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  • Jennifer M Mueller-Phillips
    The influence of director stock ownership and board...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.04 Board/Audit Committee Compensation, 14.0 Corporate Matters, 14.01 Earnings Management, 14.11 Audit Committee Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The influence of director stock ownership and board discussion transparency on financial reporting quality.
    Practical Implications:

    Understanding why stock ownership can bias directors’ objectivity, and examining how board discussion transparency can yield differential effects for stock-owning and non-stock-owning directors makes it possible to anticipate the effects of increased board transparency on earnings management and directors’ decisions. The notion of increased board discussion transparency is valid in the current environment in which shareholders are pushing for “constituency board seats” because information leaks surrounding board discussions likely will result when constituent directors report back to their shareholder groups. Hence, if controversial boardroom discussions are eventually divulged to the public, the findings suggest that directors’ judgments and decisions will be influenced by knowledge of increased board transparency.

    Citation:

    Rose, J. M., C. R. Mazza, C. S. Norman, and A. M. Rose. 2013. The influence of director stock ownership and board discussion transparency on financial reporting quality. Accounting, Organizations & Society 38 (5): 397-405.

    Keywords:
    stock ownership, board of directors, transparency in organizations, earnings management, corporate governance quality
    Purpose of the Study:

    Stock ownership requirements for directors have become commonplace, and institutional investors can pressure corporate boards to rely wholly or partly on stock based forms of pay for board service. Consistent with the underlying principles of agency theory, the usual justification for stock ownership requirements is for directors to have “skin in the game,” thus aligning their personal interests with those of company shareholders. Recent archival studies strongly favor board stock ownership requirements and indicate that firms with ownership requirements exhibit better performance the year after implementing the requirements. Existing literature often equates director stock ownership with improved financial performance and improved corporate governance. On the other hand, improved firm performance associated with stock ownership could arise from a narrow focus on short-term earnings. Support for this potential alternative explanation is provided by extant archival studies indicating that managers often become myopic when paid with stock options and stock grants. In addition, recent experimental findings suggest that director stock ownership can harm objectivity and lead to biased financial reporting.

    The current study examines whether stock ownership will induce directors to go along with management’s aggressive revenue recognition in light of pressure from the Chief Audit Executive (CAE) to take a more conservative approach. In particular, the authors examine whether the effects of board stock ownership are dependent upon board discussion transparency.

    Design/Method/ Approach:

    The current study involves a 2 X 2 between-participant randomized experiment. The experiment was computerized and administered via the Internet. The authors contacted current and former CEOs and board chairs to request the participation of board members. 72 directors completed all of the response items and correctly answered manipulation check items. Of the 72 directors who are included in the final sample, there were 58 (81%) male and 14 (19%) female directors. This data was collected prior to July 2013.

    Findings:

    The authors find that stock ownership can affect directors’ independence and objectivity as well. They conclude that independence requirements resulting from SOX and adopted by the NYSE and NASDAQ focusing on board member affiliation are threatened by directors’ ownership of stock in the companies for which they serve. The authors suggest that the temptation of stock-owning directors to engage in myopic behavior that could boost the company’s stock price can be mitigated by increasing the transparency of board discussions. In examining the effects of transparency of board discussions on the likelihood of directors agreeing with management’s aggressive reporting attempts, the authors find competing effects, depending on whether directors own or do not own stock. Specifically, directors who own stock were less likely to agree with management’s aggressive reporting when board discussions were more transparent, compared to less transparent. Yet, there were no benefits of increased transparency for directors who did own stock, and directors who did not own stock were more likely to support earnings management attempts than were stock owning directors when transparency was high.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight, Earnings Management
  • Jennifer M Mueller-Phillips
    Internal Control Quality: The Role of Auditor-Provided Tax...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 13.0 Governance, 13.05 Board/Audit Committee Oversight in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Internal Control Quality: The Role of Auditor-Provided Tax Services.
    Practical Implications:

    The results of this study are important to audit regulators as they make decisions regarding policies, and to corporate governance officials as they make decisions regarding the audit firms they engage to provide tax nonaudit services. The evidence indicates that tax nonaudit services accelerate audit firm awareness of material transactions as these services are associated with a lower likelihood of a material weakness in internal controls. In addition, further evidence supports that this finding is not simply due to impaired auditor independence. Overall, this suggests that tax nonaudit services provided by the audit firm improve internal control quality. As regulators and companies evaluate the consequences of tax nonaudit services, the findings in this paper may impact their conclusions.

