Empirical Evidence on the Implicit Determinants of Compensation in Big 4 Audit Partnerships

This study investigates the implicit financial incentives of individual Big 4 audit partners by examining the association between a partner's compensation and characteristics of the audit firm, audit partner, and individual partner clientele for Big 4 firms in Sweden. Using tax and financial data for individual audit partners and clients, our empirical findings indicate that there is significant variation in the implicit determinants that are associated with compensation across the Big 4. We find that audit partners’ compensation is positively associated with the size of their clientele or the number of publicly traded clients, both of which represent revenue‐generating opportunities. Similarly, compensation and developing an industry specialization are positively related. In three firms, gaining clients is clearly related to an increase in compensation, while losing a client is associated with a reduction in partner income in only one firm. We find that audit partner income is more sensitive to performance‐related incentives, such as attracting new clients, as partners progress in their career. Finally, we find evidence that audit failures, proxied by reporting errors related to issuing a going concern opinion, are associated with lower compensation. These results should be of interest to the auditing profession, audit firms, and regulators when they consider the effects of implicit incentives of partner compensation on audit quality.     

Diversification by the audit offices in the US and its impact on audit quality

Audit offices in the US exhibit a wide variation in the number of industries they service. Strategic management theory suggests that diversification can affect the quality of output, depending on the nature and circumstances of diversification. This paper examines the effect of diversification at the audit office level on audit quality. Five proxies of audit quality are examined, mainly, absolute discretionary accruals, propensity to meet-or-beat earnings expectations by a cent, propensity to restate financial statements, propensity to receive a comment letter after an SEC review and propensity to issue a going concern opinion. Results suggest that diversification has detrimental effects on audit quality. On the other hand, when the diversification is part of the audit firm level strategy, the detrimental effects on audit quality are dampened. Moreover, when the diversification at the office level is part of a revenue expansion strategy, the audit quality is adversely affected. However, there is no detrimental effect on the audit quality when revenue expansion is not the objective. Also, diversification across dissimilar industries leads to more adverse effect on audit quality than diversification to similar industries. Results also suggest that when the audit office is located in a market with more (less) diversified client base, the adverse effects of diversification on audit quality are weaker (stronger). Finally, the offices of big-4 audit firms handle diversification better with less adverse effect on audit quality. The findings are important since they identify additional factors that explain audit quality at the audit office level.     

An Empirical Investigation of Audit Pricing in the Public Sector: The Case of Greek LGOs

This paper investigates the associations between audit pricing and multidimensional characteristics of local governments by using a sample of Greek municipalities. The Greek institutional setting is interesting because it is politically pluralistic. Moreover, independent auditors appointed through a bid process exclusively perform the audits. Our results suggest a considerable variation on audit fees which is mainly driven by politically related factors indicating the importance of relevant theoretical anticipations in audit pricing in the public sector. Agency costs appear strong enough to explain audit pricing. We also confirm prior findings on the significance of audit complexity and size. Results also suggest that audit fees are reduced when an internal team dedicated to accrual accounting is appointed. Therefore, our conclusions offer practical implications for policy setters and regulators in the public sector in relation to audit quality.     

Audit quality,accruals quality and the cost of equity in an emerging market: Evidence from Vietnam

This study explores the relationship between audit quality, accruals quality, and the cost of equity in the context of Vietnam. Particularly, we examine the impact of auditor size and accruals quality on the industry-adjusted earnings – price ratio. Using a sample of Vietnamese listed companies, the study shows that firms audited by a Big Four auditor are associated with a lower cost of equity than firms with a non-Big Four auditor. The results indicate that the auditors' information role is more relevant than the insurance role in a civil law context with a relatively low auditor litigation risk. In addition, the findings show that companies with better accruals quality are associated with a lower cost of equity. The study has implications for managers and regulators. The findings highlight the importance of ensuring sound auditing practices and maintaining high-quality financial reporting for corporations.     

Do political connections affect the role of independent audit committees and CEO Duality? Some evidence from Malaysian audit pricing

This study examines whether political connection to firms affects the association between audit committee independence and demand for higher quality audits. In line with Carcello et al. (2002), our findings show that there is a positive association between audit committee independence and audit fees thus supporting the hypothesis that more independent audit committees demand higher audit quality. However, we find that this relationship is weaker for politically connected (PCON) firms suggesting that the independence of audit committees in Malaysian PCON firms may be compromised. Additionally, we provide evidence that PCON firms that have CEO duality are perceived by audit firms as being of higher risk than CEO duality firms without political connection.     

The impact of PCAOB international registration on audit quality and audit fees: Evidence from China

Despite the importance of registration with the PCAOB, there is surprisingly little academic research on the registration process and its impact on audit outcomes (Abernathy et al., 2013). The PCAOB allows registration of audit firms from non-US countries. However, China and a few other countries do not allow the PCAOB to conduct inspections of audit firms. We take advantage of this setting to investigate whether PCAOB-registered audit firms improve audit quality in the absence of inspections and whether they charge an audit fee premium. Our findings indicate that audit quality increases following PCAOB registration and that clients pay higher audit fees for audits by PCAOB-registered firms.     

