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  • Jennifer M Mueller-Phillips
    Audit Firms’ Client Acceptance Decisions: Does P...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 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:
    Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter?
    Practical Implications:

     This paper contributes to the literature on auditor industry expertise in many ways. First, it extends previous studies on this topic to examine whether industry specialists demonstrate different risk preferences in client acceptance decisions. The finding that partner-level industry specialists are more likely to accept less risky clients may partly explain why industry specialists have better quality clients.

    Citation:

    Hsieh, Y., and Lin C. 2016. Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter? Auditing: A Journal of Practice and Theory 35 (2): 97-120.

    Keywords:
    partner-level industry specialization, client acceptance decision, and Big N auditors
    Purpose of the Study:

    Recently, audit firms have paid more attention to client acceptance decisions due to increased litigation risk. As a result more and more studies have investigated what goes into making this important decision. However, most prior studies examine whether auditors evaluate client risk characteristics when making client portfolio management decisions and whether auditors change their portfolio management strategies in response to changed in response to changes in litigation liability. Few studies have examined the impact of auditor characteristics other than accounting firm size. Auditors with different attributes could have different risk considerations in making client portfolio management decisions. In fact, previous studies have suggested that auditors use industry experience as a risk management strategy to mitigate risk on client portfolio management decisions because industry specialists provide high-quality audits and thus decrease litigation risk and reflect a good client-auditor match. Audit firms make large investments in specialized industries, so specialist auditors have an incentive to shed risky clients to avoid litigation risk and protect their reputation; hence, whether audit firms use industry expertise as a risk management strategy to mitigate the effect of risk is an empirical issue. The authors of this paper hope to explore whether industry specialization affects the association between risk considerations and client acceptance decisions. 

    Design/Method/ Approach:

    The sample is restricted to Taiwanese listed companies audited by Big N audit firms from 1999 to 2010. The final sample contains 9,337 observations. A Client Acceptance Decision Model was created to examine the effect of auditor industry expertise on firms’ risk consideration when making client acceptance decisions. 

    Findings:
    • The authors find that auditors are less likely to accept clients with audit risk higher than that of existing clients.
    • The authors find that firm-level industry expertise has no significant effect on the association between risk consideration and client acceptance decisions.
    • The authors find that partner-level industry specialists alone are less likely to accept clients with higher financial risk or higher audit risk, which supports the hypothesis that partner-level industry specialization affects the association between risk factors and client acceptance decisions. No evidence is found that firm-level industry expertise alone affects risk considerations in client acceptance decisions. 
    Category:
    Audit Team Composition, Client Acceptance and Continuance
    Sub-category:
    Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    The Validity of Auditor Industry Specialization Measures
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Validity of Auditor Industry Specialization Measures
    Practical Implications:

     This study draws attention to the potentially large issues involved with inconsistencies in the measurement of auditor industry specialization with a focus on audit fees and audit quality. The findings of this study suggest that audit fee-based measures should probably be prioritized by researchers and that previous empirical findings based on other measurement variables need to be re-examined. Results also show that choosing a market share approach or a portfolio approach has very significant consequences, so the decision should not be made absent-mindedly. Furthermore, the choice of absolute versus relative measures of ISP if not neutral, either, and the sensitivity tests indicated that ISP calculations are very sensitive to the industry classification used.

    Citation:

     Audousset-Coulier, S., A. Jeny, and L. Jiang. 2016. The Validity of Auditor Industry Specialization Measures. Auditing: A Journal of Practice and Theory 35 (1): 139-161.

    Keywords:
    auditor industry specialization and construct validity
    Purpose of the Study:

    Industry specialist auditors are auditors who have developed a specific expertise and are therefore able to provide high quality and more efficient services to their clients. Despite being widely examined in literature, the effect of auditor industry specialization (ISP) has no wholly agreed upon degree of measurement with empirical results exhibiting inconsistencies and uncertainties.  In fact, a multiplicity of measures of industry specialization has been developed over the years. These inconsistencies found with the measurement of auditor industry specialization have led to issues in audit pricing and audit quality. The audit pricing models inconsistencies, in particular, are a challenge for researchers in archival auditing research; the results of their studies are highly sensitive to ISP measures. This study focuses on the measurement issues of ISP, with the hope to be the first study to conduct a comprehensive test of the consistency among different combinations of measurement variables, such as audit fee, client size, and number of clients, and approaches, such as absolute or relative market shares, absolute or relative portfolio shares, and weighted market shares. 

