Audit research—looking beyond North America

This paper provides a commentary on the study by Gendron and Bédard’s (2001) of the usefulness of audit research. While supportive of their desire to stimulate international debate, it is critical of their chosen methodology, arguing that research impact cannot be adequately judged from the text of published papers. It also claims that more consideration should have been given to audit research outside of North America. The paper questions the strength of the “professional capture" argument of Gendron and Bédard as a justification for North American audit research traditions and closes by highlighting the possibilities of a broader, more global outlook—not just in the assessment of research impact but also in the process of undertaking audit research.     

The Expanded Audit Report—An Empirical Investigation

There is a widespread concern about the ‘expectations’ gap in auditing. To help close this gap the profession in the United States has recently expanded its standard audit report to give a fuller understanding of the scope, nature and significance of the audit. The primary research question addressed in this paper is whether a UK derivative of the US expanded report has the power, compared to the current short form report used in the UK, to help the reasonably intelligent reader to understand better the audit and the auditor's role. The research was conducted by experiment with 140 part-time MBA students from the University of Edinburgh. The results provide clear evidence of the ability of the UK derivative to change reader perceptions. Moreover significant changes are not limited to matters directly addressed in the expansion of the audit report. A ‘halo’ effect is observed whereby the expanded wording seems to generate a feeling of well-being which spills over to matters not directly addressed in the UK derivative. However, there is a danger that such a ‘halo’ effect might widen rather than narrow the expectations gap. The policy implication is that all important dimensions, including fraud, should be addressed directly in the expansion of the audit report.     

Does Auditor Industry Specialization Improve Audit Quality?

This study examines whether auditor industry specialization, measured using the auditor's within‐industry market share, improves audit quality and results in a fee premium. After matching clients of specialist and nonspecialist auditors on a number of dimensions, as well as only on industry and size, there is no evidence of differences in commonly used audit‐quality proxies between these two groups of auditors. Moreover, there is no consistent evidence of a specialist fee premium. The matched sample results are confirmed by including client fixed effects in the main models, examining a sample of clients that switched auditors, and using an alternative proxy that aims to capture the auditor's industry knowledge. The combined evidence in this study suggests that the auditor's within‐industry market share is not a reliable indicator of audit quality. Nevertheless, these findings do not imply that industry knowledge is not important for auditors, but that the methodology used in extant archival studies to examine this issue does not fully parse out the effects of auditor industry specialization from client characteristics.     

Audit committees’ social capital and financial reporting quality

We draw on social capital theory to examine the relationship between audit committee (AC) members’ social capital and financial reporting quality. Using US data for the period 2001–2010, our results suggest that non-AC directors’ social capital does not appear to be relevant to financial reporting quality. As far as AC members are concerned, our findings show a negative relationship between their social capital and financial reporting quality, suggesting a ‘dark side’ to social capital. Specifically, we find that sitting in multiple ACs (centrality) has a negative impact on reporting quality only for those AC members designated as financial experts. When other proxies for social capital are considered (connectedness, brokerage position and strong ties), our results show that the quality of financial reporting significantly decreases with the social capital of non-financial experts sitting in the AC. We contribute to prior research by: (i) relying on social capital theory, which is widely neglected in accounting research, (ii) using multiple metrics to capture the complex dimensions of social capital, and (iii) discriminating between the effects of financial and non-financial experts’ social capital on reporting quality. Our results suggest policy-makers might wish to limit financial experts’ multiple directorships as well as assess the actual contribution of non-financial experts to AC effectiveness.     

Can Employees Be Used to Overcome Independent Audit Limitations?

