commercial loan

    Finally, manipulating whether or not the auditor provided non-audit services in addition to performing the financial statement audit had the following effects:

    • Negatively impacted perceptions of auditor independence, objectivity and reliability
    • Did not statistically impact perceptions of auditor integrity, expertise, financial statement reliability or default risk
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Was Dodd-Frank Justified in Exempting Small Firms from...
    research summary posted November 26, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.05 Evaluating Accruals/Detection of Abnormal Accruals, 08.06 Earnings Management – Detection and Response, 14.0 Corporate Matters, 14.01 Earnings Management in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Was Dodd-Frank Justified in Exempting Small Firms from Section 404b Compliance?
    Practical Implications:

    Our study evaluates a provision of Dodd-Frank which provided permanent exemption from Section 404b compliance to non-accelerated filers. Our results show that these small firms did not improve their reporting quality to the same extent as large firms implying that the Dodd-Frank exemption will probably serve to keep the reporting quality of the exempted firms at lower than achievable levels.

    We also note that as part of the Dodd-Frank legislation, the SEC was given a mandate to investigate raising the Section 404b exemption requirements from $75 million to $250 million in market capitalization (Dodd Frank 2010). While the SEC eventually decided to leave the exemption criterion at $75 million, this matter is still considered to be an open topic (SEC 2011). Our study informs this ongoing debate.

    For more information on this study, please contact

    Anthony D. Holder, PhD, CPA

    Assistant Professor, Department of Accounting - MS 103

    University of Toledo

    Toledo, OH 43606-3390

    Email: Anthony.Holder@utoledo.edu

    Web:    http://homepages.utoledo.edu/aholder4/

    Phone: 1.419.530.2560

    Fax: 1.419.530.2873 

    Citation:

    Holder, A., K. Karim, and A. Robin. 2013. Was Dodd-Frank Justified in Exempting Small Firms from Section 404b Compliance? Accounting Horizons 27 (1): 1-22.

    Keywords:
    Sarbanes-Oxley; Dodd-Frank; earnings management; exempt filers
    Purpose of the Study:

    A major component of the Sarbanes-Oxley Act of 2002 (SOX) is Section 404b, which requires auditor certification of internal controls. However, not all firms were required to comply with this section. Fearing that compliance costs may be prohibitive, SOX allowed a temporary exemption to small firms called non-accelerated filers (typically those firms with market capitalizations under $75 million). Later, the Dodd-Frank Act of 2010 made this exemption permanent.

    Needless to say, both 404b itself and the small-firm exemption, remain controversial. At the heart of the issue, as with any regulation, is the cost-benefit tradeoff. In this particular instance, what are the potential benefits small firms would have obtained had they been subject to SOX Section 404b? By focusing just on the costs of compliance, we may be overlooking these benefits. We consider these foregone benefits an opportunity cost.

    The purpose of our study is to estimate this opportunity cost. We estimate the benefits lost by small firms, because they were not subject to SOX Section 404b.

    Design/Method/ Approach:

    Our sample contains listed firms (subject to SOX), divided into the large (accelerated) and small (non-accelerated) categories. Our data span the SOX period and are from 1995-2009. We measure reporting gains using two standard approaches, one measuring the extent of earnings management and the other measuring accrual quality.

    The reporting benefits foregone by small-firms can be understood by comparing the following two quantities:

    • Post-SOX reporting gains achieved by large firms (accelerated filers).
    • Post-SOX reporting gains achieved by small firms (non-accelerated filers). If these gains (or losses) are smaller than those achieved by large firms, we know there is an opportunity cost.
    Findings:

    We detect a significant deterioration in reporting quality for non-accelerated filers but not for accelerated filers. The result is invariant to whether we compare non-accelerated filers with all accelerated filers or only with small accelerated filers.  Our findings suggest a significant opportunity cost for the exemption. Although the consideration of the cost of Section 404b compliance is outside the scope of our study, our result concerning the opportunity cost suggests that it may have been premature to grant permanent exemption to the non-accelerated filers. This result is especially important, considering contemporaneous discussions to grant Section 404b exemption to even larger firms (up to a market capitalization of $500 million).