    Design/Method/ Approach:

    The authors use an audit pricing model and an earnings quality model as their empirical fields of study to present empirical evidence about the consequences of using different proxies for ISP on audit pricing and earnings quality research results. The data, which is from 2000 to 2010, is used to compute 30 different measures of ISP in order to test their internal and external construct validity.  

    Findings:
    • The authors find that the choice of the type of measure used to identify industry specialists has a significant influence on the designation of auditors as industry specialists.
    • The authors show that the use of five different assignment approaches modifies the classification of auditors as specialists or not.
    • The authors show that the use of different calculating variables to compute these shares also leads to significant differences of classification.
    • The authors find in the audit pricing model test that the alternative use of the 30 ISP variables in an audit fee model leads to the determination of a significant ISP fee premium in 14 cases, to the determination of a fee discount in 6 cases, and to nonsignificant results in 10 cases.
    • The authors find in the earnings quality test that industry specialization is found to significantly reduce the level of discretionary accruals in only five cases compared to the 21 cases where ISP measures were associated with higher levels of discretionary accruals and with nonsignificant results found in four cases.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization and Evidence of Cost...
    research summary posted October 21, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor Industry Specialization and Evidence of Cost Efficiencies in Homogenous Industries.
    Practical Implications:

    The results of this study are important to audit firm clients, audit firms, and audit regulators as they evaluate the benefits and costs of industry specialization. For auditors and their clients, the evidence indicates that specialist auditors in homogenous industries, even when complex accounting is involved, achieve economies of scale that are passed on to clients. Clients in homogenous industries appear to benefit from a lower cost audit without a decrease in audit quality. Moreover, audit firms may benefit from increased client retention in these industries because of their expertise and competitive price. And, though audit regulators have expressed concern about concentration in the audit market, the results indicate that concentration can improve audit firms’ economies of scale in homogenous and complex industries without reducing audit quality. As audit clients, audit firms, and audit regulators consider industry specialization, this paper provides support for auditor specialization in homogenous industries.

    Citation:

    Bills, K. L., D. C. Jeter, and S. E. Stein. 2015. Auditor industry specialization and evidence of cost efficiencies in homogenous industries. The Accounting Review 90 (5): 1721-1754.

    Keywords:
    auditor industry specialization, audit fees, economies of scale, homogenous industries, complex industries
    Purpose of the Study:

    Audit firms specialize in certain industries hoping to enhance audit quality and achieve lower costs through knowledge transfer across clients. There has been mixed evidence to date regarding audit pricing for firms in specialized industries; most studies indicate that auditors charge a premium on their services, while others indicate that auditors discount their services due to achieved economies of scale. This paper examines the audit pricing effects of auditor industry specialization based on specific industry characteristics. Specifically, the authors:

    • Investigate whether the specialist auditor’s pricing behavior varies based on industry characteristics, like an industry’s similarity (homogeneity) of operations and complex accounting requirements.
    • Investigate whether the pricing decisions by the specialist auditor in industries where auditors achieve economies of scale depend on client bargaining power.
    Design/Method/ Approach:

    The authors collected audit firm market share data, operating expense data for each industry, information about AICPA audit and accounting guides, as well as data necessary to calculate control variables on companies with data available in the Audit Analytics database and Compustat. The information collected on these companies was for years 2004-2009.

    Findings:
    • The authors find that industry specialist auditors serving client firms in non-homogenous industries charge a fee premium. However, audit fees are incrementally lower for client firms in homogenous industries and client firms in homogenous and complex industries. This indicates that specialist auditors achieve cost efficiencies that are passed to clients who operate in homogenous industries. Additionally, when the client firm displays a relatively high degree of bargaining power, specialist auditors exhibit significantly lower fees.
    • The authors find that non-specialist auditors can also realize cost savings in homogenous industries, but charge higher fees to client firms in complex industries. Specialist auditors charge incrementally higher fees than non-specialists to client firms in complex, but not homogenous, industries. 
    • The authors find that audit quality provided by industry-specialist auditors in homogenous, or homogenous and complex, industries are not significantly different from other industries. These results support that specialist auditors generate production efficiencies without sacrificing audit quality. 
       