Independent financial statement auditors are appointed by shareholders to provide reasonable assurance on the reliability of financial statements published by management of reporting entities. However, in the last two decades questions have been raised concerning the credibility of external audits due to their apparent failure, especially following the spate of corporate collapses. This paper applies a critical review of literature and a multi‐theoretical governance perspective to examine the inherent limitation of independent external audits and argues that employees can contribute to reducing the limitation gap by strengthening governance through a structure that incorporates a board and employee management representation. It is argued that through this arrangement, auditors can benefit as they will be privy to additional information from employees about issues such as irregular matters that impact upon shareholders and other stakeholders, and control weaknesses across governance levels, allowing auditors to establish a broader understanding of organisational information that may otherwise be less readily available. Thus auditors can base their judgements in terms of audit risks, and develop audit plans based on more reliable information. The theoretical proposition emerging from these findings is that the traditional governance model should be refined to include employees as an additional component of governance.     

Can Audit Partners Predict Subordinates' Ability to Detect Errors?

This study examines audit partners' predictions of the ability of managers and seniors to detect financial statement errors. If partners are unable to predict the ability of their subordinates to detect errors, audit effectiveness may be affected. Audit partners are asked to predict which members of the audit team (managers or seniors) are able to detect specific types of errors. These predictions are then compared to errors detected by managers and seniors that are seeded in working papers. The results show that partners (1) exhibit significant overconfidence in the ability of subordinates to detect errors, (2) are more accurate in predicting managers' performance than seniors, (3) are more accurate at predicting subordinates' ability to detect mechanical (simple) errors than conceptual (complex) errors, and (4) are not better at predicting subordinates' ability to detect more frequent and more important errors than less frequent and less important errors.     

Audit Committee Members: What Goes on Behind Closed Doors?

Using a qualitative research paradigm, this study examines audit committee effectiveness from the perspective of audit committee members of New Zealand listed companies. The findings reveal that audit committee members perform a range of overlapping tasks and justify their existence in their audit committees by fulfilling the ‘expectations’ that are placed on them. Many quantitative research studies have examined the association between different dimensions of audit committee inputs and financial reporting outputs. The empirical evidence, however, is mixed and remains far from conclusive (Bédard and Gendron 2010). One of the primary reasons for the inconsistent findings is the lack of understanding of the actual process by which audit committees perform their responsibilities. Using a qualitative research paradigm, this study examines audit committee activities, processes and effectiveness from the perspective of audit committee members of New Zealand listed companies. The study argues that performing audit committee duties is an intended process, whereby audit committee members justify their actions and the effectiveness of their audit committees. The paper contributes to the limited literature on how audit committees operate and, by doing so, provides possible explanations for the inconsistent findings of the quantitative audit committee research. In particular, the paper invites further discussion on whether audit committee members can be (or should be assumed to be) independent when discharging their role of overseeing auditing and financial reporting‐related matters.     

Audit Committee Regulation in Australia: How Far Have We Come?

This paper presents a synopsis of the major developments in corporate governance regulations and recommendations for Australian audit committees, categorised into three distinct periods of regulation from 1976 to 2004. Earlier Australian research on audit committee formation, composition and diligence is summarised and compared. The research is then extended by presenting the results of an empirical study of 188 of the top 300 ASX listed companies with a financial year end of 30 June 2004, the first year of the third period of regulation. The results indicate that compliance with corporate governance regulations and recommendations had improved substantially with respect to: audit committee formation; the number of audit committee members, non‐executive directors on the audit committee; financial expertise of audit committee members; and the frequency of audit committee meetings. However, the number of independent directors on audit committees was well below ASX best practice guidelines.     

A scientific approach to politics? On the trail of the Audit Commission

This article explores the ways in which the Audit Commission has become a key player in the governance of welfare provisioning and democratic communities in England and Wales. It draws primarily upon an analysis of Audit Commission texts, supplemented by conversations with Commissioners and observations of Audit Commission staff at work. The argument is that a new audit-accountability nexus has been forged which crosses the divide between New Right and New Labour politics. On the one hand, there has been a revolution in the nature of accountability—the locally-based accountability associated with local government has been eclipsed by a new centralized accountability, albeit one which attempts to synthesize upward and downward accountability within itself. On the other hand, there has been a revolution in the nature of audit, culminating in the rise of audit-inspection partnerships. In the process, the Audit Commission has been cast as the scientific advisor to central government, the reforming regulator of local government, and the impartial champion of the people.     