    Citation:

    De Simone, L., M.S. Ege, and B. Stomberg. 2015. Internal Control Quality: The Role of Auditor-Provided Tax Services. The Accounting Review. 90(4): 1469-1496.

    Keywords:
    auditor fees, nonaudit services, auditor independence, internal controls, tax, financial reporting quality
    Purpose of the Study:

    Audit regulators and companies’ corporate governance officials are charged with understanding and creating policies for auditor provided nonaudit services. To make informed decisions, it is important for these groups to know the benefits and costs of auditor provided nonaudit services. Previous research has reported a positive association between tax nonaudit services and financial reporting quality and audit quality. This paper investigates the relationship between tax nonaudit services and a specific component of financial reporting quality: internal control quality. Specifically, the authors:

    • Examine the relationship between tax nonaudit services and the probability of a material weakness in internal controls (i.e. internal control quality).
    • Examine whether tax nonaudit services are beneficial to companies experiencing a shock to their internal control environment.
    • Examine how the relationship between tax nonaudit services and internal control quality is affected by audit firm tenure.

    The authors also explain the process through which they propose tax nonaudit services affects non-tax financial reporting quality.

    Design/Method/ Approach:

    The authors collected auditor internal control opinions and data necessary to calculate control variables on publicly-traded companies that are subject to SOX Section 404(b). The information collected on these companies was for years 2004-2012.

    Findings:
    • The authors find that companies that purchase tax nonaudit services are significantly less likely to disclose a material weakness. A one standard-deviation increase in tax nonaudit services is associated with approximately a 13% decrease in the rate of material weaknesses relative to the base rate. Further analysis indicates that impaired auditor independence does not account for this result.
    • The authors find that when companies experience a significant shock to their internal control environment, tax nonaudit services incrementally benefit internal control quality relative to other companies.
    • The authors find that the benefits of tax nonaudit services on internal control quality are greater in the early years of audit firm tenure.
    Category:
    Governance, Independence & Ethics, Internal Control
    Sub-category:
    Board/Audit Committee Oversight, Non-audit Services, Reporting Material Weaknesses
  • Jennifer M Mueller-Phillips
    Board Interlocks and Earnings Management Contagion.
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.05 Board/Audit Committee Oversight in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Board Interlocks and Earnings Management Contagion.
    Practical Implications:

    The evidence on the firm-to-firm spread of financial reporting behavior via board networks contributes to a little-studied area in accounting that should be important. The authors contribute to the corporate governance literature by offering evidence that contagion effects vary with board positions. They show that board supervision of management is important for ensuring high-quality financial reporting and that board linkages affect the success of this supervision. Regulators concerned about improving financial reporting quality should consider the board connectivity of companies.

    Citation:

    Chiu, P. C., S. H. Teoh, and F. Tian. 2013. Board Interlocks and Earnings Management Contagion. Accounting Review 88 (3): 915-944.

    Keywords:
    board interlocks, board networks, contagion, earnings management, governance, restatements, social networks
    Purpose of the Study:

    In the corporate world, behavior may spread through board of director networks. A board link exists between two firms whenever a director sits on both firms’ boards. A typical board in the sample has nine directors, and the median number of interlocks with other boards is approximately five. In this way, firms are widely connected by their board networks, which potentially serve as conduits for spreading behaviors from firm to firm.