    Category:
    Audit Team Composition, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Office-Level Characteristics of the Big 4 and Audit Report...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 10.0 Engagement Management, 10.01 Budgeting and Audit Time Management, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Office-Level Characteristics of the Big 4 and Audit Report Timeliness.
    Practical Implications:

    This study provides further support for the importance of office-specific characteristics on audit and financial reporting outcomes and provides evidence of the benefit of office-specific industry expertise. The study should be of interest to financial reporters and audit firms interested in reducing audit report lag times and to regulators and investors interested in increasing the timeliness of financial reporting information.

    Citation:

    Whitworth, J. D., and T. A. Lambert. 2014. Office-Level Characteristics of the Big 4 and Audit Report Timeliness. Auditing: A Journal of Practice & Theory 33 (3): 129-152.

    Keywords:
    audit report lag, industry expertise, office-level characteristics, product specialist strategy, timeliness
    Purpose of the Study:

    Timeliness of annual financial reporting information has long been a concern of investors, regulators, financial reporters, and auditors. Recent changes in the audit and financial reporting environment have resulted in longer audit report lags and have increased the importance of identifying factors associated with a timely audit. The authors examine timeliness implications of office specific attributes of the audit firm. Specifically, they examine whether office-specific industry expertise, office size, and the importance of the client to the local office are associated with audit delay (i.e., the time between fiscal year-end and the audit report date). The authors explore the sensitivity of the results to various measures and consider the impact of earnings quality. They examine two types of industry expertise and whether the aforementioned audit firm attributes are associated with a propensity to issue an early earnings announcement.

    Design/Method/ Approach:

    The authors use a regression model to test their hypotheses. They obtain audit delay, audit fees, and other audit-related information from Audit Analytics and financial information from Compustat for the years 20032008. Combining the Audit Analytics and Compustat samples provides a sample of 14,948 firm-year observations after excluding firms not audited by one of the Big 4 auditors.

    Findings:
    • The authors find that office-specific industry expertise is negatively associated with audit delay (for all but the largest quartile of firm offices, suggesting that such expertise allows audit firms and their clients to realize efficiencies within the audit process in the form of reduced post-fiscal-year-end audit time.
    • However, sensitivity analyses suggest that office-specific industry expertise is not significantly associated with audit delay for firms with the lowest accruals quality.
    • Office size and client importance are both positively associated with audit delay.
    • However, the most important clients are associated with a more timely audit.
    • Office-specific industry expertise is positively associated with the propensity to announce earnings substantially early and such expertise garnered via a product-specialist strategy is positively associated with audit delay relative to a low-cost specialist strategy.
    Category:
    Accountants' Reporting, Audit Team Composition, Engagement Management
    Sub-category:
    Budgeting & Audit Time Management, Changes in Reporting Formats, Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization, Service Bundling, and...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 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:
    Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City.
    Practical Implications:

    The authors contribute by providing some of the first evidence of service bundling in the economics of auditing literature. In doing so, they broaden the notion that strategic pricing occurs around audit switches. This study contributes to prior mixed findings of the existence of industry specialist premiums in the small-client segment, suggesting an additional reason why these mixed findings might occur. Where opportunities to package services are attractive, auditors may strategically price and discount audits with bundling premiums in mind. Where potential for such bundling opportunities is less attractive, it is possible the auditor may instead seek to generate premiums in the audit service.

    Citation:

    Ferguson, A., G. Pündrich, and A. Raftery. 2014. Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City. Auditing: A Journal of Practice & Theory 33 (3): 153-180.

