Brand Name Audit Pricing,Industry Specialization,and Leadership Premiums post‐Big 8 and Big 6 Mergers*

This paper investigates brand name, industry specialization, and leadership audit pricing in the wake of the mergers that created the Big 6 and the Big 5 accounting firms. For samples of Australian listed public companies in each of the postmerger years 1990, 1992, 1994, and 1998, we estimate national audit fee premiums for the Big 6/5 auditors and the industry specialists and leaders. We find limited support for the ability of the Big 6/5 to obtain fee premiums over non‐Big 6/5 for those industries not having specialist auditors. Nonspecialist Big 6/5 auditors are able to obtain fee premiums over nonspecialist non‐Big 6/5 auditors for those industries having specialist auditors. However, this result only holds among the smaller half of our sample. We do not find strong support for the presence of industry specialist premiums in the postmerger years, especially after 1990, using various definitions of industry specialist. We find, at best, limited support for the presence of industry leadership premiums. The evidence suggests that after the Big 8/6 audit firm mergers, some caution is required in generalizing the Craswell, Francis, and Taylor 1995 finding of national market industry specialist premiums. More generally, the study raises questions about the tenuous link between the concept of specialization and national market‐share statistics.     

The Impact of R&D Intensity on Demand for Specialist Auditor Services*

The audit fee research literature argues that auditors' costs of developing brand name reputations, including top‐tier designation and recognition for industry specialization, are compensated through audit fee premiums. Audited firms reduce agency costs by engaging high‐quality auditors who monitor the levels and reporting of discretionary expenditures and accruals. In this study we examine whether specialist auditor choice is associated with a particular discretionary expenditure ‐ research and development (R&D). For a large sample of U.S. companies from a range of industries, we find strong evidence that R&D intensity is positively associated with firms' choices of auditors who specialize in auditing R&D contracts. Additionally, we find that R&D intensive firms tend to appoint top‐tier auditors. We use simultaneous equations to control for interrelationships between dependent variables in addition to single‐equation ordinary least squares (OLS) and logistic regression models. Our results are particularly strong in tests using samples of small firms whose auditor choice is not constrained by the need to appoint a top‐tier auditor to ensure the auditor's financial independence from the client.     

Do Clients Get What They Pay For? Evidence from Auditor and Engagement Fee Premiums

Despite the intuitive appeal, prior research finds mixed evidence on whether higher audit fees translate to superior audit quality. Under the assumption that product differentiation between auditors is based, in large part, on the level of financial statement assurance, we propose more refined measures of excess audit fees that separate auditor premiums from other fee premiums. Consistent with our conjecture, we identify significant variation in audit pricing across auditors (i.e., auditor premiums) that relates positively to audit quality. Conversely, we find no evidence that higher engagement‐specific fee premiums (i.e., fee model residuals) are positively related to proxies for audit quality. Additional tests indicate that our results do not simply reflect premiums attributable to auditor characteristics evaluated in prior research (e.g., Big 4 membership, office size, and industry expertise). In fact, our findings suggest that the positive association between auditor premiums and audit quality is better captured at the auditor level than it is at the auditor “tier,” office, auditor‐industry, or engagement levels. In sum, our results suggest that auditors charging higher fees, on average, deliver superior levels of financial statement assurance, but engagement‐specific fee premiums do not reflect quality‐enhancing audit effort. These contrasting results provide a possible explanation for the mixed findings in prior research.     

IQ and Audit Quality: Do Smarter Auditors Deliver Better Audits?

This study examines the role of an individual auditor's cognitive ability in delivering high‐quality audits. Our results from analyzing archival data from Sweden show that audit partners' IQ scores obtained from psychological tests are positively associated with going‐concern audit reporting accuracy and audit fee premiums. We also find some, albeit weak, evidence that audit partners' IQ scores are negatively associated with the income‐increasing abnormal accruals of the client. These results suggest that, although audit services are standardized through various control mechanisms and audits are conducted by teams rather than by individual auditors, the cognitive ability of audit partners responsible for an audit remains important in delivering high‐quality audit services.     

