Auditor liability: A comparison of judge and juror verdicts

This research examines differences between judges and jurors in rendering liability judgments in auditor litigation cases. While any number of case contexts would allow us to contrast and compare judges and jurors, we chose one that we believed would also address a second timely issue, auditor reliance or non-reliance upon the work of others. Within the general context of litigation of an alleged audit failure, we manipulated, between-participants, external auditor reliance on the work of others (relied on outsourced work, relied on in-house internal auditors’ work or did not rely). Our results show differences in the liability assessments of judges and jurors. Judges assign more liability to auditors that rely on the work of in-house internal auditors, less liability to auditors that rely on outsourced internal auditors and the least liability to auditors that choose not to rely on the work of internal auditors (but re-perform the work themselves) while jurors assess higher liability regardless of the work done by the auditors. Mediation analyses suggests the differences found in the overall liability assessments of jurors and judges are partially driven by their divergent attitudes towards the public accounting profession with jurors’ unfavorable attitudes leading to them assign liability regardless of the work performed. Further analysis suggests juror insensitivity to our reliance manipulations may reflect a strict liability perspective (consistent with prior work by Charron and Lowe (2008)); while judges consider other factors when making liability assessments.     

The influence of corporate governance mechanisms on the quality of financial reporting and auditing: Perceptions of auditors and directors in Singapore

This study uses two hypothetical cases to examine the perceptions of auditors and directors in Singapore about corporate governance practices relating to the quality of financial reporting and auditing. In the first case, the strength of the audit committee, the existence of an internal audit function and the strength of a corporate code of conduct were manipulated. All three variables were perceived to have some influence on financial reporting and audit quality. However, some interesting differences were found between the perceptions of auditors and directors. Auditors place more weight on the internal audit function, possibly due to their familiarity with the role that internal audit can play in reducing audit risk and enhancing controls. Directors have more confidence in board enforcement of a strong code of conduct, possibly reflecting the view that this encourages staff to adhere to higher ethical standards. In the second case, audit partner rotation, outsourcing of internal audit services and whether the audit firm audited all companies within a group were manipulated. Auditors believed that their ability to resist management pressure was enhanced when they audited all companies within the group. No significant differences were found for the other variables, suggesting that neither group believes that these practices impair audit independence.     

The influence of jurors' perceptions of auditor tenure on blame

This study investigates whether jurors' judgments of auditor blameworthiness are influenced by the length of an auditor's tenure with a client. We use an experiment to determine whether tenure affects juror perceptions of an auditor's competence and independence. We then examine whether these perceptions influence the attribution of blame. Results, consistent with both sides of the mandatory auditor rotation debate, indicate that tenure has a positive impact on perceptions of competence and a negative impact on perceptions of independence. Further, as juror perceptions of the auditor's competence and independence decrease, attributions of blame increase. These results have implications for auditor tenure research as well as for auditors involved in litigation. By utilizing structural equation analysis, we find that the effects of auditor tenure on perceptions of audit quality are complex. Perceptions of both competence and independence are significantly related to extended tenure; however, these perceptions independently affect the assignment of blame. While longer tenure improves perceptions of competence and lessens blame, it decreases perceptions of independence resulting in greater blame. From a litigation perspective, the auditor's tenure with a client is a double-edged sword that must be addressed strategically in court.     

The mediated effect of SAS No. 99 and Sarbanes–Oxley officer certification on jurors’ evaluation of auditor liability

This study experimentally examines the impact of implementing Statement on Auditing Standard (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit and the financial statement and internal control certification requirement by key corporate officers under the Sarbanes–Oxley Act (SOX). The study investigates the prediction that the new regulations affect jurors’ assessment of guilt for failing to discover fraud, and also whether the regulations affect jurors’ perceptions of the appropriateness of auditors’ actions regarding fraud detection and of auditors’ and officers’ responsibility for the fraudulent financial statements. The study tests whether these perceptions mediate the association between the regulations and mock jurors’ guilt assessments. Results show that jurors assess auditors as less guilty under SAS No. 99 and in the presence of the officer certification requirement. SAS No. 99 decreases guilt assessments indirectly through jurors’ perception that auditors acted more appropriately under the new standard. Although jurors did view auditors as more responsible under SAS No. 99, their responsibility perceptions had no effect on guilt assessments. An additional finding is that the officer certification requirement has an indirect effect on guilt assessments via jurors’ perceptions of the officers’ responsibility for the fraudulent financial statements.     