    Keywords:
    audit fees, industry specialization, mining industry, non-audit services, second-tier firms, service bundling
    Purpose of the Study:

    This study examines auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms. In this study, the authors consider whether an auditor industry specialist may strategically price a bundle of services in the small-client segment. They argue that the small company sector is a good environment to consider the existence of service bundling. The setting is the mining development stage entity (MDSE) market in Perth, the biggest industry and city in Australia by client numbers. This market is characterized by small (high-growth) firms where auditing is arguably of less importance to the client compared to tax advisory, the other primary service provided to them. Further, the firms are relatively homogeneous, an appealing feature of industry studies. Thus, the authors have arguably an attractive setting to observe service bundling by an industry specialist.

    First, the authors examine whether industry specialist auditors earn audit fee premiums in the Perth MDSE segment. To do this, an audit pricing model is developed and includes controls likely to impact on audit fees in a mining industry context. Second, the authors redefine the dependent variable to consider the pricing implications of the bundle of services provided by industry specialists.

    Design/Method/ Approach:

    The authors utilize an OLS regression model to test for audit fee premiums with respect to brand name and industry leadership. A sample of 1,799 firms listed on the ASX as of December 31, 2009 is obtained. Of the 1,799 listed entities nationally, 668 (37.13 percent) are domiciled in Perth, making it the largest city-level market by client numbers in Australia. At the city-level, the market share of non-Big 4 firms is 70.1 percent in Perth.

    Findings:

    The authors find no evidence of auditor industry leadership audit fee premiums accruing to either Big 4 (EY) or non-Big 4 (BDO) leaders. However, when the dependent variable is redefined to include non-audit services (NAS), the industry leader, BDO, obtains a total fee premium. This finding is of added interest given that the industry leader is a second-tier firm, implying that strategic audit pricing, such as service bundling, is not confined to Big 4 auditors. Nor is it confined to merely one location, since bundling premiums are observed at the national level. The authors argue MDSEs have little in the way of financial statement complexity, so they do not value specialist audits, but rather are willing to pay more for NAS. Last, in supplementary analysis, the authors find some evidence of partner-scale effects.

    Category:
    Audit Team Composition, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Industry Expertise – Firm and Individual, Non-audit Services
  • 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
  • Jennifer M Mueller-Phillips
    Audit quality and the market value of cash holdings: the...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit quality and the market value of cash holdings: the case of office-level auditor industry specialization.
    Practical Implications:

    While theoretical literature has extensively examined the link between audit quality and firm value, very little empirical evidence has been provided as to the potential channels in which high-quality audits enhance firm value. This study extends and complements the existing line of research by providing useful insights into the role of audit quality in constraining managerial diversion or misuse of corporate cash resources. The results of this study are useful in assessing the effects of audit quality on firm value, specifically the market value of cash holdings.

    Citation:

    Kim, J. B., J. J. Lee, and J. C. Park. 2015. Audit Quality and the Market Value of Cash Holdings: The Case of Office-Level Auditor Industry Specialization. AUDITING: A Journal of Practice & Theory 34 (2): 27-57.

    Keywords:
    audit quality, auditor industry specialization, capital expenditures, cash holdings, cash management efficiency
    Purpose of the Study:

    In the past, research has been conducted in regards to the impact of managerial cash expenditures on the market value of cash holdings within corporations. Specifically, the misuse of corporate cash resources by management has been shown to result in investors discounting the value of cash holdings. This study investigates the monitoring role of high-quality auditors defined as office-level industry specialists in the stock market valuation of cash assets. The authors pose the idea that high-quality audits facilitate external discipline, thereby preventing potential misuse of cash holding and the associated destruction of cash values.  The study aims to provide large-sample, systematic evidence on whether higher-quality audits contribute to an increase in the market value of cash holdings.

    Design/Method/ Approach:

    Once problematic data were excluded, the sample consisted of 14,688 Big 4 client-year observations for publicly traded U.S. companies over the sample period of 20032011. The relation between audit quality and the market value of cash holdings was investigated by applying a regression model developed in previous research. The authors controlled for certain factors that have been previously shown to affect the market value of cash, including audit financial reporting quality and corporate governance.