    In this study, the authors investigate whether financial reporting behavior spreads through interlocking corporate boards. The test design emphasizes contagion of bad financial reporting choices, specifically, earnings management that results in a subsequent earnings restatement, although it also allows for inferences about good reporting contagion. The authors use restatements to identify firms that have managed earnings and the period when the manipulation occurred. They refer to a firm that later restates earnings as contagious. The authors define the contagious period as starting in the first year for which earnings are restated and ending two years after. Any firm that shares an interlocked director with the contagious firm during the contagious period is therefore exposed to an earnings management infection via the board network. They consider a multiyear contagious period to allow the earnings management infection to incubate, which is analogous to an epidemiological setting for viral infections. The key test investigates whether an exposed firm is more likely to manage earnings during the contagious period as compared to an unexposed firm.

    Design/Method/ Approach:

    The authors use the U.S. Government Accountability Office’s (GAO) first release of restatements between January 1, 1997 to June 30, 2002 to identify contagious firms and their contagious periods. They keep only the earliest restatement within the sample period when a firm has multiple restatements. The authors obtain director names from Risk Metrics. In the 19972001 sample period the authors identify a sample of 118 observations.

    Findings:
    • The authors find strong evidence that a firm is more likely to manage earnings when exposed within a three-year period to earnings management from a common director with an earnings manipulator. The contagion effect is economically substantial.
    • The regression odds ratio suggests that a board link to a manipulator doubles the likelihood that the firm will manage earnings.
    • The authors also find evidence for good financial reporting contagion. A board link to a non-manipulator significantly decreases the likelihood of the firm being a manipulator.
    • Both bad and good accounting behaviors are contagious across board networks.
    • Earnings management contagion is stronger when the shared director has a leadership position as board chair or audit committee chair, or an accounting-relevant position as an audit committee member, in the exposed firm.
    • The contagion is also stronger when the linked director is the board chair or CEO of the contagious firm, but not when the linked director is the CEO of the exposed firm.
    • Earnings management contagion is exacerbated when the exposed firm is located within 100 miles of the contagious firm and shares a common auditor with the contagious firm.
    • The evidence supports the proposition that earnings manipulation spreads through board networks.
    Category:
    Accountants' Reporting, Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Board/Audit Committee Composition, Board/Audit Committee Oversight, Earnings Management, Earnings Management, Restatements
  • Jennifer M Mueller-Phillips
    Audit committee stock options and financial reporting...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 13.0 Governance, 13.04 Board/Audit Committee Compensation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit committee stock options and financial reporting quality after the Sarbanes-Oxley Act of 2002.
    Practical Implications:

    This study contributes to existing literature by re-examining the relationship between audit committee compensation and financial reporting quality. The findings indicate the continuance of a negative relationship between audit committee members’ stock-option compensation and financial reporting quality in the post-SOX era. These results are relevant to regulators, compensation committees, and auditors because they imply that shifting audit committee director compensation away from stock options has the potential to improve financial reporting quality.

    Citation:

    Campbell, J. L., J. Hansen, C. A. Simon, and J. L. Smith. 2015. Audit Committee Stock Options and Financial Reporting Quality after the Sarbanes-Oxley Act of 2002. AUDITING: A Journal of Practice & Theory 34 (2):91-120.

    Keywords:
    audit committee quality, financial reporting oversight, financial reporting quality, independence
    Purpose of the Study:

    The Sarbanes-Oxley Act (SOX) was passed by Congress in 2002 in order to improve the accuracy and reliability of corporate disclosures. The introduction of SOX resulted in a substantial increase in audit committee members’ required level of independence and responsibility. In defining independence, however, regulators did not restrict companies from providing equity incentives for audit committee members. Pre-SOX research has shown stock option incentives to be associated with lower financial reporting quality. This study aims to re-examine the association between audit committee equity-based incentives and financial reporting quality (as proxied by a company’s propensity to meet or beat its consensus analyst forecast) in the post-SOX environment.