    Category:
    Auditing Procedures - Nature - Timing and Extent, Corporate Matters, Independence & Ethics, Internal Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management, Evaluating Accruals/Detection of Abnormal Accruals, Impact of 404 on Fees and Financial Reporting Quality, Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Policy and Research Implications of Evolving Independence...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Policy and Research Implications of Evolving Independence Rules for Public Company Auditors
    Practical Implications:

    The results of this study are important to policy makers, academics, and audit committees in evaluating the implications of independence rules for public companies.  The evidence gathered indicates several areas where policy makers could evaluate the effectiveness of the existing independence requirements, or even modify the requirements without sacrificing audit quality or auditor independence – either in fact or in appearance.  Both academics and policy makers could also benefit from additional research in certain areas of auditor independence to more clearly determine the impact of established policies or potential effects of future policies.  Audit committees can also utilize the study to understand the results of prior research performed on the expanded role of the audit committee and the impact of that role on auditor independence.

    For more information on this study, please contact any of the authors.

    Citation:

    Gramling, A., J. G. Jenkins, and M. H. Taylor. 2010. Policy and research implications of evolving independence rules for public company auditors. Accounting Horizons 24 (4): 547-566.

    Keywords:
    Auditor independence, independence regulation, policy and standard setting
    Purpose of the Study:

    Auditor independence is fundamental to public accounting. This paper summarizes academic literature related to auditor independence and considers the implications of reported results for public policy and standard setting activities.  The purposes of the study are:

    • To assess the extent to which research supports the proposition that the current independence rules are strongly correlated with independence in fact or independence in appearance; and
    • To offer observations that are based on extant literature regarding possible reconsideration and/or modification to existing independence rules; and
    • To identify areas of research that might inform future decisions related to auditor independence rules
    Design/Method/ Approach:

    The paper consists of a summary of the extant auditor independence literature, and provides an update to previous reviews of the literature.  The authors use the SEC rules on auditor independence as their organizing framework and present summaries of the research in five categories:

    • Financial, Business, and Employment Relationships
    • Provision of Nonaudit Services
    • Fee Issues
    • Rotation Issues
    • Expanded Role of the Audit Committee
    Findings:
    • Financial, Business, and Employment Relationships: There is limited research related to the effects of various types of relationships on independence (either perceived or in fact). Much of the research on employment relationships is from the pre-Sarbanes-Oxley(SOX) era, and finds that perceived independence may be negatively affected. The authors were not able to identify specific research on the effects of financial and business relationships on auditor independence.
    • Provision of Nonaudit Services: Research has demonstrated a relation between the provision of nonaudit services and the perception of reduced audit quality under certain conditions. However, much of the research on the provision of nonaudit services and audit quality as measured by various financial statement elements fails to identify deleterious effects.
    • Fee Issues: Research generally indicates auditors in both pre-SOX and post-SOX environments are more likely to allow significant clients (i.e., larger fees) to engage in aggressive financial reporting if those clients have weak governance and/or monitoring mechanisms.  However, pre-SOX research suggests that perceived independence is not affected by the size of fees.
    • Rotation Issues: Much research reports audit partner rotation improves auditor independence, both perceived and in fact.  However, research findings on audit firm rotation are mixed.
    • Expanded Role of the Audit Committee: Research suggests that audit committees are unlikely to approve permitted nonaudit services unless perceived benefits exceed the perceived risks of independence failure. In addition, disclosure requirements may reduce the likelihood that audit committees approve nonaudit services even if they would increase audit quality. 
    Category:
    Independence & Ethics
    Sub-category:
    Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Reining in auditors: On the dynamics of power surrounding an...
    research summary posted October 27, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Reining in auditors: On the dynamics of power surrounding an ‘‘innovation’’ in the regulatory space
    Practical Implications:

    This study shows that in practice the independent regulatory bodies implemented after the scandal of Enron and the collapse of Arthur Anderson are influenced by the accounting profession, despite their claim of independence. The Big Four firms are exerting a great influence on them, while the interest of the public only takes a small place in the discussion. Regulatory regimes thus face the challenge to ensure that the institutions they created fulfill the role they were given.

