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  • Jennifer M Mueller-Phillips
    Malleable Standards of Care Required by Jurors When...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 06.09 Litigation Risk, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Malleable Standards of Care Required by Jurors When Assessing Auditor Negligence
    Practical Implications:

    This study is relevant for practitioners, investors, and regulators. It demonstrates to firms that the effectiveness of high audit quality as a defense in litigation may be decreased depending on the timing of jurors’ assessment of SOC. One way to try and lower the probability of jurors’ assessing SOC after receiving audit knowledge is to warn the jury about the potential affects. Simply changing the jurors’ instructions has been found to mitigate the outcome effects.

    Citation:

    Maksymove, Eldar M., and M. W. Nelson. 2017. “Malleable Standards of Care Required by Jurors When Assessing Auditor Negligence”. The Accounting Review. 92.1 (2017): 165.

    Keywords:
    auditor liability; jury; audit quality; mediation; anchoring; sample size; audit adjustment
    Purpose of the Study:

    In court cases against auditors due to audit failure, often times the main defense used is that there was a high audit quality. This is true if the audit was performed at a level similar to what prudent auditors would have done in the same circumstances, also known as standard of prudent care (SOC). This study examines whether jurors’ definition of SOC is malleable based on the timing of the SOC assessment in accordance with the jurors’ exposure to the audit quality of the case. Specifically, whether or not the juror learns of audit quality first and then assesses SOC, or vice versa. 

    Design/Method/ Approach:

    The research project contains four experiments. The first experiment is a simulation where 125 participants, found using Amazon’s Mechanical Turk (AMT), are asked to assume the role of jurors who are considering a case of alleged auditor negligence. The level of audit quality and the timing of jurors’ SOC assessments are manipulated. In the subsequent three experiments 60-63 of the previous participants were asked to determine SOC based on the level of audit quality being manipulated and a change in some of the background information.

    Findings:

    Overall, the authors find that the timing of the SOC assessment in accordance with the jurors’ exposure to the audit quality of the case does in fact change the outcome of the SOC assessment. Therefore, the results indicate the jurors SOC assessments are malleable.

    The authors find the following:

    • In situations where SOC is determined prior to jurors learning about the audit quality of the case, the verdict better discriminates between high and low-quality auditors. This is due to the fact that the audit quality of the case cannot affect the jurors’ decision of what SOC should be.
    • On the other hand, when SOC is assessed after jurors learn about the audit quality of the case, it can cause SOC assessments to vary. This leads to inconsistent rulings of whether or not the auditor was negligent.
    • The reasoning behind the second situation is as follows. The jurors’ knowledge of higher audit quality in the case directly lowers the negligence judgment. However, when doing the SOC assessment after learning about the higher audit quality, the jurors raise SOC. This then increases the negligence judgment. The authors refer to this effect as competitive mediation. 
    Category:
    Audit Quality & Quality Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Attempts to Measure Audit Quality, Litigation Risk
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • 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:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • Jennifer M Mueller-Phillips
    The Effect of Joint Auditor Pair Composition on Audit...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 11.07 Attempts to Measure Audit Quality, 15.0 International Matters in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effect of Joint Auditor Pair Composition on Audit Quality: Evidence from Impairment Tests
    Practical Implications:

    Regulators are constantly trying to find ways to improve audit quality. The findings in this paper are useful to policymakers in understanding the benefits of a joint audit. It is also useful to companies and investors who are interested in what audit pairs provide a superior audit. 

    Citation:

    Lobo, Gerald J., L. Paugam, D. Zhang, and J. Francois Casta. 2017. “The Effect of Joint Auditor Pair Composition on Audit Quality: Evidence from Impairment Tests”. Contemporary Accounting Research 34.1 (2017): 118.

    Purpose of the Study:

    Regulators across the globe have been trying to find ways to increase audit quality, and one idea that has been proposed is requiring joint audits. Currently, joint audits are mandatory in France for any company preparing consolidated financial statements. This paper examines whether the auditor pair composition is related to audit quality. The three auditor compositions are Big4-Big 4 (BB), Big4-non-Big 4 (BS), and non-Big 4 non-Big 4 (SS). For the purposes of this study only BB and BS pairs are analyzed. The impairment of goodwill is examined to measure audit quality. This is due to management’s large discretion for the impairment of goodwill. The way auditor’s handle the impairment of goodwill often highlights how well they are maintaining objectivity and transparency of the auditor’s tests. It is important to note in BS pairs the Big 4 firm is most likely to be the one performing the impairment test.