    Design/Method/ Approach:

    After removing problematic data, the sample collected for the study consisted of audit committee members’ equity holdings and compensation data for a sample of 2,172 company-year observations from 2006 to 2008. This information was then used in conjunction with a series of probit models in order to examine whether audit committee member’ equity incentives are associated with the likelihood of meeting or beating the analyst forecast. In order to mitigate the effect of outliers, the top and bottom 1% of the selection was winsorized.

    Findings:

    Findings were consistent with stock-option incentives being associated with lower financial reporting quality. Specifically, it was found that:

    • 58.8 percent of the average audit committee members’ pay is in the form of stock options and grants.
    • The likelihood of meeting or beating analyst expectations is positively associated with audit committee members’ stock-option compensation and holdings.
    • There is no association for non-equity compensation and holdings, and meeting or beating analyst expectations.
    • A company whose audit committee holds the mean value of exercisable options (i.e., about $200,000 in exercisable options) is associated with a 10.0 percent increase in the likelihood of meeting or beating its consensus analyst forecast.
    • A high-growth opportunity company whose audit committee holds the mean value of exercisable options is associated with a 17.8 percent increase in the likelihood of meeting or beating its consensus analyst forecast.
    Category:
    Governance, Independence & Ethics
    Sub-category:
    Board/Audit Committee Compensation, Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Welcome to the day-to-day of internal auditors: How do they...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Welcome to the day-to-day of internal auditors: How do they cope with conflict?
    Practical Implications:

    This study makes an original contribution to the development of new knowledge on internal auditing. It concludes that internal auditors tend to lack independence and audit committee members often exercise disturbingly weak power (on the internal audit function), as compared to the top managers. This points to the difficulty of applying an idealized conception of independence and purist governance principles to practice. That is, it encourages auditors to consider the appropriateness of internal auditing as a meaningful independent assurance device in operating the corporate governance "mosaic."

    Citation:

    Roussy, M. 2015. Welcome to the day-to-day of internal auditors: How do they cope with conflict? Auditing: A Journal of Practice and Theory 34 (2): 237-264.

    Keywords:
    audit committee, conflicts, coping, independence, internal audit
    Purpose of the Study:

    The internal audit function (IAF) was made mandatory in both private and public companies in North America in the early 2000s. This paper proposes a ''micro-level'' analysis of the way in which internal auditors express role conflicts in their day-to-day practice and how they perceive, manage, and resolve them. The study seeks to show that the independence of the internal auditor is often not up to the standards that are expected of the internal audit function (IAF), and therefore unlikely to play an effective governance oversight role compatible with the ideal of the new public management governance reform.

    Design/Method/ Approach:

    A field study was conducted involving semi-structured interviews with 42 internal auditors working in 13 public sector organizations. Interviews were conducted between May and October 2010. Each interviewee had 10-15 years of experience in internal auditing, with 20-25 years of professional experience total. Data was interpreted in the light of a theoretical analysis framework designed especially for this study. Organizational and social context was taken into consideration for each interview.

    Findings:

    Overall, the results indicate that internal auditors have a relative lack of independence (as compared with the Institute of Internal Auditors’ standards.) More specifically:

    • While internal auditors are strategic in managing conflicts, they do not consider the cumulative effect that their coping behavior has on their lack of independence.
    • The audit committee does not greatly influence internal auditors’ coping tactics at any stage in the audit process.
    • Auditors use “pragmatic” behavior because they are embedded in a specific organizational and social context that they are ‘‘forced’’ to take into account.
    • The analysis casts doubt on the audit committee’s ability and commitment to consolidate and ensure internal auditor independence.

    Ultimately, the study concludes that internal auditors behave as if the IAF were a means for managerial control, instead of a governance mechanism.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Board Monitoring and Endogenous Information Asymmetry.
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience, 14.10 CEO Compensation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Board Monitoring and Endogenous Information Asymmetry.
    Practical Implications:

    The author claims that motivating the CEO to reveal information may or may not be beneficial. The disconnection between compensation and outcomes results from active monitoring. Compensation contracts rely on board evaluation, not on the final outcomes, to provide incentives. The proactive board activity can result in poor firm performance. This proactive activity requires extra care to reign in an expert: the CEO.