     

    For more information on this study, please contact Bertrand Malsch. 

    Citation:

    Malsch, B. and Y. Gendron. 2011. Reining in auditors: On the dynamics of power surrounding an “innovation” in the regulatory space. Accounting, Organizations and Society 36 (7): 456-476.

    Keywords:
    Dynamics of power, independent audit regulators, arm’s length regulation, outside monitoring, tradition of self-regulation, Canadian Public Accountability Board
    Purpose of the Study:

    In the past, auditors largely self-regulated and were subject to peer reviews.  In the aftermath of Enron and the collapse of Arthur Andersen, new “independent” institutions have been created to oversee financial auditing. Accounting firms are now accountable to regulatory organizations localized outside the boundaries of the profession’s jurisdictional domain.

     

    First, the authors investigate how the creation of the Canadian Public Accountability Board (CPAB) has affected the dynamics of power among the main players enlisted in Canada’s regulatory field of public accounting. They were especially interested in examining which organizations gained, maintained or lost their position of power in the regulatory space under study, and the extent to which the new regulatory practices were consistent with the independent regulator’s claim of “outside monitoring”. The authors’ analysis is also directed at the exercise of power and influence in the globalized audit regulatory space.

     

    Second, they extend the boundaries of their argument by showing that patterns of resistance against the logic of arm’s length regulation operate in a variety of audit regulatory sites. The analysis provides some insights into the dynamics of power which the creation of independent audit regulators engendered in other spaces, and the collaborative processes taking place across networks of regulators in trying to ensure that their mandates and practices are coherent and consistent.

    Design/Method/ Approach:

    The empirical material relates to a specific time frame, from the establishment of CPAB in 2003 until year 2009.  The following sources of information have been used: public statements issued by a number of independent audit regulators and regulatory agencies, internal documents, documents retracing the public consultation process initiated in June 2003 on regulatory project 52-108 regarding the creation of CPAB, and minutes of all meetings held between 2005 and 2009 by two agencies set up by the European commission. Two rounds of semi-structured interviews were conducted.  The first round of interviews, carried out from 2003 to 2005 mostly in Canada, consists of more than 60 interviews with audit committee members, financial analysts, financial auditors, regulators, etc. Two of these interviews take on special significance retrospectively in the context of the study: one with the first chief executive officer (CEO) of CPAB, and the other with a member of CPAB’s board of directors. The second round involves seven interviews conducted in 2008–2009 in Europe. The second-round interviews involve three high-ranking partners of the Big Four, as well as one board member and three executives from independent audit regulatory organizations.

    Findings:
    • The authors find that the accounting profession is resistant to the establishment of an independent regulatory organization. The logic of self regulation in the profession influences the new regulatory organization significantly, in spite of the efforts of a number of non accounting organizations to constrain the influence of the accounting establishment and its key allies in reshaping regulation in accordance with their interests. 
    • The authors find that the regulator is influenced partially in practice by a private circuit of power. The targets of regulation, especially the Big Four firms, are powerful in the face of audit regulators.
    • The authors find that there is a major regulatory gap where both the international firms and the global standard-setting bodies are not subject to global and strong regulatory oversight.
    • The authors find that the patterns of resistance to the logic of arm’s length regulation are influential across a number of jurisdictions. Of course, the degree of influence varies in time and space.
    • The authors find that the ‘public’ is often a marginal figure in the discourses constructed by the actors studied. 
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    The Role of Firm Status in Appointments of Accounting...
    research summary posted June 7, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 13.0 Governance, 13.02 Board/Financial Experts, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Role of Firm Status in Appointments of Accounting Financial Experts to Audit Committees
    Practical Implications:

    The primary contribution of this study is finding that status-related concerns can prevent firms from appointing AFEs to their boards. This result has clear implications for regulators, as firms without AFEs are more likely to encounter accounting reporting problems. Specifically, recent regulation changes by the SEC to introduce a more broad definition of “financial expert” may damage the improvement of financial reporting that was intended by SOX. This research is consistent with previous findings that directors’ concerns for firm status and their own welfare can negatively affect accounting reporting quality. 