    Findings:

    Overall, the results of the study support the idea that higher-quality audits contribute to an increase in the market value of cash holdings. Specifically:

    • The market value of cash is significantly higher for firms audited by local practice offices with both national and city-specific industry specialization.
    • The marginal value of cash is 34 cents higher for the client of a joint industry specialist at both the national and city levels than for the client of a non-specialist.
    • The positive association between joint-industry specialization and the value of cash holdings is more significant than those of national-only or city-only industry specialization.
    • When the auditor has joint-industry specialization, cash holdings are more closely associated with capital investment, and the market value of capital expenditures is significantly higher.
    • The market value of cash holdings increases significantly following the change of auditors to joint-industry specialists.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience
  • Jennifer M Mueller-Phillips
    Auditor Style and Financial Statement Comparability.
    research summary posted July 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor Style and Financial Statement Comparability.
    Practical Implications:

    The authors find support for the idea that auditors develop in-house rules to facilitate comparability within their clientele. These auditor style effects also appear to reduce comparability between clients audited by different auditors. Big 4 accounting firms may have an effect on another earnings attribute that has not previously been investigated, namely, accounting comparability. The authors find that firms audited by Big 4 auditors have greater accounting comparability than firms audited by non-Big 4 auditors, which suggests another dimension in which the two auditor groups differ. It is also the case that each Big 4 audit firm has its own style, which affects accounting comparability and is therefore another source of variation within the Big 4 group of auditors.

    Citation:

    Francis, J. R., Pinnuck, M. L., & Watanabe, O. 2014. Auditor Style and Financial Statement Comparability. Accounting Review 89 (2): 605-633.

    Keywords:
    big 4 accounting firms, comparability, earnings, expertise
    Purpose of the Study:

    Comparability is defined by the Financial Accounting Standards Board (FASB) as the quality of information that enables users to identify similarities and differences in the financial performance of two firms. The FASB states that comparability in financial reporting is the primary reason for developing accounting standards, and the centrality of comparability is stressed in accounting textbooks, particularly financial statement analysis texts accounting standards on their own do not fully determine financial reporting outcomes; economic agents and institutional incentives also play an important role.

    This motivates the investigation of the role that auditors play in the implementation of comparability in the United States. For the purpose of this study the authors define accounting comparability as the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms. In the empirical context, this means that firm-pairs in the same industry and fiscal year, and therefore subject to the same general economic shocks, are expected to have a similar accruals and earnings structure, all things being equal. The study focuses on the role of the auditor, the authors argue that each Big 4 audit firm has its own unique set of internal working rules that guide and standardize the auditor’s application of auditing and accounting standards.

    Design/Method/ Approach:

    The authors use a regression model to examine the relation between accounting comparability and auditor style. The primary tests are based on pairs of firm-year observations from Compustat in the same industry-year for the period 1987 to 2011.

    Findings:

    The authors find that two firms in the same industry-year and audited by the same Big 4 auditor have more comparable earnings than two firms audited by two different Big 4 auditors. Pairs of firms in the same industry-year with the same Big 4 auditor have more similar total and abnormal accruals; firm-pairs with the same Big 4 auditor have a higher covariation in earnings over time; and auditor fixed effects are a statistically significant determinant of accruals.  Big 4 auditors have a greater effect on accounting comparability than non-Big 4 auditors.

    A single set of uniform accounting standards is often advocated as a means to increase comparability of financial statements, reflecting the rationale for the FASB-IASB convergence project. This study documents that the role of an economic agent, the auditor, is also important in facilitating the production of accounting comparability. The authors argue that the Big 4 style effect arises from each audit firm having its own unique set of in-house rules with respect to the interpretation and implementation of GAAS (auditing standards) and the interpretation and enforcement of GAAP (accounting standards).

    Category:
    Audit Team Composition
    Sub-category:
    Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality...
    research summary posted March 4, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 14.0 Corporate Matters in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics?
    Practical Implications:

    The fact that the Big 4 effect is generally insignificant indirectly supports the argument that the Big 4 distinction may reflect client and not auditor characteristics. The results suggest that differences in these proxies between Big 4 and non-Big 4 auditors largely reflect client characteristics and, more specifically, client size. The study has not resolved the question, although it encourages other researchers to explore alternative methodologies that separate client characteristics from audit-quality effects.

    For more information on this study, please contact Alastair Lawrence.