    Citation:

    Tian, J. J. 2014. Board Monitoring and Endogenous Information Asymmetry. Contemporary Accounting Research 31 (1): 136-151.

    Keywords:
    boarding monitoring, information acquisition, information asymmetry, project decision, executive compensation, CEO compensation
    Purpose of the Study:

    Boards of directors are frequently questioned pertaining to their monitoring role in executive decision making and compensation. The sequence of financial fraud in the early 2000s called public attention that boards have not done enough to align executive incentives with shareholders’ interests. Since shareholders do not normally observe executives’ actions and may not even know what actions executives should have taken to maximize shareholder value, increasing board effort to reduce such information asymmetry is commonly viewed as desirable.

    The present study challenges this common view that increasing board effort in monitoring is always desirable. This view neglects a key fact in corporate decision making: the information asymmetry between the CEO and shareholders is a result of the CEOs expertise. This study highlights the fact that CEOs are hired for their superior ability to make strategic decisions, particularly for their unique skills to acquire, process and interpret information relevant to these decisions.

    Design/Method/ Approach:

    The authors uses analytical modeling to conclude on the questions of interest.

    Findings:

    If board monitoring eliminates all information asymmetry, the board can easily ensure that decisions are made in the best interest of shareholders. It resolves all uncertainty in the remaining decision problems. However, preserving uncertainty is crucial ex ante in order to motivate a risk-averse CEO to acquire information, as effort need not be expended if there is no concern for uncertainty. Thus, board monitoring creates a time consistency problem for the CEO to acquire information.

    The board should actively engage in monitoring activities only when the board is able to evaluate the information provided by the CEO with high accuracy. That is, when board monitoring is able to produce enough information about the CEO’s effort directly, preserving uncertainty to incentivize the CEO to acquire information is a second-order concern. However, if a project requires special skills for implementation and board evaluation may not be accurate enough, it is better for the board to remain passive and not interfere with the CEO’s decisions.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Board/Audit Committee Oversight, CEO Compensation, CEO Tenure & Experience
  • Jennifer M Mueller-Phillips
    Chief Financial Officers as Inside Directors.
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 14.0 Corporate Matters, 14.06 CFO Tenure and Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Chief Financial Officers as Inside Directors.
    Practical Implications:

    These results have implications for boards when deciding on the appointment or replacement of insiders to the board. Specifically, since only a few non-CEO executives can be granted a board seat, the board should carefully consider which executive would enhance the effectiveness of the board. The results demonstrate that the CFO can enhance board effectiveness with respect to the quality of the financial reports. Yet, the results also show that CFOs who serve on the board are more entrenched. Therefore, boards should carefully consider whether the benefits of appointing the CFO to their board outweigh the costs.

    Citation:

    Bedard, J. C., Hoitash, R., and Hoitash, U. 2014. Chief Financial Officers as Inside Directors. Contemporary Accounting Research 31 (3): 787-817.

    Keywords:
    chief financial officers (CFO), organizational structure, board of directors, financial statements
    Purpose of the Study:

    Chief financials officers possess specialized knowledge and play a key role in the current economic and regulatory environment. This is the first study to distinguish a specific board insider, the CFO, from other insiders based on that officer’s specific knowledge and role within the corporate hierarchy. The authors investigate the association between the inclusion of a company’s chief financial officer on its board of directors with financial reporting quality and with CFO entrenchment. They examined first how financial reporting quality is affected by board membership of the CFO based on two contrasting perspectives. The first is consistent with the agency theory that a board seat provides officers with power and influence; thus, there could be negative consequences from reduced board independence associated with officer appointments. With CFOs on the board, the authors could observe lower financial reporting quality among companies making this choice. On the other hand, the CFO can positively contribute to board effectiveness by improving mutual advice and collaboration. Companies should perform better in those areas relating to CFO functions. The second concern is the risk of entrenchment at the cost of investors.