Audit Partners’ Role in Material Misstatement Resolution: Survey and Interview Evidence

Auditors are expected to identify and resolve material misstatements (MMs) in management's financial statements. However, beyond the audit opinion, the audit process is opaque. To address this, we independently survey 462 audit partners and interview 24 audit partners, CFOs, and audit committee members on how partners assess and address MM risk, resolve MMs, and the consequences of MMs. Partners identify MMs in approximately 9% (15%) of public (private) engagements and use qualitative factors to waive apparent MMs. Loan covenant and going-concern issues increase MM risk more than earnings benchmark issues. Partners point to a variety of both auditor and client factors as threats to audit effectiveness. Partners often rely on rapport with management and involve the national office and audit committee in resolving MMs. Partner incentives around restatements are context specific. Our results provide new insights into the auditor's role in financial reporting that are relevant to academics, practitioners, and regulators.     

Whistle-blowing by external auditors: Seeking legitimacy for the South African Audit Profession?

Auditing is often cited as playing an important role in managing agency-related costs and, accordingly, being integral to the sound functioning of capital markets. There may, however, be more to the attest function than a technical rational practice. By virtue of relying heavily on claims to technical expertise, professionalism, prudential judgement and public confidence, auditing is both a source of legitimacy for organisations and, paradoxically, dependent on claims to legitimacy for its continued existence. From this perspective, recent regulatory developments, purportedly enacted to increase arms-length control over the profession, may not only be about improving perceived audit quality and practice but also about ensuring continued faith in the well-established ‘rituals’ of the assurance function. A reporting duty imposed on South African external auditors, akin to whistle-blowing, is used as a case study to explore this perspective. In doing so, this paper contributes to the scant body of interpretive research on auditing, simultaneously offering one of the first insights into auditing regulation from an African perspective.     

Do Audit Clients Successfully Engage in Opinion Shopping? Partner‐Level Evidence

This study investigates whether companies engage in audit opinion shopping activities by exerting influence over an audit firm's decision to switch the engagement partner (“partner‐level opinion shopping”) in the Chinese setting, where the identities of engagement partners are publicly disclosed. Adopting the empirical framework developed by Lennox [2000], we show evidence that companies successfully engage in partner‐level opinion shopping. Further, partner‐level opinion shopping is more likely to be successful if a company is economically important to an audit firm, and it is less likely to be successful if the audit firm is formed as a partnership rather than a corporation. We also find that companies successfully engaging in partner‐level opinion shopping exhibit significantly lower earnings quality. Finally, we directly compare audit records between incoming and outgoing partners and find that, for companies that successfully improve audit opinions after partner switching, incoming partners have a significantly higher propensity to issue clean opinions than their outgoing counterparts.     

Audit committee performance: ownership vs.independence – Did SOX get it wrong?

This study documents a positive relationship between audit committee stock ownership and firm performance in large US firms from 1998 to 2008. This study also finds a positive relationship between changes in ownership and performance. These results persist throughout the sample period, do not weaken after Sarbanes–Oxley and are robust to controlling for endogeneity between ownership and performance. After testing shows that there is no relationship between audit committee independence and firm performance, these findings suggest that audit committee stock ownership is an important corporate governance mechanism and potentially a more relevant variable than audit committee independence from a policy perspective.     

Does an Agency‐Type of Audit Model Fit a Stewardship Context? Evidence from Performance Auditing in Dutch Municipalities

The degree of auditor independence is an important issue in the performance auditing literature. However, little attention has been paid to the influence of the context in which an audit body operates. This paper investigates how an audit model with a high degree of auditor independence, which is consistent with agency theory's rather formal view of relationships in organizations, functions in a context with more informal relationships, as implied by stewardship theory. Based on two case studies and a survey, the paper concludes that Dutch councilors are more satisfied with audit reports if in their municipality there is a fit between context and audit model.