    Design/Method/ Approach:

    The sample includes French firms from the SBF 250 index for the years 2006-2009. There were a total of 551 observations for the BB and BS pairs. The authors examined how the auditor pair type affected recognition of economic impairment and transparency of impairment-related disclosures.

    Findings:

    Overall, the authors find that BS audit pairs are associated with having a higher audit quality when compared to BB audit pairs. The authors believe this is due to a better coordination and development of a hierarchy in BS audit pairs and a higher incentive for better audit quality from the Big 4 firm in BS audit pairs. This is because the Big 4 firm in BS audit pairs are at a higher risk of reputational harm, than if they are paired with another Big 4 auditor in a BB audit pair.

    Specifically, the authors find the following:

    • In situations where low-performance indicators are present, BS audit pairs are more likely to recognize an impairment loss and recognize a larger impairment loss than BB pairs.
    • BS audit pairs are more likely to be more transparent in the disclosure of impairment for goodwill. On the other hand, BB pairs are more likely to show reductions in impairment-related disclosures when they book an impairment.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, International Matters
    Sub-category:
    Attempts to Measure Audit Quality
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • Jennifer M Mueller-Phillips
    Understanding Audit Quality: Insights from Audit...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Understanding Audit Quality: Insights from Audit Professionals and Investors
    Practical Implications:

    This study provides evidence that should help inform the public discussion of audit quality in the post-Sarbanes-Oxley era and adds empirical substance to theoretical frameworks of audit quality.  

    Citation:

    Christensen, B. E., S. M. Glover, T. C. Omer, and M. K. Shelley. 2016. Understanding Audit Quality: Insights from Audit Professionals and Investors. Contemporary Accounting Research 33 (4): 1648 – 1684. 

    Purpose of the Study:

    Much debate exists surrounding the definition, composition, and measurement of audit quality. This debate continues despite the importance of audit quality and the large body of research investigating the topic. This paper contributes to this debate by obtaining perceptions and measures of audit quality from audit professionals and investors, two groups heavily interested in the audit and financial reporting process.  Furthermore, this study provides evidence that contributes to understanding and defining audit quality, providing empirical evidence regarding many of the audit quality indicators proposed by the PCAOB, adding empirical substance to existing theoretical frameworks of audit quality and highlighting differences and consistencies between auditor and investor expectations about the audit process. 

    Design/Method/ Approach:

    The authors conducted a survey of audit professionals and investors to obtain their insights on audit quality.

    Findings:
    • The authors find that audit professionals define audit quality primarily in terms of compliance with professional auditing standards, while investors rely more on the individual characteristics of the engagement team performing the audit.
    • The authors find almost unanimous agreement that individual auditor characteristics influence audit quality.
    • The authors find evidence that input from parties outside the core engagement team such as the national office and engagement review partners is an important attribute of audit quality.
    • The authors find evidence that client-specific factors such as restatements, SEC enforcement actions, and the frequency of audit committee meetings are significant indicators of audit quality; however, they also find that investors’ perceptions of audit quality do not fully incorporate the importance of the audit committee in the audit process to the same extent as auditors. 
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    Understanding the Relation between Financial Reporting...
    research summary posted January 17, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Understanding the Relation between Financial Reporting Quality and Audit Quality
    Practical Implications:

    These findings imply that recognizing the relation between financial reporting quality and audit quality and the observability of differing outcomes can provide greater insight into the interpretation of research findings. They also suggest that greater consideration of how changing and differing economic situations affect financial reporting and audit outcomes will provide deeper insight into the determinants and consequences of both audit quality and financial reporting quality. Finally, recognizing and controlling for the potential endogeneity can lead to greater insights into both financial reporting quality and audit quality. The authors also provide a framework for identifying potential areas for future research. 

    Citation:

    Gaynor, L. M., A. S. Keaton, M. Mercer and T. L. Yohn. 2016. Understanding the Relation between Financial Reporting Quality and Audit Quality. Auditing: A Journal of Practice and Theory 35 (4): 1 – 22. 