Toward an Archival Measure of the Likelihood of Auditor–Client Management Negotiation: An Exploration of the Audit Lag Measures Conjecture*

Salterio (2012) hypothesized that adaptations of an audit efficiency measure, audit report lag (the length of time between the financial statement year‐end date and the auditor's report date), could provide measures of underlying auditor–client management (ACM) negotiation likelihood. Salterio argued that these measures would enable archival researchers to examine issues that heretofore were the exclusive domain of experimental and field researchers. Using an audit report lag measure and a measure of abnormal audit report lag lags (the residual based on audit report lag determinants model), we show that a larger lag is associated with higher audit fees after controlling for other known determinants of audit fees. We also show that larger lags are associated with higher levels of discretionary accruals—that is, lower accrual quality. Based on our findings, we suggest that there is support for Salterio's hypothesis that audit report lags and abnormal audit report provide valid archival proxies for the differences in year‐end ACM negotiation likelihood. We suggest that this proxy will allow researchers to study issues related to published accounting numbers in light of whether negotiations are likely to have occurred in addition to providing regulators and others the means to determine what clients of audit firms are more likely to have different types of ACM relationships.     

The impact of board composition and family ownership on audit committee formation: Evidence from Hong Kong

This study investigates empirically the relationship between three major corporate governance attributes (family shareholding, non-executive directors and independent chairman) and the existence of audit committees across a sample of 397 publicly traded firms in Hong Kong. The results show that at a medium level of family shareholding (between 5% and 25%), the convergence-of-interest effect is dominant and the existence of audit committees decreases. At a high level of family shareholding (more than 25%), the entrenchment effect is dominant and as a result, the existence of audit committees increases. In addition, we show that the response of investors to audit committee existence is not dependent upon family shareholding when there is an independent chairman. The findings of our study also suggest that there is a positive association between the proportion of independent non-executive directors on the corporate board and audit committee existence. In addition, the results show that the positive association between independent non-executive directors is stronger for firms with an independent chairman. Implications of these findings for regulators are discussed.     

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.     

An Assessment of the Impact of IFRS Adoption on Public Sector Audit Fees and Audit Effort – Some Evidence of the Transition Costs on Changes in Reporting Regimes

While many countries have adopted International Financial Reporting Standards (IFRS) for private sector enterprises, New Zealand (NZ), Australia and the United Kingdom adopted IFRS for all sectors, including the public sector. This approach is consistent with the concept of sector‐neutral accounting standards that gained wide acceptance in NZ and Australia in the early 1990s. Although a number of studies have assessed the impact of IFRS adoption in the private sector, and the public sector has provided some evidence as to the effects of IFRS adoption on financial statements, the costs of adopting IFRS have not been examined. One measure of cost is the change in audit fees in an IFRS reporting environment. The authors examine the impact of IFRS adoption in the NZ public sector on audit fees and audit effort. They obtained data regarding audit fees and audit effort in the NZ public sector and compared the pre‐adoption year with the first year of adoption for all segments. Their results indicate a substantial increase in audit fees and audit effort in the first year of IFRS adoption for all segments, with some variation across the segments. Two sectors, local authorities and energy companies, have had significant increases in audit fees and audit effort. These findings provide some empirical evidence regarding the cost of transition to IFRS and are of interest to researchers and regulators in countries that are currently considering transitioning to IFRS or IFRS‐based International Public Sector Accounting Standards standards in reporting for the public sector.     

Auditor's Engagement Risk and Audit Fees: The Role of Audit Firm Alumni

Abstract:  This study explores the effect of the association of audit firm alumni with their alma mater on audit prices. The tests indicate that there is a moderate reduction of up to 21% in the level of audit fee when alumni (i.e., former employees) of the incumbent audit firm sit on the client board of directors which is consistent with the engagement risk theory. This suggests that there is an 'alumni effect' in the market for audit services. The findings hold only in the large company segment of the market. The results are robust to different model specifications and alternative samples. The sample comprises all executive and non-executive directors who run the UK quoted companies and are simultaneously ICAEW qualified chartered accountants. The study's implications for the accounting profession and the regulators are also discussed.     

审计标准随机运用的经验证据

就心理学的区别—固化理论视角而言,做出审计决定后,审计人员应当会从利于证实审计结论正确性视角出发解读审计标准,即存在着审计标准随机运用现象。国际上的一些经验研究证实了存在这种情况,当然也有不同看法。本文基于中国的经验数据,验证了我国存在着审计标准随机运用现象,这一结论部分解释了上有政策、下有对策现象。如何有效地防止和避免审计标准的随机运用,使得审计标准的运用更为客观和有效,是政府部门制定审计标准时必须考虑的问题。当然,政策发挥作用的过程将不可能一蹴而就。     

Does CEO duality constrain board independence? Some evidence from audit pricing

This study examines whether CEO duality affects the association between board independence and demand for higher quality audits, proxied by audit fee. The findings show that there is a positive association between board independence and audit fees. This result is consistent with findings of Carcello et al. (2002) that more independent boards demand higher audit quality and effort. However, this positive association is only present in firms without CEO duality, thus suggesting that CEO duality constrains board independence. The results support recommendations against CEO duality by showing that dominant CEOs may compromise the independence of their board of directors. Additionally, evidence is provided that board size (the number of directors on the board) is positively associated with audit fee pricing. This is consistent with prior studies that indicate that larger board sizes are associated with inefficiency and negative firm performance.     

