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 influence of auditor narcissism and moral disengagement on risk assessments of a narcissistic client CFO

Global capital markets rely heavily on independent and skeptical auditors as gatekeepers to provide assurance that corporate financial reports are free of material fraud. The rise of narcissism among the ranks of both client and audit professionals challenge this gatekeeper function. In addition, auditor moral disengagement may undermine auditor skepticism, further eroding public confidence in the integrity of financial reporting and the audit process. We conduct a quasi-experiment with 118 auditors from three international audit firms. In a simulated interview with a client CFO, we examine whether auditors underestimate risks of fraudulent financial statements due to the interactive effects of (1) client narcissism (manipulated verbally and nonverbally) and (2) auditor narcissism. We also examine the influence of auditor moral disengagement on client risk assessments. Results indicate that CFO verbal and nonverbal narcissism significantly influenced auditors’ assessment of management-related client risk. Moreover, auditor narcissism was found to interactively influence client risk inferences such that auditors higher in narcissism exhibited narcissistic tolerance (lower risk assessments) when the hypothetical CFO displayed high verbal narcissism. Auditor moral disengagement was negatively associated with client risk assessments. We discuss the implication of these findings on future audit judgment research, audit firm policy and training on maintaining auditor skepticism, and the audit oversight role of standard-setters.     

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.     

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.     

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.     

Can clients of economically dependent auditors benefit from voluntary audit firm rotation? An experiment with lenders

This study utilizes a nationwide random selection of 111 lenders in a 2?×?2 between-subjects experiment to determine whether the level of an auditor's economic dependence on a client and type of auditor rotation affect lenders’ independence and reliability perceptions and decisions to lend money to a potential borrower. Previous literature shows that financial statement users use client importance as a measure of audit quality when revenue streams are not equal across clients. This can negatively affect perceptions of independence and financial statement reliability. As United States regulators look for ways to improve audit quality under the current partner rotation mandate, this study explores whether an audited entity that voluntarily adopts a policy of firm rotation can mitigate the negative effects of the auditor's dependence on the client. Findings suggest that lenders view clients of economically dependent auditors (CEDA) as less independent from its auditor and perceive its financials as less reliable than clients without a dependent auditor (non-CEDA). Lenders are less likely to grant a loan to CEDA. However, under firm rotation, there is not only an increase in lenders’ perceptions of reliability of CEDA financials, but also no difference in perceptions of reliability of CEDA and non-CEDA financials.     

The market reaction to auditor resignations

Under UK company law, external auditors who resign must warn shareholders and creditors of any matter that ought to be brought to their attention. Auditor resignations and the subsequent change in auditor are informative corporate events. Resignation from office is likely to be a costly signal for the audit firm, particularly when the client is a quoted company. Our analysis of daily data suggests that there is a negative reaction to the auditor resignation on the date of the resignation letter, even though very few auditors indicate there were problems of which the shareholders and creditors should be made aware. This provides backing for the statutory rules on disclosure of the auditor resignation. We also find that the extent of the market reaction on the day of the resignation is related to the size of the resigning audit firm.     

The effect of auditor litigation risk on clients' access to bank debt: Evidence from a quasi-experiment

We exploit staggered state-level shocks to third-party auditor legal liability in the U.S. to test whether auditor litigation risk affects client companies' access to private debt markets. We find that an exogenous increase in auditor litigation risk leads to an increase in both clients' likelihood of receiving bank loans and the average amount of the bank loans that clients receive. In support of our proposed mechanism that auditor litigation risk leads to improvements in clients' audit and financial reporting quality, we find that these same shocks lead to a reduction in accruals, an increase in going-concern opinions, a decrease in restatements, and an improvement in accruals' ability to predict future cash flows. We also find that increased auditor litigation risk leads to an increase in the contractibility of clients’ accounting numbers, as proxied by the use of debt covenants, and a decrease in the cost of borrowing.     

Pro forma disclosures,audit fees,and auditor resignations

The disclosure of non-GAAP (pro forma) earnings numbers by managers in the post-SOX era continues to attract attention from regulators, media, and researchers. However, there is limited empirical evidence on how auditors view clients that emphasize pro forma earnings over GAAP earnings. We study the extent to which audit fees and auditor resignations are associated with opportunistic non-GAAP disclosures. We find that during the pre-SOX period, optimistic pro forma differences, measured using either IBES actual earnings or hand-collected pro forma earnings, are associated with higher audit fees and a higher likelihood of auditor resignations. Additional results indicate that auditors seem to be more concerned with non-GAAP earnings disclosures in the post-SOX period.     

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.     

The influence of large clients on office-level auditor oversight: Evidence from the property-casualty insurance industry

We analyze the loss-reserving practices of 562 insurance companies in 1993 to assess the relation between client influence and auditor oversight. Consistent with Petroni [1992. Management's response to the differential costs and benefits of optimistic reporting in the property-casualty insurance industry. Journal of Accounting and Economics 15, 485–508.], we find that financially struggling insurers tend to under-reserve. However, this behavior is attenuated when the weak insurer is important to the local practice office of the auditor. This result holds across various measures of client influence and supports the contention of Reynolds and Francis [2001. Does size matter? The influence of large clients on office-level auditor reporting divisions. Journal of Accounting and Economics 30, 375–400.] that auditors allow less accounting discretion to their larger clients.     

UK investors’ perceptions of auditor independence

The auditor’s role in society is that of validating the truth and fairness of financial statements. If owners of organisations doubt the auditor’s independence, financial statements will lack credibility. This questionnaire-based study investigated how investors perceive three potentially independence-impairing auditor–client relationships: the joint provision of audit and non-audit services, an audit firm’s economic dependence upon a client and long-term relationships between auditor and client. The objective was to determine whether, after a series of high-profile corporate collapses, owners retain faith in the integrity of the auditor. The results suggest that economic dependence and the provision of non-audit services are perceived as greater threats to auditor independence than long-term relationships between the auditor and client.     