A Survey of Time Budget Pressure and Reduced Audit Quality Among Australian Auditors

This paper reports the results of a survey of Australian auditors' perceptions of their time-budget pressure, as well as whether they had exhibited "reduced audit quality" (RAQ) behaviours. Further questions examined why RAQ practices were used and what areas of the audit were likely to be subject to these practices. There appears to be a high level of time-budget pressure on auditors, and many auditors have at some time performed RAQ practices, potentially having implications for the quality of the audit function. These results point to the importance of placing an appropriate value on the audit function to ensure that time budgets are adequate.     

The effects of disclosing critical audit matters and auditor tenure on nonprofessional investors’ judgments

In an effort to provide more meaningful information to financial statement users, the Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring the audit firm to disclose whether or not it identified a critical audit matter (CAM) and its tenure with the client. To our knowledge, ours is the first study to explore how nonprofessional investors’ judgments are influenced by (1) the relative effects of a CAM disclosure versus a disclosure that the auditor did not identify a CAM, and (2) the disclosure of the audit firm’s tenure. We find that, relative to disclosing that no CAMs were identified, disclosing a CAM reduces investment intentions. We do not find a significant effect of tenure disclosure on investment intentions, despite evidence that participants attended to and understood the tenure manipulation. Concerning investors’ cognitive processes, we find that perceptions of both risk of material misstatement and management disclosure credibility mediate the effect of CAM disclosure on investment intentions, while perceived audit quality suppresses this effect. Our contributions include furthering the understanding of cognitive mechanisms through which CAM disclosure influences investment intentions, identifying a relatively unique setting in which perceptions of management disclosure credibility and audit quality move in opposite directions, and providing evidence that auditor tenure disclosure does not appear to affect investment intentions. Our findings should be of interest to regulators, auditors, issuers, and investors.     

Do the Big 4 and the Second-tier firms provide audits of similar quality?

In this paper, we examine audit quality for Big 4 and Second-tier auditors during 2003–2006. We utilize the auditor’s propensity to issue a going concern audit report for distressed clients as a measure of audit quality. In addition, since the purpose of an audit is to improve financial reporting quality, we utilize abnormal accruals as an observable proxy for audit quality. Further, we utilize the client- and year-specific ex ante equity risk premium as a proxy for audit quality as perceived by investors. We control for auditor self-selection bias using the matched-pairs sample approach discussed by Francis and Lennox (2008). We find weak evidence that the Big 4 have a higher propensity to issue going concern audit opinions for distressed companies. However, the level of performance-adjusted abnormal accruals for Big 4 and Second-tier audit firm clients appears to be similar. With respect to investor perceptions, we find the client-specific ex ante equity risk premium to be lower for Big 4 clients than for Second-tier audit firm clients. Overall, our findings suggest little difference in actual audit quality but a more pronounced difference in perceived audit quality. Collectively, the evidence we provide informs the current discourse on audit quality, auditor choice, and the viability of Second-tier auditors as an alternative to the Big 4.     

The influence of judges' attitudes on liability assessments related to failed audits exhibiting significant audit team over-time or significant use of off-shore auditors

This study provides evidence on how audit firms' decisions to use offshore (outsourced) auditors or to assign on-site (local) auditors extensive overtime affect judges' evaluation of auditor legal liability I conduct a behavioral experiment in which actual judges responded to a hypothetical audit lawsuit. The results suggest auditors may be penalized during the litigation process depending on the extent of overtime or off-shoring and judges' attitude toward the public accounting profession. Judges with a positive attitude toward public accounting assessed more liability for an audit firm that used offshore (outsourced) auditors than for the use of extensive overtime for on-site auditors or a control condition. However, judges with a negative attitude toward the auditing profession assessed higher liability for auditors except when on-site auditors bore significant overtime in the final weeks of the audit.     