    Keywords:
    financial reporting quality, audit quality, quality proxies, and quality determinants.
    Purpose of the Study:

    Understanding the determinants of high quality reporting is an important goal of both auditing and financial accounting research. These two areas share many related issues; however, the research within each area tends to draw on prior research within that area. This exclusion has created a pressing need for a review of each stream of literature, with a special focus on how the areas of research intersect and relate to each other. This paper attempts to bridge the gap between the financial reporting quality and audit quality literatures.

    Design/Method/ Approach:

    The authors begin by developing definitions of financial reporting quality and audit quality that are grounded the authoritative literature. Next, they link the new definitions to the operational measures of these constructs used in financial reporting and audit quality research. With this understanding, the authors create a person/task/environment framework for conceptualizing the determinants of financial reporting and audit quality. 

    Findings:
    • The authors find that both audit quality and financial reporting quality literatures often underplay the distinction between pre-audit financial reporting quality and audit quality and use the same metric as a proxy for either financial reporting or audit.
    • The authors find that financial reporting quality and audit quality are often inseparable in terms of observable financial reporting outcomes in archival research.
    • The authors find that both financial reporting quality and audit quality are heavily influenced by the underlying economics of the business.
    • The authors find that financial reporting quality and audit quality are often endogenously determined. 
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    Do Industry-Specialist Auditors Influence Stock Price Crash...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Do Industry-Specialist Auditors Influence Stock Price Crash Risk?
    Practical Implications:

    This study shows that industry specialists reduce a specific type of risk, stock price crash risk, which has become increasingly important following the Enron scandal and the recent financial market crisis. It also shows that the effects of opacity and conservatism on crash risk are moderated by auditor quality, furthering the emerging literature on the determinants of crash risk. 

    Citation:

    Robin, J. Ashok and Hao Zhang. 2015. Do industry-specialist auditors influence stock price crash risk? Auditing: A Journal of Practice and Theory 34 (3): 47-79.

    Keywords:
    Auditor quality, industry specialization, crash risk
    Purpose of the Study:

    In the past, a great deal of research has been done examining the idea that high-quality auditors benefit reporting quality in a variety of ways.  Other research has been done to focus on direct economic consequences for investors.  Some of this research has found that high-quality auditors can reduce the cost of debt, lower equity costs, diminish IPO underpricing, and even influence loan syndicate structure.  One issue that has not been examined, however, is whether high-quality auditors can reduce the crash risk for equity investors.  This paper focuses on this question.  Because crash risk is primarily caused by bad news hoarding, the authors believe that high-quality auditors can function as information mediators and reduce the crash risk in the following ways:

     

    • High-quality auditors are more likely to uncover bad news and suppress the mangers’ bad-news hoarding activities due to their greater capability
    • High-quality auditors have stronger incentives to disclose bad news in a timely manner and suppress managers’ bad-news hoarding activities

     

    In addition to mediating some of the bad news, the authors also believe that high-quality auditors also reduce crash risk by decreasing agency costs, decreasing malfeasance by managers, improving operating decisions, and decreasing expropriation.  This study could prove very valuable to investors, as crash risk is an important consideration in portfolio management. 

    Design/Method/ Approach:

    The research evidence is collected from a twenty-year sample period ranging from 1990-2009.  The authors obtained stock return data from the Center for Research in Security Prices (CRSP) database.  Accounting data and auditor characteristics were obtained from the Standard and Poor’s Compustat database. After making exclusions based on a number of criteria, the final sample amounted to 58,365 firm-year observations. Regression models were run on these observations to arrive at the author’s findings. 

    Findings:
    • The authors find that across all six models tested, to a statistically significant degree, stock price crash risk is lower for firms audited by industry-specialist auditors.
    • Results also indicated that crash risk is higher in firms with higher standard deviation and mean of stock returns, younger age, higher ROA, greater intangible assets, greater share turnover, and lagged negative skewness.
    • Concentrated institutional ownership can induce effective monitoring and lead to lower further crash risk.
    • Conservatism is negatively and significantly related to crash risk.
    • Auditor specialization provides benefits beyond reporting benefits.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality
  • Jennifer M Mueller-Phillips
    On the Benefits of Audit Market Consolidation: Evidence from...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    On the Benefits of Audit Market Consolidation: Evidence from Merged Firms.
    Practical Implications:

    The study results are important to audit firms and audit clients as they show audit efficiency benefits (lower audit hours and improved audit quality) post-merger. Although a merger with an international Big 4 firm may bring some reputational improvements, mergers with domestic Big 10 firms create improvements in audit efficiency. Audit firms interested in merging in the Chinese market should consider the benefits of local expertise and higher fees in a merger transaction. These results provide further insights into mergers and acquisitions and the benefits of economies of scale when performing audits.   

    Citation:

    Gong, Q., O. Z. Li, Y. Lin, and L. Wu. 2016. On the Benefits of Audit Market Consolidation: Evidence from Merged Audit Firms. The Accounting Review 91 (2): 463488.

    Keywords:
    audit mergers, efficiency gains, audit fees, audit hours
    Purpose of the Study:

    This study assesses whether there is an improvement in audit efficiency associated with audit firm mergers. The authors specifically investigate if there is a change in audit hours, quality, and fees in the period after the audit firm merger. With the public disclosure of Chinese audit firm hours, the authors can empirically assess changes in audit operations subsequent to an audit firm merger.

    The Chinese audit market has undergone rapid transformation due to the increase in stock offerings and publicly traded firms. International Big 4 firms have increased financial and human resource investments in the Chinese audit firm market. In response to this changing environment, domestic Chinese firms have entered into merger transactions to bolster their market share to achieve economies of scale to compete with the Big 4 firms. The Chinese government and the China Institute of Certified Public Accountants (CICPA) have supported increasing the size for domestic firms. This rapid market consolidation provides a unique context to evaluate the effects on audit firm mergers on audit efficiency and quality. Due to limited empirical studies on audit firm mergers, the authors embark on this study to understand the impact of audit firm mergers on auditor effort and audit quality.

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study. Audit firm merger information is from the CICPA database, financial newspapers, and audit firm websites. Audit firm client financial information is from the China Stock Market and Accounting Research Database (CSMAR). The sample period is from 2005-2009. Eighteen mergers are included in the sample population.

    Findings:
    • The authors find that audit firm mergers reduce audit effort represented by a 15.38 percent decrease in audit hours after an audit firm merger.
    • When assessing audit quality, the authors find that the probability of a financial statement decreases after an audit firm merger and that the probability of a modified audit opinion increases. These both support that audit quality improves after a merger. In addition, the probability of earning manipulation decreases with accounting conservatism increasing. The audit firm client’s accrual quality is not associated with audit firm mergers.
    • Combining the reduction in audit effort with the improvement in audit quality, these results show an improvement to audit efficiency after an audit firm merger. 
    • In supplemental analyses, the authors evaluate the effect of audit efficiency over time and note that the improvements occur over a three-year period with the highest reduction in audit effort (hours) occurring in the third year.
    • The authors also find that audit efficiencies are greater when the audit firm merges with a domestic Big 10 audit firm rather than with international Big 4 firm. The authors note that this difference could result from differences in the types of firms that the acquirers target.
    • In evaluating audit fees, the authors find that audit fees increase after an audit firm merger and the increase is not a result of market conditions.  
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Attempts to Measure Audit Quality, Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    Do Big 4 Auditors Provide Higher Audit Quality after...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality, 11.11 Impact of Firm and External Inspection Programs in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Do Big 4 Auditors Provide Higher Audit Quality after Controlling for the Endogenous Choice of Auditor?
    Practical Implications:

    The evidence presented in this paper is of interest to managers, audit committees, investors, creditors, and regulators. Managers and audit committees would like to know whether the Big 4 actually do provide higher quality audits. This information will help them choose an auditor. Given that Big 4 auditors earn a fee premium, managers and audit committees must decide whether the services they receive from the auditor are worth the premium. Investors and creditors will also be interested in the results, as this will help them assess the credibility of firms’ financial reports. Regulators are also interested in whether the Big 4 accounting firms actually provide higher quality audits.

    Citation:

    Eshleman, J. D., and G. Peng. 2014. Do Big 4 Auditors Provide Higher Audit Quality after Controlling for the Endogenous Choice of Auditor? Auditing: A Journal of Practice & Theory 33 (4): 197-219.

    Keywords:
    audit quality, audit quality proxies, Big 4 auditor, propensity-score matching
    Purpose of the Study:

    The purpose of this paper is to re-examine whether Big 4 auditors deliver higher audit quality after controlling for the endogenous choice of auditor.

    One of the earliest theories in the audit literature is that Big 4 auditors, due to their larger size and better training programs, provide higher audit quality than other auditors. The argument is that larger audit firms have more reputation to lose by sacrificing their independence on any given audit engagement. In addition, larger audit firms have more resources to invest in training programs, resulting in better trained auditors. To the extent that discretionary accruals capture opportunistic earnings management, this implies that Big 4 auditors tolerate less earnings management than other auditors. However, firms select their auditors and auditors decide if they will accept the firm as their client. Audit firms will tend to prefer less risky clients with higher earnings quality. In this study, the authors choose an audit quality proxy, which they believe better captures whether the client engaged in non-GAAP reporting. The proxy is the likelihood of a firm issuing an accounting restatement.

    Design/Method/ Approach:

    The authors use a regression model to test their hypotheses. The authors obtain financial statement data from the Compustat Fundamentals Annual file, and auditor and restatement data from Audit Analytics for the period 20002009. The first hypothesis is tested with a sample of 5,950 observations. The second hypothesis is tested with a sample of 3,248 observations.

    Findings:
    • Clients of non-Big 4 auditors are significantly more likely to subsequently issue an accounting restatement than are clients of the Big 4. This result holds after controlling for a set of innate firm characteristics known to affect the likelihood of issuing a restatement. This is consistent with non-Big 4 auditors allowing a higher frequency of material misstatements than Big 4 auditors.
    • In additional analyses, results show that clients of Big 4 auditors are significantly less likely to be sanctioned by the SEC for an Accounting and Auditing Enforcement Release (AAER) than are clients of other auditors.
    • The authors construct a matched sample of Mid-tier and small auditors. They find no evidence that Mid-tier auditors provide higher audit quality than the small audit firms.
    • The authors also construct a matched sample of Big 4 and small auditors. Clients of small auditors are significantly more likely to subsequently issue an accounting restatement than are clients of the Big 4.
    • Taken together, the evidence suggests a hierarchy of audit firms, with Big 4 auditors providing the highest audit quality, small auditors providing the lowest level of audit quality, and Mid-tier auditors providing audit quality in between the Big 4 and the small auditors.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Impact of Firm & External Inspection Programs, Proxies for Audit Quality
  • Jennifer M Mueller-Phillips
    The Effect of China’s Weak Institutional Environment on t...
    research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits.
    Practical Implications:

    This study suggests that the strength of the institutional environment can significantly influence audit quality, and subsequently financial reporting quality even for global accounting firms with standardized training and auditing procedures.  Furthermore, this study has important implications for the SEC which has voiced concerns about the quality of auditing in China, and the PCAOB which has been barred by the Chinses government from conducting inspections of auditing firms located in mainland China.

    Citation:

    Ke, B., C. S. Lennox, and Q. Xin. 2015. The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits. The Accounting Review 90 (4): 1591-1619.

    Keywords:
    Audit quality, Big 4, China
    Purpose of the Study:

    The Big 4 audit firms operate on a global scale and assert that they maintain a uniformly high level of quality around the word by providing their employees standardized training and through the global application of consistent auditing methodologies. However, there is some reason to suspect that the strength of a country’s institutional environment might influence the supply of audit quality such that Big 4 firms provide lower-quality audits in countries with relatively weak institutional environments. Because it is difficult to control for all differences between countries, this can be difficult for researchers to examine empirically. To combat this issue, this study takes advantage of a unique characteristics of Chinese firms.  Hong Kong is seen as having a stronger institutional environment relative to mainland China and firms that are listed on both the mainland exchange and the Hong Kong exchange must prepare and audit two separate sets of financial statements. This allows the authors to better isolate how variability in institutional strength affects audit quality for the clients of Big 4 firms. In particular, the study address the following research objectives:

    • Whether Big 4 firms assign their most experienced audit partners to clients who are listed on both exchanges relative to those only listed on the mainland exchange.  
    • Whether audit quality of cross-listed firms is higher than firms solely listed on the mainland exchange.
    • Whether differences in audit quality between firms that are cross-listed and firms that are only listed on the mainland China exchange lead to differences in financial reporting quality.
    Design/Method/ Approach:

    The authors use data on publicly traded Chinese companies from the years 1995-2012 to examine differences in audit quality, and financial reporting quality for firms cross-listed on both the HK exchange and the mainland China exchange, relative to firms solely listed on the mainland China exchange.  To examine differences in partner experience, the researchers utilize data from a unique dataset supplied by the Chinese Institute of Certified Public Accountants.