    Design/Method/ Approach:

    The authors used a sample of 7,034 firm year observations. The study sample is based on companies included in the Audit Analytics governance database for 2004 through 2007. The main results are reported using two-stage models. The first stage addresses factors associated with the presence of the CFO on the board, and the second stage tests the association of CFO board membership with financial reporting quality, CFO compensation, and turnover.

    Findings:
    • Companies with CFOs on the board have more effective internal control over financial reporting, higher accruals quality, and lower likelihood of restatements.
    • The results showed a 4.28 percentage point reduction in material weakness (MW) disclosure likelihood.
    • This suggests that suggest that these CFOs are more likely to share information with other board members about the status of the financial reporting function and secure sufficient resources to invest in the establishment, documentation, and testing of internal controls.
    • The results implied that CFOs are more aligned with shareholder interests.
    • CFOs who serve on their own boards receive 26.9 (36.3) percent higher cash (total) compensation.
    • Further, CFOs serving on their own boards are less likely to face turnover following poor corporate performance. However, the authors also find that board membership does not protect the CFO from turnover when poor performance relates specifically to financial reporting quality.
    • These results suggest that serving on the board generally enables CFOs to gain more resources from the company and avoid penalty in times of difficulty, unless that difficulty is related to their direct responsibility.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Board/Audit Committee Composition, CFO Tenure & Experience
  • Jennifer M Mueller-Phillips
    Does Internal Audit Function Quality Deter Management...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Does Internal Audit Function Quality Deter Management Misconduct?
    Practical Implications:

    These findings suggest that regulators, audit committees, and other stakeholders should consider ways to improve IAF quality, specifically IAF competence, and IAFs improve corporate governance by assisting audit committees in monitoring management. This study provides empirical evidence consistent with the proposition that IAF quality and competence deter management misconduct. IAF quality and, particularly, IAF competence are important in deterring observable instances of management misconduct, both accounting- and nonaccounting-related. These findings are important because in the early 2000s, regulators responded to public outcry over observable management misconduct, yet IAF quality was largely left out of the regulatory debate and reforms that followed.

    Citation:

    Ege, M. S. 2015. Does Internal Audit Function Quality Deter Management Misconduct? Accounting Review 90 (2): 495-527.

    Keywords:
    corporate governance, internal audit function, internal audit quality, management misconduct
    Purpose of the Study:

    This study examines the relation between internal audit function (IAF) quality, as defined by standard-setters, and the likelihood of management misconduct, such as financial reporting fraud, bribery, and misleading disclosure practices. Standard-setters posit that IAFs serve as a key resource to audit committees for monitoring senior management and that high-quality IAFs deter management misconduct. However, U.S. regulators do not enforce IAF quality or require disclosures relating to IAF quality. The U.S. Securities and Exchange Commission (SEC) proposed requirements to increase IAF quality by adding the appointment, compensation, retention, and oversight of the internal auditor to audit committee responsibilities, but these proposed requirements were abandoned. Ten years later, after withdrawing its recent proposal to require high-quality IAFs, NASDAQ is considering how to revise the proposed rules. These proposals demonstrate the need for evidence regarding whether IAF quality results in improved monitoring of management.

    This study informs standard-setters, regulators, audit committees, and shareholders about whether IAF quality deters management misconduct incrementally to other monitors.

    Design/Method/ Approach:

    The author obtained the initial sample from the Institute of Internal Auditors’ proprietary Global Auditing and gathered additional information from COMPUSTAT. The final sample covers 1,398 firm-years representing 617 unique firms from 2000 through 2009. The management misconduct sample comes from four data sources: the Federal Securities Regulation Database, the Stanford Securities Class Action Clearinghouse, SEC’s website and the Department of Justice website.

    Findings:

    The author finds a negative relation between IAF quality and management misconduct, even after controlling for other determinants of misconduct, including board of director, audit committee, and external auditor quality. This effect is economically significant, as a firm with IAF quality one standard deviation above the mean is approximately 2.3 percentage points less likely to have management misconduct than a firm with average IAF quality. This is approximately 29.5 percent of the 7.7 percent unconditional probability of management misconduct. Further analysis reveals that IAF competence, but not objectivity, is negatively related to the likelihood of management misconduct, suggesting that IAF competence is important in deterring management misconduct.