    Citation:

    Erkens, D. H., and S. E. Bonner. 2013. The Role of Firm Status in Appointments of Accounting Financial Experts to Audit Committees. The Accounting Review 88 (1): 107–136.

    Keywords:
    accounting financial experts; audit committees; director status; firm status
    Purpose of the Study:

    Since 1999 regulators have exerted pressure on firms to appoint accounting financial experts (AFE) to their audit committees in an attempt to improve the monitoring of financial reporting. Despite prior research showing more positive financial reporting outcomes, firms have been reluctant to appoint these experts. This study examines the effect of firm status on some firms’ reluctance to appoint AFEs to their audit committees. The authors propose that higher status firms may be more reluctant to appoint AFEs, which could potentially result in more financial reporting problems. 

    Design/Method/ Approach:

    The sample selected consists of 875 firms and 3,590 firm-year observations that are included in the S&P 1500 index from 1999 to 2008. Firms included in the sample have board member biographical information and board composition data available in the RiskMetrics or BoardEx databases and cannot have previously appointed an AFE to the audit committee. This data, combined with an aggregate measure of firm and director status is used to test the following hypotheses:

    1. The average status of appointed AFEs is less than the average status of sitting directors.
    2. Director status is positively related to firm status
    3. The difference in status of appointed AFEs and sitting directors is larger for higher status firms than it is for lower status firms.
    4. The probability that a firm will appoint an AFE to its audit committee in a given year is negatively related to the status of the firm.
    Findings:
    • Higher status firms were reluctant to appoint AFEs to their audit committees because typical AFEs are of lower director status than typical directors. 
    • The gap between the status of AFEs and sitting directors was larger for higher status firms. 
    • Directors’ personal incentives related to appointing higher status directors outweigh the concerns about damaging firm status.
    • Firms that have directors who serve on other boards with AFEs, have corporations nearby with AFEs, or have an auditor with a significant fraction of clients that have AFEs are more likely to appoint AFEs to their audit committees.
    • Firms with complex accounting or past accounting problems are also more likely to appoint AFEs. 
    Category:
    Corporate Matters, Governance, Independence & Ethics
    Sub-category:
    Audit Committee Effectiveness, Board/Financial Experts, Impact of SEC Rules Changes/SarBox
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  • Jennifer M Mueller-Phillips
    An Examination of Partner Perceptions of Partner Rotation:...1
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality
    Practical Implications:

    The findings of this study shed light on the perceived benefits and detriments of the five versus seven year partner rotation requirements.  The results highlight the potential unintended consequences of implementing the accelerated rotation including a reduction in partner quality of life and auditor independence and audit quality. 


    For more information on this study, please contact Brian Daugherty. 
     

    Citation:

    Daugherty, B., D. Dickins, R. Hatfield, and J. Higgs.  2012.  An Examination of Partner Perceptions of Partner Rotation:  Direct and Indirect Consequences to Audit Quality. Auditing: A Journal of Practice & Theory 31 (1): 97-114. 

    Keywords:
    Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life.
    Purpose of the Study:

    This study examines practicing audit partner perceptions regarding the mandatory partner rotation and cooling off periods.  Specifically, the authors investigate how recently enacted and stringent rules might negatively impact auditor quality of life leading to deterioration in audit quality.  As a result of the Sarbanes-Oxley Act of 2002 (SOX), the US moved from a seven-year rotation with a two-year cooling-off period to a five-year rotation and five-year cooling-off period.  This change in standard provides the authors the opportunity to investigate the perceptions of partner that have worked under both standards.

    Design/Method/ Approach:

    The authors conducted in-depth semi-structured interviews with seven practicing audit partners.  Most of these partners were managing partners from various geographic locations.  Based on those interviews, the authors developed a model of the effects of mandatory rotation and created a field survey that was completed by 370 audit partners.  Collection of survey results occurred prior to May 2011. 