    Citation:

    Lawrence, A., M. Minutti-Meza, and P. Zhang. 2011. Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics? The Accounting Review 86 (1): 259-286. 

    Keywords:
    Big 4 versus non-Big 4 audit quality; discretionary accruals; ex ante cost-of-equity capital; analyst forecast accuracy; propensity-score matching; attribute-based matching
    Purpose of the Study:

    This study examines whether differences in proxies for audit quality between Big 4 and non-Big 4 audit firms could be a reflection of their respective clients’ characteristics.

    The question of Big 4 superiority is important, given that many studies rely on the Big 4 versus non-Big 4 distinction as an audit-quality proxy. Hence, it is prudent to confirm that this distinction does not simply reflect client characteristics. Furthermore, incorrectly classifying Big 4 auditors as superior to non-Big 4 auditors has unnecessary negative ramifications for smaller auditors, such as audit committee’s auditor selection bias and discriminatory clauses in loan and underwriting agreements, which could result in a loss of current and future clients.

    Design/Method/ Approach:

    In the research, the authors use three audit-quality proxies – discretionary accruals, the ex ante cost-of-equity capital, and analyst forecast accuracy – and employ propensity-score and attribute-based matching models in attempt to control for differences in client characteristics between the two auditor groups while estimating the audit-quality effects. Also, they use propensity-score matching models in an attempt to control for differences in client characteristics between the two auditor groups while estimating auditor treatment effects.

    Findings:

    Using the matching models and full samples, the authors find that the treatment effects of Big 4 auditors are insignificantly different from those of non-Big 4 auditors with respect to our three audit-quality proxies.

    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit Fee Decisions, Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Industry- versus Task-Based Experience and Auditor...
    research summary posted September 26, 2013 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Industry- versus Task-Based Experience and Auditor Performance
    Practical Implications:

    The results of this study are important for audit firms to consider when staffing their engagements, particularly for mid-tier accounting firms.  The authors note that firms may want to consider allocating non-specialist staff among a few different industries. According to their research, there appears to be benefits due to the industry experience regardless of whether they have task-related experience.  This allows for non-specialist auditors to continue gaining task-based experiences while expanding their industry-based experiences. 

    For more information on this study, please contact Robyn Moroney.
     

    Citation:

    Moroney, R., and P. Carey. 2011. Industry- versus Task-Based Experience and Auditor Performance. Auditing: A Journal of Practice & Theory 30 (2):1-18.

    Keywords:
    Audit quality; industry-based experience; task-based experience
    Purpose of the Study:

    Prior research has shown that both industry-related experience and task-related experience improve auditor performance.  This is important because, other than training, experience is the main opportunity for an auditor to gain knowledge and improve their audit performance.  In these earlier studies, researchers focused on either task-based experience or industry-based experience.  This allows researchers to find that task-based experiences improve performance or industry-based experience improves performance but not which one is more important.  Since auditors gain industry experience by working on audit tasks for clients within an industry and vice versa, the relative importance of each has not been evaluated.  The purpose of this study is to make comparisons about whether industry-based or task-based experience is more important in the performance of non-specialist auditors.  It also seeks to determine whether continued experiences within one industry continues to increase auditor performance or if it levels out.

    Design/Method/ Approach:

    The authors collected evidence from their experiment prior to January 2009.  The authors use a sample of non-specialist auditors (including senior associates, managers, and partners) from 8 non-Big 4 accounting firms.  Participants completed two cases, one with a research and development expenditure in the manufacturing industry and another case involving investments in the superannuation (pension fund) industry.  Answers from 5 questions about each case resulted in a performance rating based on comparison of the participant’s answers to the “correct” answer as provided by an expert panel.

    Findings:
    • The authors find that industry-based experience is relatively more important than task-based experience in non-specialist auditors.
    • The authors find performance due to industry-based experience increases quickly.  As auditors spend higher percentages of their annual time in a particular industry their performance scores increase noticeably between the 0% category and the 1-10% category and again between the 1-10% category and 11-20% category. 
    • The authors also find that the impact of industry-based experience levels out once auditors spend approximately 20% of their annual time in that industry. 
       
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience