Does auditor tenure affect accounting conservatism? Further evidence

Accounting regulators are concerned about the potential threat of long-term auditor–client relationships on auditor independence, leading to lower audit quality. Jenkins and Velury (2008, hereafter JV) document a positive association between the conservatism in reported earnings and the length of the auditor–client relationship. A primary objective of this study is to extend JV by providing evidence that the relationship between conservatism and auditor tenure is not unique for all firms. In particular, this study finds that the positive association only exists for large firms or firms strongly monitored by their auditors, while for smaller firms or firms weakly monitored by their auditors, I observe a significantly negative association between auditor tenure and conservatism.     

Earnings volatility and audit report lag

This study investigates whether earnings volatility influences audit report lag. If auditors view earnings volatility as affecting risk, and adjust effort in response to risk, we expect earnings volatility to impact audit report lag. Using a sample of 13,075 firm-year observations over the period 2004–2015, we find a negative relation between earnings volatility and audit report lag, consistent with auditors responding to less volatile earnings with increased effort. We also find that the association between earnings volatility and audit report lag is driven by non-industry-specialist auditors, auditors with short tenure, and small and medium sized auditor offices. Furthermore, we examine whether earnings management conducted by way of earnings smoothing affects our results. We find that low earnings volatility has a stronger impact on increasing audit report lag when there is a high degree of earnings smoothing     

Is the quality of female auditors really better? Evidence based on the Chinese A-share market

Unlike previous studies in which a single index was used to measure audit quality, this study establishes a new comprehensive index to measure audit quality via Discretionary Accrual, as estimated by Jones’ basic model (1991) and Audit Opinions. The former is used to measure the quality of financial statements, and the latter is used to measure the auditors’ independence in the mainstream international literature. We examine whether and how an auditor’s gender affects the quality of his or her audits under the framework of empathy theory and gender role socialization theory. Using a large sample of 9861 auditor-firm-year observations from Chinese A-share–listed companies from 2011 to 2015, we find that the audit quality of signed auditors shows significant gender differences: these significant gender differences differ from the findings of previous studies that female auditors could provide a higher-quality audit than male auditors; that is, in our study the audit quality of the male auditors exceeds that of the female auditors. After distinguishing the positive and negative directions of the Discretionary Accrual, we find no significant gender differences in audit quality between male and female auditors when the earnings had been adjusted upward by the client; that is, female and male auditors had the same audit risk perception. However, when the client adjusted earnings downward, which indicates a lower audit risk for the auditor, the audit quality of female auditors was significantly lower than that of the male auditors. After controlling for the age and position of the auditors, we also find that the gender differences in the auditors’ audit quality decreased significantly or even disappeared when the auditor’s age exceeded 45?years and/or their position was manager or above. These results are consistent with the empathy theory and gender role socialization theory.     

Does auditor tenure influence the reporting of conservative earnings?

In this study, we examine the relation between auditor tenure and the reporting of conservative earnings. Using several measures of conservatism, we document a positive association between the conservatism in reported earnings and the length of the auditor–client relationship. We further document an increase in conservatism between short and medium tenure that does not deteriorate over long tenure. Collectively, the results imply lower conservatism for short auditor tenure, which suggests that mandating auditor rotation may have an adverse affect on the conservatism in reported earnings.     

Does auditor ratification matter to bondholders? Evidence from new bond issues

We investigate the relation between shareholder votes on auditor ratification and the client’s credit risk, using both parametric and nonparametric regression techniques. Using data from 2006 to 2016, we show that the proportion of shareholder disapproval for auditors heterogeneously impacts credit risk, as shown by bond spread and bond rating. The results suggest that higher shareholder disapproval of the auditor has an adverse effect on yield spread and bond ratings after controlling for firm characteristics associated with audit quality, such as auditor size and tenure.     

Using machine learning to predict auditor switches: How the likelihood of switching affects audit quality among non-switching clients

In this paper, we utilize machine learning techniques to identify the likelihood that a company switches auditors and examine whether increased likelihood of switching is associated with audit quality. Building on research that finds a deterioration in audit quality associated with clients that engage in audit opinion shopping, we predict and find lower audit quality among companies that are more likely to switch auditors but remain with their incumbent auditor. Specifically, we find that companies more likely to switch auditors have a higher likelihood of misstatement and larger abnormal accruals. These results are consistent with auditors sacrificing audit quality to retain clients that might otherwise switch. Our findings are especially concerning because there is no public signal of this behavior, such as an auditor switch. Our methodology is designed such that it could be implemented by investors, audit firms and regulators to identify companies with a higher probability of switching auditors and preemptively address the deterioration in audit quality.     

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.     

Auditor choice and accruals patterns of cross-listed firms

We examine the association between auditor choice and the accruals patterns of Chinese listed firms that cross-list in Hong Kong. Our evidence suggests that the clients of Big 4 auditors report lower unsigned discretionary accruals relative to the clients of non-Big 4 auditors. Further, we find that cross-listed firms with non-Big 4 auditors are more likely to understate their earnings and experience larger reversals of accruals in the future than cross-listed firms with Big 4 auditors. These findings suggest that Big 4 auditors play a meaningful role in improving earnings quality for cross-listed firms, which helps to explain why cross-listed firms have higher earnings quality than their domestic counterparts, as documented in the previous literature.     

Auditor size, tenure, and bank loan pricing

Using a large sample of U.S. bank loan data from 1996 to 2008, we investigate the relation between two auditor characteristics, namely, auditor size and tenure, and loan interest rates. Our results show the following: First, we find that the loan interest rate is significantly lower for borrowers with prestigious Big 4 auditors than for borrowers with non-Big 4 auditors. Second, we find that auditor tenure is negatively associated with the loan interest rate, suggesting that a long client–auditor relationship lowers the loan borrowing cost. Third, we find that the negative association between auditor size and loan rate is more pronounced for transaction-based term loans than for relationship-based revolving loans. Fourth, our sub-period tests show that our results are driven by the post-Sarbanes–Oxley Act period. Our study provides direct evidence that auditor size and tenure are incremental credit risk-reducing factors in the bank loan market.     

Client influence and auditor independence revisited: Evidence from auditor resignations

Financial scandals such as the Enron-Andersen debacle provoke concerns that auditors lack independence when faced with influential clients. Unlike previous studies that examine whether client influence affects audit quality on ongoing engagements (providing mixed results), we investigate whether client influence (which engenders “independence risk”) at the audit-office level affects auditor resignations from high engagement-risk clients. We construct summary measures of engagement risk, using client disclosures on Form 8-K filings, potential risk factors (e.g., litigation risk), and auditor action (e.g., issuance of a going concern opinion) on the previous year’s financial statements. Focusing on risky clients, we find that auditors are more likely on average to resign from influential clients, and this positive association holds for auditors that are less likely to have mechanisms in place to mitigate independence risk. Also, importantly, influential clients are prevalent across the spectrum of client size, and the positive association between client influence and auditor resignations holds for both large and small clients.     

Disclosure of fees paid to auditors and the market valuation of earnings surprises

We investigate if the SEC’s recently mandated disclosure of fees for audit and nonaudit services paid by firms to their incumbent auditors affected the market’s perception of auditor independence and earnings quality. Following the initial fee disclosures in 2001, we find that the market valuation of quarterly earnings surprises (earnings response coefficient) was significantly lower for firms with high levels of nonaudit fees than for firms with low levels of such fees. In contrast, in the year prior to the new fee disclosures, there was no reduction in earnings response coefficients for firms that subsequently reported high nonaudit fees. Our evidence suggests that mandated fee disclosures provided new information that was viewed by the market as relevant to appraising auditor independence and earnings quality.