Outsourcing and Audit Risk for Internal Audit Services*

Some companies now outsource their internal audit function to public accountants. Internal auditors and accounting firms disagree about the merits of outsourcing. Each type of auditor claims to provide more cost‐effective services and appears to claim superior expertise. This paper uses agency theory to examine outsourcing and reconciles the outsourcing debate without resorting to differential auditor expertise. Under the assumptions that public accountants' “deep pockets” provide incentives to outsource and their higher opportunity cost provides a disincentive, we characterize the optimal employment contract with each auditor. We find that public accountants provide higher levels of testing, but possibly for a higher expected fee. This result supports both the internal auditor's claim as the lower cost provider, and the public accountant's claim of higher quality. We also find that incentives to outsource generally increase in various measures of risk, including the risk that a control weakness exists and the size of the loss that can result from an undetected control weakness.     

Does Audit Committee Accounting Expertise Help to Promote Audit Quality? Evidence from Auditor Reporting of Internal Control Weaknesses

In this study, we examine whether audit committee accounting expertise helps to promote audit quality by motivating auditors to conduct diligent internal control audits and make appropriate internal control assessments because audit committee accounting expertise safeguards auditors from dismissal following adverse internal control opinions. Among clients with existing and likely internal control material weaknesses (as proxied by future restatements of audited financial statements), we find a greater likelihood of adverse internal control audit opinions when the audit committee has greater accounting expertise (measured by the proportion of accounting experts on the audit committee). Among all clients, we find a lower likelihood of subsequent auditor dismissal following an adverse internal control audit opinion when the audit committee has greater accounting expertise. In further analyses, we find that this lower likelihood of subsequent auditor dismissal occurs when at least two audit committee members possess accounting expertise. We also find some evidence that CFO influence (but not CEO influence) over the audit committee negates the increased likelihood of adverse internal control opinions when internal control material weaknesses likely exist, as well as the decreased likelihood of auditor dismissal following adverse internal control opinions. These findings have important implications for regulators and corporate nominating committees interested in promoting audit committee effectiveness.     

The Use and Characteristics of Foreign Component Auditors in U.S. Multinational Audits: Insights from Form AP Disclosures*

This paper investigates the common, yet previously opaque, practice of using foreign audit firms (component auditors) to conduct portions of audit work for U.S. public companies. U.S. regulators have expressed concern for the transparency and quality of audits using component auditors. Employing data disclosed in the newly mandated PCAOB Form AP, we find that component auditor use is largely structural, determined by the size and complexity of clients' multinational operations. We do not find that the mere use of component auditors is detrimental to audit outcomes, but rather the amount of work conducted by component auditors is associated with lower audit quality (i.e., higher likelihood of misstatement), higher likelihood of nontimely reporting, and higher audit fees, which collectively suggest that component auditor engagements are associated with adverse outcomes. Furthermore, we find that only the work performed by less competent component auditors and those facing geographic and cultural/language barriers, including significant geographic and cultural distance, weak rule of law, and low English language proficiency, is associated with adverse audit outcomes. Overall, these findings provide initial archival evidence that the use of certain component auditors on U.S. multinational audits is associated with audit coordination issues, which suggests that PCAOB Form AP disclosures provide relevant information.     

Auditors' Responses to Workload Imbalance and the Impact on Audit Quality*

Using detailed data for fieldwork hours and audit hours by rank from audit engagements in Korea, we examine whether audits conducted under workload imbalance, proxied by busy‐season audits, impair audit quality, and how auditors adjust staff assignments for busy‐season audits. We generally find that busy‐season audits are associated with lower audit quality, and that audit firms reduce the involvement of senior auditors during busy‐season audits. In addition, the greater the involvement of senior auditors and junior auditors, the lesser the deterioration in audit quality. Finally, although there is no increase in interim audits in response to workload imbalance during busy seasons, increasing interim audits can mitigate the negative impact of busy‐season audits on audit quality. Our results are relevant to auditors and regulators, who have expressed concerns about the adverse effects of workload imbalance on audit quality.     

Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective

We study the pricing of audit services for strategic alliances, a governance structure involving an incomplete contract between separate firms. Since incomplete contracts do not specify all future contingencies, we expect that the nonverifiability of information and potential agency behavior in alliances increase audit complexity, resulting in higher audit fees. Our findings support this prediction. We then separate strategic alliances into joint ventures and contractual alliances, as the latter involve more complexity. We find that our audit fee results are largely driven by contractual alliances. We perform additional tests to rule out the concern that our audit fee results might be attributable to the impact of strategic alliances on distress risk, audit risk, or control risk. Contrary to the distress risk argument, we find that auditors are less likely to issue going‐concern modified opinions when there is an increase in strategic alliances. Contrary to the audit risk argument, we find that an increase in strategic alliances is unrelated to the likelihood of financial misstatements. Contrary to the control risk argument, we find that an increase in strategic alliances is unrelated to internal control weakness opinions.     

Auditor Fees and Fraud Firms

The issue of whether auditor fees affect auditor independence has been extensively debated by regulators, investors, investment professionals, auditors, and researchers. The revised Securities and Exchange Commission (SEC) requirements that resulted from the implementation of the Sarbanes‐Oxley Act (2002) limit nonaudit services (NAS) and mandate NAS fee disclosure. The SEC's requirements are based on the argument that auditor independence could be impaired—and hence audit quality may be reduced—when auditors become economically dependent on their clients or audit their own work. Economic bonding leads to reduced independence, which can lead to reduced audit quality. We study a sample of firms sanctioned by the SEC for fraudulent financial reporting in Accounting and Auditing Enforcement Releases (SEC‐sanctioned fraud firms) and examine whether there is a relationship between auditor fee variables and the likelihood of being sanctioned by the SEC for fraud. We use SEC sanction as a measure of audit quality that has not previously been used in the auditor fee literature and is more precise than some of the other proxies used for flawed financial/auditor reporting. We find, in univariate tests, that fraud firms paid significantly higher (total, audit, and NAS) fees. However, in multivariate tests, when controlling for other fraud determinants and endogeneity among the fraud, NAS, and audit fee variables, we find that while NAS fees and total fees are positively and significantly related to the likelihood of being sanctioned by the SEC for fraud, audit fees are not. These findings suggest that higher NAS fees may cause economic bonding, thereby leading to reduced audit quality. Our findings of significantly higher NAS fees and total fees in fraud firms hold after controlling for latent size effects and other rigorous testing. These results contribute to the literature that examines the SEC's concerns regarding NAS and can be used by policy makers for additional consideration.     

制度背景、审计师特征与审计质量研究

利用2011-2015年的A股上市公司财务数据,以及中国注册会计师协会网站手工收集的注册会计师的信息,采用固定效应回归模型,考察审计师特征对审计质量的影响。研究发现,女性、高学历、合伙人和接受过会计专业教育的注册会计师主持项目的审计质量高。进一步研究发现,政府监管和媒体监督在审计师特征影响审计质量中发挥着正向调节作用,主要研究结论在一系列稳健性测试后依然成立。研究表明,审计师特征和制度背景是影响审计质量的重要因素,研究对会计师事务所、政府监管部门具有重要启发意义。     

Auditor Responses to Shareholder Activism

In this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions (ICOs) and first‐time going concern opinions (GCOs). Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors' concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse ICOs documented in our baseline tests reflects higher‐quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.     

Do Clients’ Enterprise Systems Affect Audit Quality and Efficiency?