The Relative Importance of Audit Quality Attributes

Corporate collapses and audit failures have threatened the credibility of the audit function, with audit quality once again being a major issue. Motivated by the significance of auditing and perceptions of audit quality in enhancing the reliability and credibility of financial statements, this article investigates the relative importance of audit team and audit firm attributes in perceptions of audit quality by users of audit services. Data are gathered from 81 users of audit services and analysed using adaptive conjoint analysis in order to measure the relative importance of audit team and audit firm attributes in perceptions of audit quality. The results show that, in general, users of audit services perceive audit team attributes as being relatively more important than audit firm attributes in perceptions of audit quality. The findings of the study have implications for regulators and the accounting profession concerned with improving confidence in corporate governance and the effectiveness and integrity of the audit process, and for audit firms in monitoring and promoting the quality of their audit services.     

Problem directors on the audit committee and financial reporting quality

The objective of this paper is to examine empirically the consequences for financial reporting quality of having audit committees that include problem directors, that is, directors with prior involvement in corporate bankruptcies, major accounting restatements, or other accounting scandals. An ordinary least squares regression model is used to examine the association between problem directors on the audit committee and financial reporting quality as proxied by accruals and real earnings management. Results reveal that there is a positive association between the presence of problem directors on the audit committee and real earnings management, and this association is more pronounced in cases where those problem directors have been involved in prior instances of accounting restatements and fraudulent reporting practices.     

Audit Standards and Auditor Liability: A Theoretical Model

The business of auditing is heavily regulated. Auditor regulation exists through licensing, professional standards and liability. The auditor's liability for losses to financial statement users from audit failure is subject to a test of negligence. What constitutes due audit care is, however, not generally well-specified. Furthermore, reviews of litigation against auditors conclude that compliance with professional audit standards does not always act as a complete defence to allegations of negligence. The current situation can be described as one where (ex ante)—from the point of view of the auditor—uncertainty exists about the ‘legal’ standard of due audit quality (as seen by the courts in the event of litigation). This uncertainty about legal standards fundamentally affects audit behaviour in ways that are not immediately intuitive. This paper draws on insights from the economics and law literature (e.g., Kolstad et al., 1990; Shavell, 1984a, 1984b and 1987; Calfee and Craswell, 1984 and 1986) and provides an analysis of the effects of uncertainty about auditor negligence on the produced level of audit quality and on audit fees. The auditor subject to a negligence rule will produce too low or too high an audit quality level, as compared to the socially optimal level. It is shown that uncertainty about the legal standard of ‘due audit quality’ is fundamental to understanding audit quality supplied. This uncertainty is the explicator of an insurance component in audit fees. A surprising insight is that a large uncertainty about the legal standard of care can reduce rather than increase the quality of audit work supplied and increase the insurance component. Relying on insurance premiums can be more effective than direct expenditure in reducing risk. The effect of the imposition of ex ante precise audit quality standards, in combination with an uncertain negligence rule, is discussed. Since the influence of ex ante standards is indirect through its effect on ex post liability, auditing standards cannot be analysed independently of ‘legal’ standards. If the legal standard of care were clear, there would be no role for audit standards. Audit standards only affect audit behaviour if legal standards of care are unclear, and they help to clarify the legal standard. An effective combination is for ex ante standards to be set below the ex post standards of care so that they provide a lower bound on acceptable work. Under a lowest common denominator approach set too far below legal standards, audit standards would be irrelevant as far as operational decisions were concerned. As the level of standards are raised, so costs are first imposed on the lowest quality providers.     