事务所审计任期会影响审计质量吗?——来自发布补充更正公告的上市公司的经验证据

本文以中国A股市场上针对2003年至2009年年报发布过补充更正公告的上市公司为研究样本,对事务所任期与审计质量之间的关系进行了重新讨论。与现有文献不同,我们在讨论中引入了审计风险的概念。我们发现,虽然从整体上看,事务所任期越长,审计质量越差。但是,进一步的分析发现,这一现象仅仅存在于涉及到的审计风险相对较低的上市公司中,而对于补充更正内容涉及到的审计风险相对较高的上市公司来说,事务所审计任期对审计质量并没有产生显著影响。我们的分析结果表明,事务所任期对审计质量的影响是有限的。在较高的审计风险水平下,事务所不会因为任期较长而丧失审计独立性。     

Income smoothing and audit fees

In this study, we examine the effect of income smoothing on auditors' pricing decisions. Analyzing a sample of 12,823 firm-year observations from U.S. companies in non-regulated industries for the period 2000–2018, we find that income smoothing is negatively associated with audit fees, suggesting that auditors favorably view smoothed earnings. This result holds when we control for other variables that have been identified as determinants of audit fees in prior literature, including client-specific (e.g., client size, audit complexity, litigation risk, and corporate governance), auditor-specific (e.g., auditor quality, auditor tenure, and auditor expertise), and engagement-specific (e.g., audit opinion, busy season, reporting lag) factors. Our results also hold across (1) alternative smoothing measures (with and without considering the use of accruals to smooth earnings), (2) different sources of income smoothness (innate vs. discretionary components) and (3) various robustness tests. Overall, our evidence supports the notion that auditors perceive income smoothing as signaling rather than opportunistic behavior, and thus charge lower audit fees. To our knowledge, this is the first study that examines income smoothing directly from the perspective of auditors.     

Non-audit service and auditor independence: an examination of the Procomp effect

This paper examines whether non-audit service provision impairs auditor independence, and whether the degree of auditor independence in Taiwan changed in the wake of the 2004 Procomp scandal. The auditors involved in the Procomp affair were suspended from practice for 2 years and were sued, and we posit that these unprecedented sanctions and litigation affected subsequent auditor behavior. Considering the measurement errors involved in discretionary accruals, we propose an alternative analytic approach in which the dependent variable in the regression analysis is the difference between audited earnings and forecast earnings, scaled by total assets, and the primary independent variable is the non-audit fees ratio. After controlling for the effects of financial leverage, operating and market performance, industry, company size, audit firm size, management forecast error, and management attempts to manipulate earnings, regression analysis indicates that the coefficient for non-audit fees ratio is negative and significant in 2003 but not in 2004. Using non-audit fees instead of non-audit fees ratio to conduct the regression analysis yields similar results. This finding is consistent with the notion that auditors make a trade-off between gaining service fees and avoiding litigation and reputation loss. Limitations and policy implications are also offered.

Non-audit services, auditor quality and the value relevance of earnings

This paper tests the hypothesis that there is an inverse relation between non‐audit services (NAS) provided by a firm auditor and the value relevance of earnings (measured as the earnings response coefficient) and that this relation is weaker for firms with Big 6 auditors. The hypothesis is based on anecdotal evidence and previous research that suggests that the provision of NAS by the external auditor is likely to adversely affect investors’ perceptions of the credibility of financial reports, and that Big 6 auditors, because of reputational capital and litigation costs, are likely to mitigate the adverse effects of NAS. Results using 840 firm‐year observations of Australian companies document a statistically significant inverse relationship between NAS and the value relevance of earnings, and this inverse relationship is weaker for Big 6 auditors, therefore supporting the hypothesis.     

Does audit quality matter more for firms with high investment opportunities?