    Findings:
    • Partners assigned to cross-listed firms are significantly more experienced than partners assigned to clients that are not cross-listed. This suggests that Big 4 firms may assign auditors based on the strength of the institutional environment such that their more experienced auditors are assigned to stronger institutional environments.
    • Cross-listed firms are associated with higher levels of audit quality relative to firms only listed on the mainland China exchange. This is consistent with the assertion that Big 4 audit firms may provide lower-quality audits in weaker institutional environments.
    • Cross-listed firms are associated with lower levels of financial reporting quality relative to firms only listed on the mainland China exchange. This suggests that the lower level of audit quality provided by Big 4 firms in weaker institutional environments negatively impacts financial reporting quality.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Attempts to Measure Audit Quality, Diversity of Skill Sets (e.g. Tenure & Experience)
  • Jennifer M Mueller-Phillips
    Audit Firm Tenure, Non-Audit Services, and Internal...
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 04.07 Audit Firm Rotation, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality.
    Practical Implications:

    The lower quality and higher effort associated with first-year audits represent additional costs that should be considered in the ongoing debate on mandatory audit firm rotation. The differential findings for private and public clients suggest that market and related regulatory forces discipline auditors of SEC clients to maintain a high level of audit quality even when tenure is long or NAS fees are high. The findings are important for regulatory policies related to audit firm tenure and auditor-provided NAS. The finding that quality declines in private-client audits as NAS fees increase or tenure becomes long should be of interest to standard setters in the private sector.

    Citation:

    Bell, T. B., Causholli, M., & Knechel, W. R. 2015. Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality. Journal Of Accounting Research 53 (3): 461-509.

    Keywords:
    audit firm tenure, audit quality, non-audit services, independence
    Purpose of the Study:

    After decades of debate and research, the auditing profession, regulators, and researchers continue to wrestle with two longstanding concerns about perceived threats to auditor independence and audit quality: (1) Social bondingbecoming personally friendly with, or increasingly trusting of, client management, and (2) Economic bondingbecoming financially dependent on multiperiod fees from audits and non-audit services (NAS) provided to the client. Regulators have argued that social bonding from long tenure erodes professional skepticism and induces auditor complacency, while economic bonding from non-audit fees prompts auditor concessions or shirking in response to management’s financial reporting demands. On the other hand, the auditing profession has argued that there is no systemic decline in audit quality as audit firm tenure or fees from NAS increase, and that restrictions on tenure or NAS disrupt auditor learning, constrain the financial and human resources available for audit production, and impede knowledge spillovers.

    The authors use data from internal assessments of audit quality in a Big 4 firm to investigate the impact of audit firm tenure and auditor-provided non-audit services (NAS) on audit quality.

    Design/Method/ Approach:

    The data used in this study consists of audit quality assessments, audit firm tenure, audit and NAS fees, total and staff-level audit labor hours, and other key client and engagement characteristics for 265 U.S. audits conducted by a Big 4 firm for both publicly listed (57%) and privately held (43%) clients. Audit firm personnel collected the data during the annual internal quality reviews performed during late spring through early fall of 2003.

    Findings:
    • Audit quality is lowest in first-year audits, improves shortly thereafter, and declines somewhat as tenure becomes very long.
    • The probability that a second-, third-, or fourth-year audit receives a high quality rating is, on average, 21 percentage points higher than the probability for a first-year audit, while audit quality for audits where tenure is greater than 13 years is not significantly different from that of a first-year audit.
    • Audit effort is significantly higher in first-year audits in spite of discounted fees.
    • In audits of SEC registrants, quality increases slowly over the entire tenure range, while audits of private clients exhibit a rapid increase in quality in early years and an equally steep decline in later years.
    • Audit partner specialization in the client’s industry is associated with higher audit quality in both the full sample and in first-year audits. For SEC clients, the authors also find that audit quality and audit effort each are positively associated with discretionary accruals (DAs), suggesting that auditors recognize the risks associated with unusual accruals and respond by conducting more effective procedures.
    • When ex-Andersen clients are removed from the sample, the authors no longer observe lower audit quality in first year audits.
    Category:
    Audit Quality & Quality Control, Independence & Ethics
    Sub-category:
    Attempts to Measure Audit Quality, Audit Firm Rotation, Audit Firm Rotation, Non-audit Services