Enterprise systems (ESs) are widely used to support business processes along the enterprise value chain. It has been shown that ESs, by integrating business functions and making information about day‐to‐day activities available, enhance operational transparency and improve the internal information environment. However, while ES‐based business infrastructures can offer many benefits, their prevalence and increased complexity have also brought new challenges to external auditors. Motivated by the prominence of this issue for auditors and regulators and by the scarcity of research jointly examining ESs and auditors’ work, we investigate whether the presence and extent of client firms’ ES implementations are related to the quality and efficiency of auditors’ work. Using proprietary archival data on ES implementations and controlling for self‐selection, we find that ES implementation improves the quality and efficiency of current and future years’ audit work. Specifically, there are fewer restatements, a greater likelihood of auditors issuing going‐concern opinions to firms that do not survive, higher accruals‐based auditing quality, a lower likelihood of Form 10‐K filing delays, and generally lower audit fees. We further show that the benefits of ESs generally increase with the scope of implementation and are generally greater when the ES includes accounting and finance systems. Inconsistent with improvement in the quality of auditors’ work, we find no evidence that ESs help auditors identify material weaknesses in advance of restatement announcements and we find that, even in the presence of ESs, auditors issue an excessive number of going‐concern opinions to clients that survive.     

“金税三期”税收征管对上市公司审计费用的影响

税收征管作为公司外部治理手段,能够作用于公司经营环节,进而影响审计师面临的业务风险和审计风险,由此影响到公司的审计费用。但目前鲜有文献研究税收征管对公司审计费用的影响。本文借助"金税三期"工程这一"准自然实验",以2010—2019年A股上市公司为样本并使用双重差分法,研究发现"金税三期"工程提高了上市公司的审计费用。机制分析表明,"金税三期"工程推高了上市公司实际税率,降低了上市公司的盈利水平,提高了审计师的业务风险,进而提高了审计费用。同时,"金税三期"工程强化涉税信息监管,提高了上市公司会计信息质量,降低了审计师的审计风险,从而降低了审计费用。综合来看前者对审计费用的影响大于后者,导致了上市公司审计费用的提高。进一步分析发现,"金税三期"工程对审计费用的这一影响,在非国有上市公司和由非国际四大会计师事务所审计的上市公司中更为显著。     

The Influence of Nonaudit Service Revenues and Client Pressure on External Auditors' Decisions to Rely on Internal Audit*

This paper investigates how external auditor provision of significant nonaudit services and client pressure to use the work of internal audit influence external auditors' use of internal auditors' work. More specifically, we study how external audit evidence gathering choices are influenced by nonaudit fees and client pressure. Our research is motivated by an observation that the magnitude of nonaudit services provided to audit clients introduces the risk that client management may leverage its position with the external auditor and potentially affect the audit process. We address this issue by extending prior research and focusing on the importance of various explanatory variables, including nonaudit service revenues, client pressure, internal audit quality, and coordination, to the external auditor's decision to rely on the work of internal audit. We use data primarily obtained through surveys completed by internal and external auditors. The survey responses represent 74 separate audit engagements. Our findings reveal that when significant nonaudit services are not provided to a client, internal audit quality and the level of internal‐external auditor coordination positively affect auditors' internal audit reliance decisions. However, when the auditor provides significant nonaudit services to the client, internal audit quality and the extent of internal ‐ external auditor coordination do not significantly affect auditors' reliance decisions. Furthermore, when significant nonaudit services are provided, client pressure significantly increases the extent of internal audit reliance. Thus, external auditors appear to be more affected by client pressure and less concerned about internal audit quality and coordination when making internal audit reliance decisions at clients for whom significant nonaudit services are also provided.     

The Earnings Quality Information Content of Dividend Policies and Audit Pricing

Recent studies indicate dividends are associated with higher‐quality earnings. Our study extends the literature by examining whether dividends' information is associated with auditors' assessment of their clients' earnings quality. Our results show that auditors charge lower fees to dividend‐paying clients than to nondividend‐paying clients and the average fee discount ranges from 6.0 to 10.6 percent. More importantly, we find dividends have an interactive effect with respect to earnings persistence and earnings manipulation: the negative association between audit fees and earnings persistence is more pronounced for dividend firms; and dividend payouts mitigate the positive relation between earnings manipulation risk and audit fees. Our results imply dividends reduce audit risk by enhancing clients' earnings quality information. We contribute to the literature by showing that auditors reflect the earnings quality information content of firms' dividend policies in their pricing decisions.     