The attitude of Libyan auditors to inherent control risk assessment

Previous empirical evidence contradicts the practices of audit risk assessment recommended by the professional auditing standards. Key differences represent the presumption that auditors can readily distinguish between different categories of risk, how they assess such risks in practice, their application to the different account levels and their capacity to differentiate between what may constitute potentially high or low risks. The paper addresses these differences in the context of the Libyan auditors’ perceptions and practices. The nature and development of the audit profession in Libya makes this a good comparator for the US and UK contexts of audit behaviour. Equally importantly, the religious, political and socio-cultural context combined with Libya's role as an emergent economy is representative of many other economies in the world, thus providing a good comparator for assessing the validity and applicability of the established auditing management principles and procedures. One hundred and sixty four practicing auditors in Libya were investigated, initially by questionnaire and subsequently interview of a smaller sample of 20 auditors. The evidence reinforces prior empirical evidence that inherent and control risks are assessed interdependently, auditors are aware of the risk differentials depending on the level of account and are cognizant of factors normally associated with potentially high and low risk levels.     

An Analysis of Submissions on Proposed Regulations for Audit and Assurance in New Zealand

After numerous collapses of finance companies in New Zealand, and widespread losses by investors, self‐regulation of the auditing profession was no longer considered adequate or acceptable internationally. The New Zealand Government sought to restore public perceptions of audit quality and investor confidence in the financial markets with proposals to change existing accounting standards and audit and assurance requirements. The proposals included a review engagement for some entities, and imposing the force of law on auditing standards. We analyse the public submissions on the auditing and assurance aspects of these proposals. Many respondents object to the proposal, requiring small public sector and not‐for‐profit entities to obtain review engagements, and to give auditing standards the force of law.     

An analysis of attributes that impact information technology audit quality: A study of IT and financial audit practitioners

The importance of information technology (IT) auditing has grown with increased reliance on IT for business operations and new regulations regarding the assurance of IT for these operations. Prior work on IT and financial auditing has suggested several general frameworks that may affect IT audit quality; however, the prior work has not provided measurable constructs nor has it considered whether these proposed constructs are the same or different. Building on prior work that has proposed frameworks of IT audit quality, we identify and evaluate potential constructs suggested by these frameworks as well as financial auditing literature. We develop a survey tool and ask IT and financial accounting practitioners to assess the impact of these items on IT audit quality. A factor analysis is used to refine the set of IT audit quality factors identified, and we are able to provide insight into the prioritized impact of each factor on IT audit quality. In comparison to prior research, we find that additional factors are significant for IT audit quality and that the relative importance of the factors for IT audit quality differs for IT versus financial auditors.     

Board liability for cyberattacks: The effects of a prior attack and implementing the AICPA’s cybersecurity framework

A significant litigation trend is the rise in lawsuits filed against boards of directors following cybersecurity incidents. We perform an experiment to examine factors we predict will influence directors’ litigation risk. We examine whether jurors are more likely to hold directors liable when a company previously experienced an immaterial cyberattack, and whether subsequently implementing the American Institute of Certified Public Accountants’ cybersecurity risk management reporting and assurance framework (the “Framework”) can mitigate the effects of a prior attack. Consistent with counterfactual reasoning theory, we find jurors are more likely to hold directors liable for a cyberattack when a company previously experienced an attack. Importantly, we also find that directors can reduce this liability risk after a prior cyberattack by subsequently implementing the Framework, especially when they obtain external assurance. Our results have important implications for research, boards, regulators and public policymakers, audit firms, and attorneys who handle cybersecurity-related cases.     

The effects of audit firm rotation on perceived auditor independence and audit quality

Our study explores loan officers’ perceptions of auditors’ independence and audit quality under three experimental audit firm rotation scenarios. We use a case experiment with a between-subjects design to determine whether rotation of the audit firm impacts financial statement users’ perceptions of auditor’s independence and quality. Findings based on 212 useable responses indicate that loan officers do perceive an increase in independence when the company follows an audit firm rotation policy. However, the length of auditor tenure within rotation fails to significantly change loan officers’ perceptions of independence. Findings also indicate that neither the presence of a rotation policy nor the length of the auditor tenure within rotation significantly influences the loan officers’ perceptions of audit quality.     

Does the severity of a client’s negative environmental,social and governance reputation affect audit effort and audit quality?