    Findings:

    The audit partners in the study believed that rotation generally improved independence which has a positive impact on audit quality.  However, partners also expressed that accelerated rotation reduced client-specific knowledge and had a negative impact on audit quality.  Partners suggested that the accelerated rotation and extended cooling-off period imposed by SOX has increased the need to relocate if the partner wishes to remain in the same industry.  As a result partners often choose to gain new industry experience and stay in the same location, rather than to relocate.  This decision maintains the partner quality of life, but possibly at the expense of industry depth and to the detriment of overall audit quality.  Partners also discussed a two to three-year new-client familiarization process, resulting in an increase in the amount of time that engagements suffer from “start-up efficacy”.  In sum, although the partners view rotation in general as a means to improve independence, they believe the accelerated rotation imposed by SOX may actually result in a reduction in independence and possibly audit quality.

    Category:
    Audit Quality & Quality Control, Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox, Impact of SOX, Industry Experience
  • The Auditing Section
    Do Investors’ Perceptions Vary with Types of Nonaudit F...
    research summary posted April 13, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.01 Scope of Services, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services, 04.08 Impact of SEC Rules Changes/SarbOx in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Do Investors’ Perceptions Vary with Types of Nonaudit Fees? Evidence from Auditor Ratification Voting
    Practical Implications:

    This paper added to the discussion on what types of services audit firms should and should not provide to their audit clients. The evidence in this paper supports the view that investors do not view tax services provided to audit clients in the same light as audit-related services.  The findings of this study are relevant to managers and boards of directors who purchase non-audit services (audit-related, tax or other) from the external auditor.  This study is also useful to practicing auditors to address audit committee concerns on non-audit services.

    Citation:

    Mishra, S., K. Raghunandan, and D.V. Rama. 2005. Do Investors’ Perceptions Vary with Types of Nonaudit Fees? Evidence from Auditor Ratification Voting. Auditing: A Journal of Practice & Theory 24 (2): 9-25.

    Keywords:
    audit fees; audit committees
    Purpose of the Study:

    Beginning in 2001, the Securities and Exchange Commission (SEC) required registrants to disclose fees paid to auditors in the following categories: audit, financial information system design and implementation (FISDI), and other fees.  In 2003 the SEC updated the disclosure requirements by adding two new fee categories: tax fees and audit-related fees (which were previously reported in “other fees”) and eliminating FISDI, based on the prohibition of these services by the Sarbanes-Oxley Act.  The SEC  suggested the expanded disclosure would provide better information for investors to determine for themselves if auditor ndependence is impaired as a result of non-audit services provided and the nature of fee arrangements.            

    The SEC asserted that investors and financial statement users would view audit-related and tax fees more favorably than “other” fees.  The authors test this assertion by examining the relation between shareholder auditor ratification votes and ratios of audit-related, tax, and other fees to audit fees.  If investors view audit-related and tax fees differently than other non-audit fees then the authors expect auditor ratification voting to vary by fee ratio.      

    Design/Method/ Approach:

    Using firms in the S&P 1500 the authors select a sample of 248 firms that submit auditor ratification for shareholder vote during 2003.  The authors then gather the results of the ratification votes for these firms from the subsequent Form 10-Q or 10-K filings. The authors also gather company financial information from various public sources and evaluate the impact of fee ratios on the outcome of shareholder ratification votes.

    Findings:
    • Shareholders voting against auditor ratification increased substantially from 2001 to 2002 to 2003.  The authors posit that this result is largely driven by Andersen’s failures and Enron’s demise. As expected, other fees impact shareholder ratification votes unfavorably.
    • Tax fees impact shareholder ratification votes unfavorably; which is contrary to the SEC assertion that investors view these tax fees favorably.  However, this supports the PCAOB’s actions in 2005 relating to restricting some auditor-provided tax services.
    • Audit-related fees are viewed favorably by investors, which is consistent with the SEC’s assertion and opposite of the result of tax fees.
    • Overall, the results support the SEC assertion of a need for separate categories of non-audit fees (audit-related, tax and other) as shareholder voting on auditor ratification appears to be influenced by these non-audit fees. 
    Category:
    Standard Setting, Auditor Selection and Auditor Changes
    Sub-category:
    Impact of SOX, Scope of Services, Impact of Fees on Decisions by Auditors & Managmeent, Non-audit Services, Impact of SEC Rules Changes/SarBox
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