Effects of managerial overconfidence and ability on going-concern decisions and auditor turnover

I examine how the appearance of managerial overconfidence and managerial ability affect 1) auditors' decisions to issue a going concern opinion and 2) auditor dismissal rates after issuing a going concern opinion. Managerial attributes are likely to have an influence on auditors' decisions because auditors obtain and evaluate information about client management's remedy plans when there is substantial doubt about the entity's ability to continue as a going concern. While prior literature on managerial overconfidence classifies all managers who demonstrate overconfident behaviors in one group, I argue that the literature needs to take managerial ability into consideration when measuring overconfidence. I find that auditors are more likely to issue a going concern opinion to clients with seemingly overconfident managers only when the management who appears overconfident is also incompetent. I also find that auditors are more likely to be dismissed after issuance of a going concern opinion when the client company has seemingly overconfident management. Finally, I find that the association between managerial overconfidence and auditor dismissal subsequent to issuance of a going concern opinion is stronger when management is relatively more powerful than the company's audit committee.     

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.     

The impact of revolving door practice and policy on nonprofessional investors’ perceptions of auditor independence

This study investigates whether an ex-auditor’s employment with an audit client impairs nonprofessional investors’ perceptions of auditor independence, and whether the strength of the US revolving door policy improves their perceptions of auditor independence. Despite nonprofessional investors owning over one-third of the US equity holdings, the literature has not examined how revolving door policy impacts their perceptions of auditor independence. Two between-subjects experiments examine these issues. The first experiment finds that investors perceive the ex-auditor’s integrity to be significant in explaining the firm’s decision to manage earnings, irrespective of the firm’s previous working relationship with the ex-auditor. The results from experiment two indicate that strengthening the revolving door policy above that of the American Institute of Certified Public Accountants’ policy does not improve perceptions of auditor independence. Academics may be interested in triangulating the independence ‘in appearance’ results of this study to the independence ‘in fact’ results of other studies, since the Securities and Exchange Commission asserts that both facets of independence are equally important. The results may also be of interest to academics and practitioners, as prior research suggests that restricting auditors’ moves to management positions with the client impairs firms’ abilities to hire quality auditors.     

Earnings quality: Some evidence on the role of auditor tenure and auditors’ industry expertise

Prior studies suggest that auditors with short tenure are associated with lower earnings quality because of the lack of client-specific knowledge and/or low balling. In this study, we examine whether industry specialization of auditors and low balling affect the association between auditor tenure and earnings quality. We find that the association between shorter auditor tenure and lower earnings quality is weaker for firms audited by industry specialists compared to non-specialists. In addition, we do not find results consistent with the low balling explanation.     

Managing risk in a poor economy: The association between economic activity and auditor response to risk

We examine the association between economic climate and auditor risk acceptance as measured by the auditors' reaction to internal control weaknesses. We hypothesize and find that auditors address risk in a way that is conditioned on the economic environment. In particular, we find that during periods of weak economic activity, auditors tend to assess lower risk premiums and are less likely to resign in response to an adverse ICFR opinion. However, we find evidence that economic factors do not influence fees assessed by incoming auditors following a resignation in the presence of an ICFR weakness. Our results indicate that auditors modify their engagement risk strategies during challenging economic times and accept higher levels of risk to attract and retain clients. For the riskiest clients, however, economic factors do not appear to influence auditors' risk pricing.     

Belief perseverance among accounting practitioners regarding the effect of non-audit services on auditor independence

We hypothesize, based on management control processes in large firms (Covaleski et al., 1998), that large-firm practitioners will be less likely than small-firm auditors to report beliefs that non-audit services (NAS) impair auditor independence. Based on Goldman and Barlev’s (1974) analysis of auditor-firm conflict of interests and procedural independence safeguards, we also predict that auditors will report less concern over impairment than non-auditors. We investigate also belief perseverance – whether practitioners tend to maintain prior reported beliefs after reading research on the relationship between NAS and auditor independence.     

A comparison of auditor and client initial negotiation positions and tactics

This study examines the initial negotiation positions and tactics of auditors and clients facing a revenue recognition conflict. We investigate the degree of flexibility in auditor and client initial negotiation positions, whether auditors and clients accurately perceive the other party’s positions, and the types of negotiation tactics that may be used by both parties. The results indicate that auditors and clients approach conflict resolution in very different ways. Clients were more flexible, determined the auditor’s goals and limits more accurately, and were more likely to use negotiation tactics such as bid high/concede later and trade-off one reporting issue for another. The implications of these findings and directions for future research are discussed.     

The relative effectiveness of persuasion tactics in auditor–client negotiations

In this study, we examine the effectiveness of four persuasive arguments that auditors may use to convince clients to accept their desired position in auditor–client negotiations. In addition, we investigate how the style in which the argument is communicated by the auditor impacts its effectiveness. Our results indicate that the type of persuasion tactic used by auditors significantly impacts the amount of concessions made by clients. Specifically, we find that, while threatening to qualify the audit opinion can result in significant client concessions, a tactic of simply informing the client that other companies have handled the accounting issue in a way consistent with the auditor’s preference is as effective, or more effective, than all of the other tactics examined at eliciting significant concessions as well as engendering positive affect toward the auditor. This result is consistent with findings from the persuasion literature relating to the pervasive power of social validation. We also find that clients offer more concessions, evaluate the auditor more positively, and are more satisfied with the negotiation outcome when auditors communicate their arguments using a cooperative, as opposed to a contentious, communication style. The results of this study indicate that auditors may benefit from training in persuasion tactics in order to achieve more desirable negotiation outcomes.