The Loss of Information Associated with Binary Audit Reports: Evidence from Auditors' Internal Control and Going Concern Opinions

This study provides evidence that binary signals in audit reports are unable to fully communicate underlying risks that are inherently continuous in nature. Specifically, we find that companies whose audit reports signal an improvement in internal control effectiveness relative to the prior year are still more likely to subsequently restate the current year's financial statements than companies with no material weaknesses in either year. Similarly, companies deemed to no longer have substantial doubt of continuing as a going concern are still more likely to declare bankruptcy than companies with no going concern opinion in either year. Results in both settings suggest the presence of residual risk that cannot be communicated through a binary audit report, despite the fact that auditors recognize the risk, as evidenced by higher audit fees and longer audit report lags. Our findings are strongest when the reported improvement is more pronounced, and our results hold in matched samples. Our study provides empirical evidence that supports recent regulatory efforts to improve the content of the audit report and offers suggestions for future research.     

Do Auditors Accurately Predict Litigation and Reputation Consequences of Inaccurate Accounting Estimates?

To effectively manage audit risk, auditors must correctly predict the potential litigation and reputation consequences associated with inaccurate accounting estimates. Accurate predictions are critical because underestimation of negative consequences leads to excess legal exposure and overestimation leads to overauditing. Our paper examines whether auditors correctly anticipate these litigation and reputation outcomes. We provide manager‐ and partner‐level auditors with case facts from an auditor negligence lawsuit and ask them to predict the proportion of juries that will return verdicts against their firm. We then compare auditors' predictions to the actual verdicts we observe when we provide the same set of case facts to mock jurors who deliberate as part of juries. We find that auditors overestimate the likelihood of negligence verdicts, especially when audit quality is relatively high. Our supplemental measures help explain the reasons for this overestimation: auditors tend to underestimate jurors' perceptions of audit quality and willingness to attribute inaccurate estimates to situational factors. Finally, we examine auditors' predictions about how a news article about the litigation will affect their reputation with the general public. Similar to our litigation results, we find that auditors tend to overestimate the article's negative impact on auditor reputation. Collectively, our findings suggest that auditors overestimate litigation and reputation consequences resulting from inaccurate accounting estimates. This overestimation is consequential as it leads to inefficient allocation of audit resources.     

Whistleblowing Allegations,Audit Fees,and Internal Control Deficiencies*

We investigate whether audit fees and auditors' opinions on internal controls are associated with whistleblowing allegations externally filed to regulatory agencies. We find that firms subject to whistleblowing allegations have significantly higher audit fees, regardless of the substance of these allegations, whereas an auditor is more likely to issue an adverse opinion on internal controls when the allegation is substantiated, rather than frivolous. Further, our findings suggest that auditors are involved in the auditing of whistleblowing when the allegation is still in an internal stage. We also show that firms subject to external whistleblowing allegations have a lower likelihood of restating financial statements prepared in the allegation year when greater audit effort is made in that year. Our study is among the first to demonstrate the role of auditors in the context of whistleblowing.     

Competition and Big 6 Brand Name Reputation: Evidence from the Ontario Municipal Audit Market*

The 1991 amendment to the auditor appointment requirement of section 86 of the Ontario Municipal Act removes certain barriers to entry into the Ontario municipal audit market. The purpose of this study is to provide evidence that the amendment has enhanced competition in this market. The results indicate that there is a general reduction in the real municipal audit fees compared with the pre‐amendment levels, and that the market has become more contestable following the amendment. Notwithstanding the heightened competition, the Big 6 audit firms continue to command audit fee premiums over the non‐Big 6 audit firms. This suggests that Big 6 audit fee premiums possibly reflect brand name reputation rather than monopoly/oligopoly rents.