    Misconduct firms have low IAF quality and IAF competence during misconduct years as compared to a matched sample of firms. Then, in post-misconduct years, misconduct firms increase IAF quality through IAF competence. This increase in competence is due to hiring more certified internal auditors and increasing training. However, misconduct firms do not appear to have lower IAF objectivity during or after misconduct years compared to a matched sample. These results are consistent with the proposition from standard-setters that IAFs serve as a key resource for audit committees in monitoring management.

    The findings suggest that high-quality IAFs are effective at deterring both types of management misconduct. Disclosures related to IAF quality would assist stakeholders in predicting accounting-related management misconduct.

    Category:
    Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Management Integrity
  • Jennifer M Mueller-Phillips
    Transplanting Anglo-American Accounting Oversight Boards to...
    research summary posted July 23, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 15.0 International Matters in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Transplanting Anglo-American Accounting Oversight Boards to a Diverse Institutional Context.
    Practical Implications:

    This study is of relevance to several other countries that exhibit, albeit to varying degrees, a tradition of party patronage, clientelism, institutional weaknesses and state ineffectiveness. The findings have implications for various actors and stakeholders in financial reporting. For example, global regulators should realize that independence from the profession, while simultaneously ignoring local institutional impediments, by no means guarantees the operation of effective national OBs across the globe. Furthermore, in the absence of effective oversight, particularly amid a severe financial crisis, there is a real risk that the quality of auditing will fall and audit fees will plunge, conditions that may bring about a major legitimation crisis for the profession.

    Citation:

    Caramanis, C., Dedoulis, E., & Leventis, S. 2015. Transplanting Anglo-American accounting oversight boards to a diverse institutional context. Accounting, Organizations & Society (42):12-31.

    Keywords:
    accounting legislation, auditing oversight boards, diverse institutional context, international accounting
    Purpose of the Study:

    Accounting and auditing oversight boards (OBs) serve as a basic mechanism for tackling perennial problems in corporate financial reporting and auditing, within the broader complex and hierarchical global regulatory system. The introduction of accounting and auditing oversight boards (OBs) has been promoted on a global scale as a key component of the international financial architecture that has emerged over the past two decades. Such institutions, modeled on the Anglo-American tradition, are domestically organized and embedded within distinctively diverse institutional contexts. Their role is to ease agency problems, improve the quality of financial reporting, and help provide stability in the global financial system.

    The authors employ an institutional approach, located within the broader political economy framework of global capitalism, to examine the establishment and operation of the new regulatory regime in Greece. The authors place emphasis on the interaction between global structural elements, institutions, influences and pressures, and on local socio-political characteristics that may condition the establishment and effective operation of OBs at the local (state) level. The focus on Greece offers a clear vantage point for examining the issue at hand for two main reasons. First, the country is known for its clientelistic political system and well-documented reform (in)capacity problems. Second, Greece has been in a deep, multifaceted crisis since 2008, illustrating the importance of each nation to the stability of the new, complex, and interdependent international financial system.

    Design/Method/ Approach:

    This study follows a case study research design and its empirical part, which spans the period 20032014, is based on a mix of data sources and triangulation research methodology. The data sources include publically-available archival material. The written evidence is supplemented with 10 focused, semi-structured, face-to-face interviews. The interviews covered, depending on the interviewee’s personal knowledge, a series of issues related to the establishment and performance of ELTE (the Accounting and Audit Committee).