This paper examines the association of firms with high investment opportunities with high quality audits (proxied by Big 5 auditors) and whether that association results in a lower likelihood of earnings management. Firms with high investment opportunities may demand high quality audits for curbing earnings management. This is because they have more flexibility in the provision of discretionary accruals that arises from the attendant operating uncertainty which creates particular monitoring problems. Big 5 auditors will provide high quality audits that will constrain earnings management for firms with high investment opportunities because the risk of losing (and hence the likelihood of maintaining) auditor independence is higher. Results show the following. First, firms with high investment opportunities are more likely to hire Big 5 auditors than firms with low investment opportunities. Second, firms with high investment opportunities are more likely to have more discretionary accruals but this relationship is weaker when they have Big 5 auditors. These results are robust to various sensitivity tests.     

审计师变更与盈余管理关系的实证研究--来自中国A股市场的经验证据

通过对2001～2003年A股上市公司的实证研究发现:审计师变更与公司可操纵应计利润的增长具有显著正相关关系,且两者关系在不同年度、不同前期审计意见的情况下有所不同.这表明,一方面审计师变更影响到后任审计师的独立性,即公司能够通过更换审计师实现盈余管理的目标;另一方面,对前期非标审计意见的公司,审计师采取了较为谨慎的做法,且伴随着监管政策的逐渐强化,后任审计师的独立性逐年提高.     

Does auditor designation by the regulatory authority improve audit quality? Evidence from Korea

In Korea, the regulatory authority designates external auditors for firms that are deemed to have strong incentives and/or great potential for opportunistic earnings management, and mandates these firms to replace their incumbent auditors with new designated auditors and to retain them for a certain period, typically one to three years. We call this regulatory regime ‘auditor designation’. This paper investigates whether the auditor designation rule in Korea is effective in deterring managers from making income-increasing earnings management. Consistent with our hypothesis, we find that the level of discretionary accruals is significantly lower for firms with designated auditors than firms with a free selection of auditors. We also find that firms with mandatory auditor changes (i.e., auditor designation) report significantly lower discretionary accruals compared to firms with voluntary auditor changes. The above findings are robust to a battery of robustness checks. Overall, our results are consistent with the notion that the auditor designation enhances audit quality and thus the credibility of financial reporting.     

经济依赖度、盈余管理水平与审计独立性——来自上市商业银行的经验证据

以2001～2010年我国上市商业银行为研究对象,从盈余管理的角度,以异常贷款损失拨备作为审计独立性的代理变量,以未预期费用作为经济依赖的代理变量,验证了审计师在银行业的经济依赖对审计独立性的影响.研究结果表明,未预期审计费用、总费用和非审计费用率对异常贷款损失拨备没有显著影响,而未预期非审计费用则对异常贷款损失拨备具有显著的负向影响.总体而言,审计师在为上市商业银行提供业务过程中,过高的经济依赖,促使其接受了客户的盈余管理偏好,审计独立性受到损害.     

Audit firm tenure and financial restatements: An analysis of industry specialization and fee effects

This study investigates the relation between audit firm tenure and clients’ financial restatements. Specifically, we extend the audit tenure literature by assessing restatement-based reporting failures using dimensions of auditor expertise and independence previously assumed to underlie short and long audit tenure problems. Short tenure expertise and independence effects are hypothesized using audit firm industry specialization and audit fees as proxies. Long tenure independence effects are hypothesized using nonaudit fees as a proxy. Using matched-sample logistic regression and 382 companies with and without financial restatements during 2000–2004, the results support prior findings by indicating a negative relation between the length of the auditor–client relationship and the likelihood of restatement. For short tenure engagements, we find that auditor industry specialization and audit fees are negatively related to the likelihood of restatement. This result is consistent with concerns about reduced audit quality due to a lack of client-specific knowledge and low audit fees on new audit engagements. Alternatively, the long tenure results indicate an insignificant relation between nonaudit fees and the likelihood of restatement. This finding contradicts independence concerns about nonaudit fees paid to entrenched auditors.