In recent years, investors have begun to value companies’ reputations through their environmental, social, and governance (ESG) practices. ESG risk can affect business processes and controls and can heighten financial risk and threaten a firm’s survival. This study examines whether and how the severity of media coverage of a firm’s negative ESG issues (tainted ESG reputation) is associated with audit effort and audit quality. I find that auditors manage the higher expected engagement risk conveyed by tainted ESG reputation by applying higher audit effort. Next, I observe that the increased effort is associated with auditors likely detecting and requiring adjustments for material misstatements and that tainted ESG reputation is associated with fewer misstatements (i.e., reduces poor audit quality). The association between tainted ESG reputation and audit quality is driven primarily by increased audit report lag, not by increased audit fees. Further, I find that tainted ESG reputation is positively associated with audit effort and reduces poor audit quality for up to three years. The results also show that the audit effort and audit quality effect vary across the three components of ESG.     

Further evidence of earnings management and opportunistic behavior with principles-based accounting standards: The case of conditional asset retirement obligations

FASB Interpretation No. 47 (FIN 47) clarifies the diverse accounting practices for conditional asset retirement obligations (CAROs) that arose under SFAS No. 143, which is classified as a principles-based standard by the SEC. Prior research suggests that the subjectivity in SFAS No. 143 provides management with the opportunity to manage earnings and avoid the recognition of CAROs. This study examines firms that recorded adjustments for CAROs upon FIN 47 adoption. We demonstrate that effective monitoring is essential to promote adherence with principles-based standards, and that gatekeepers may not be effective when standards are ambiguous. Univariate tests and logistic regressions reveal that FIN 47 adopters have audit committees with a greater number of financial experts and are audited by BIG 4 firms. Particular firm-specific factors are also found to be associated with the adoption decision. The results also indicate that newly-reported obligations related to asbestos in firm-owned property and restoration costs for leased premises were subject to prior management discretion. This study extends existing literature on SFAS No. 143 and FIN 47 and studies examining earnings management with principles-based standards. The case of FIN 47 provides further evidence that significant opportunities for earnings management and discretion exist within a principles-based accounting environment, particularly when standards lack clarity. It also confirms the critical role of monitoring by the audit committee and external auditors to promote adherence with the substance of such standards.     

Accounting journals and the ABS quality ratings

This study aims to look behind the quality ratings for accounting journals, listed in the ABS Academic Journal Quality Guide (Kelly, Morris, Rowlinson and Harvey, 2009). Significant variations exist in the perceptions of journal quality across the six UK business schools that contribute ratings to the ABS guide, with the most optimistic perceptions tending to come from those schools whose ratings are more highly correlated with quality scores for critical and interpretive research, as reported in Lowe and Locke's (2005) article in Accounting, Organizations and Society (30:1, 81–98). Pessimistic perceptions are more likely to exist in those schools whose ratings are more highly correlated with Lowe & Locke's scores for functional and capital markets research paradigms. There are also notable variations in journal ratings across time. Given that perceptions vary so much across schools, paradigms and time, how much credence can be given to any single rating system for journal quality? This study concludes that if the ABS guide is to be used by university decision-makers or heads of school then the ABS ratings for any given year need to be treated with extreme caution and with an appropriate recognition of their intrinsic limitations.     

The Small Company Audit Qualification: A Preliminary Investigation

In recent years there has been much debate in the UK regarding the value and feasibility of the small company audit. The lack of formal internal control systems and the application of universal auditing standards has given rise to the use of a special ‘Small Company (Example 6) Audit Qualification’. However, doubts concerning the uniformity of practice between auditors has created difficulties for users in interpreting its meaning. This paper examines the extent to which a number of financial, organisational and auditor variables are able to explain the receipt of a ‘Small Company Audit Qualification’. The main empirical findings, using multivariate logistic analysis on a sample of 540 small company reports, are that companies audited by large audit practices, companies which had a prior year qualification, a secured loan, declining earnings, large audit lags and few non-director shareholders were more likely to receive an audit qualification than other companies.