    Findings:
    • The findings show that deeply-ingrained domestic socio-political characteristics of a delegative nature have indeed inhibited the development and operation of the local Greek OB. The newly-established OB has been affected by the all-pervasive clientelistic political system, the weaknesses of state apparatus, and the country’s reform (in)capacity problems.
    • The appointment of ELTE’s elite has been decided by successive governments, mainly on the basis of clientelism and political patronage.
    • The Greek OB has remained in a dormant state since its inception. It still lacks appropriate infrastructure and sufficient administrative personnel and has not been granted permission by the government to appoint its own audit quality inspectors. As a consequence, the performance of audit quality inspections has been, at best, erratic.
    • ELTE, as an institution, has failed to become a significant decisional point in the flow of influence, power and policy in the realm of accounting, which is so important for effecting progress.
    • The analysis shows that ELTE’s decade-long failure is related to the country’s delegative characteristics. The Ministry of Economy has failed to take effective corrective action and there is evidence of distrust or distaste toward truly independent authorities that would act as mechanisms of horizontal control.
    Category:
    Governance, International Matters
    Sub-category:
    Board/Audit Committee Oversight
  • Jennifer M Mueller-Phillips
    The legitimacy of new assurance providers: Making the cap...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The legitimacy of new assurance providers: Making the cap fit.
    Practical Implications:

    The central concern of this paper is the struggle by newly appointed auditors for legitimacy in a discretionary assurance space. In these domains, auditors are unable to rely on their traditional state-backed monopoly of financial audit. This paper examines efforts to establish jurisdiction by parties positioned in new assurance roles. This involved negotiating a complex and challenging terrain comprising clubs seeking to push their own interests and mistrust about the proprietary of rival club’s practices and bona fides. The authors highlight practical coping mechanisms employed to boost the legitimacy of the new audit functions.

    Citation:

    Andon, P., Free, C., & Sivabalan, P. 2014. The legitimacy of new assurance providers: Making the cap fit. Accounting, Organizations & Society 39 (2): 75-96.

    Keywords:
    salary caps in sports, auditing, organizational legitimacy
    Purpose of the Study:

    As the emerging vistas of auditing in the 21st century become more diverse and far-reaching than ever, the movement of assurance beyond the traditional boundaries of the financial audit raises important questions about the extent to which conventional audit concepts can travel to new fields, as well as the receptivity of new fields to purveyors of new assurance services. Recognizing a growing interest in auditing and assurance in new audit spaces, the authors aim to investigate efforts by auditors to establish jurisdiction in new audit spaces through two in-depth field studies of the positioning of salary cap auditors in the National Rugby League (NRL) in Australia and Canadian Football League (CFL) in Canada. The salary cap auditor in each league has established himself as a respected and widely recognized figure that has been increasingly invoked as a symbol of fair-play and propriety by leaders.

    Design/Method/ Approach:

    The authors employed a comparative case study design of the role of the salary cap auditor in two high-profile professional sports leagues  the NRL in Australia and the CFL in Canada. They investigate these issues through an in-depth review of archival sources and 18 interviews with key stakeholders in the NRL and CFL salary cap. The evidence was gathered prior to 2014.

    Findings:

    In these cases, at the intersection of the fields of accounting and football, the authors identify a number of legitimating strategies employed in order to build symbolic capital for the respective auditors. These strategies take the form of practical coping mechanisms  purposive, pragmatic action aimed at resolving an immediate impediment at hand rather than some grand, overall purposeful scheme. Three important practical gambits used in both cases, although differently pursued, were:

    1. Conscious ingratiation;
    2. Sanctioning; and
    3. Appeals to fairness, a key doxic notion in both fields. 

    Despite inhabiting similar roles, the appointed auditors are shown to possess markedly different backgrounds and employ different resources, tactics and dispositions to impose themselves in their roles. In the NRL case, the selection and positioning of the auditor was importantly influenced by a drawn out ownership battle that led to deep antagonism and mistrust between factions of the game’s administration. Several interviewees talked about the premium placed on the social capital and commitment of an ‘insider’ who was widely known and respected within rugby league circles. In the CFL case, the salary cap auditor appointment was made amid ongoing concerns about the financial viability of the league. This conferred significant value on cultural capital relating to financial management, particularly in the skills attached to forensic accounting expertise.

    Category:
    Governance