Audit report lag: the role of auditor type and increased competition in the audit market

This study investigates the effect of auditor type (private vs. state) and increased competition in an audit market on audit report lag (ARL). This is the first study to provide evidence regarding the effect of audit market competition on ARL. Utilising structure–conduct–performance theory, we predict that competition pressures private auditors to be more efficient and to have less reporting lag than state auditors. We also predict that competition among auditors after a liberalisation period forces auditors to be more efficient and to record less ARL than before. We use a unique data set in Iran, whereby the audit market liberalisation (an audit market where services were previously provided primarily by a state entity) has resulted in both state and private auditors simultaneously providing audit services. The findings are consistent with the following hypothesis, that is ARL is shorter for private auditors than it is for state auditors, and ARL decreases as competition increases in the Iranian audit market. Consistent with the structure–conduct–performance theory, the findings suggest that increased competition in the audit market results in higher efficiency, as reflected by a shorter ARL.     

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.     

Do Big-Four affiliates earn audit fee premiums in emerging markets?

The paper investigates whether Big-Four affiliated (B4A) firms earn audit premiums in an emerging economy context, using Bangladesh as a case. The joint determination of audit and non-audit service fees is also examined using a sample of 122 companies listed in the Dhaka Stock Exchange. Our findings reveal that although the B4A firms do not generally earn a fee premium in Bangladesh, they charge higher audit fees for clients not purchasing non-audit services. This suggests that the B4A firms may actually lower audit fees to attract non-audit services, and cross subsidizes audit fees through non-audit-services fees. The lack of a B4A premium implies that there is lack of quality audit in emerging markets. We also document that audit and non-audit service fees are jointly determined in Bangladesh. Thus, we provide evidence of joint determination of audit and non-audit service fees in an emerging economy context.     

Evidence on the Joint Determination of Audit and Non-Audit Fees

In this study we investigate whether the characteristics of clients, auditors, and the auditor‐client relationship simultaneously determine audit and non‐audit fees. As done in prior studies, we maintain that fees proxy for the level of service provided and follow the physical flow of knowledge. Estimating single‐equation models of audit and non‐audit fee models, we confirm prior findings of an association between audit and non‐audit fees. Studies conclude that such evidence is consistent with knowledge spillovers between the two services. However, we document empirically that audit and non‐audit fees are simultaneously determined. Because the data indicate audit and non‐audit fees are jointly determined, we then investigate whether previously documented associations between audit and non‐audit fees are the result of biased estimation induced by using endogenous variables in single‐equation models. In contrast to results from single‐equation estimations, we find no association between audit and non‐audit fees using a simultaneous specification of the fee system, suggesting that single‐equation estimations suffer from simultaneous‐equations bias. In sum, the findings are not consistent with the existence of economies of scope from the joint performance of audit and non‐audit services after controlling for the joint behavior of audit and non‐audit fees. Given the ongoing debate over the level of allowed non‐audit services by auditors, the argument for the joint provision of audit and non‐audit services is less justified than if joint‐supply benefits had been documented.     

Audit partner rotation and negative information hoarding: evidence from China

We analyse the impact of mandatory audit partner rotation (MAPR) on negative information hoarding about audit clients using a sample of Chinese firms. Our findings suggest that the outgoing audit partners hoard negative information in pre-MAPR, as revealed by a decrease in crash risk, while the incoming audit partners disclose negative information in post-MAPR. Additional analysis suggests that the results are more pronounced among reviewing partners than engaging partners. We also find that when the outgoing audit partner has strong professional abilities or weak personal network with the client or incoming partner, there is less negative information hoarding around MAPR.     

Internal audit,alternative internal audit structures and the level of misappropriation of assets fraud

In recent years, the importance of good corporate governance has received significant public and regulatory attention. A crucial part of an entity's corporate governance is its internal audit function. At the same time, there has been significant public concern about the level of fraud within organizations. The purpose of this study is to assess whether organizations with an internal audit function are more likely to detect and self‐report fraud than those without. In this study, we use a unique self‐reported measure of misappropriation of assets fraud for the first time. The fraud data are from the 2004 KPMG Fraud Survey, which reported fraud from 491 organizations in the private and public sector across Australia and New Zealand. The internal audit data are from a separate mail survey sent to the respondents of the KPMG Fraud Survey. We find that organizations with an internal audit function are more likely than those without such a function to detect and self‐report fraud. Furthermore, organizations that rely solely on outsourcing for their internal audit function are less likely to detect and self‐report fraud than those that undertake at least part of their internal audit function themselves. These findings suggest that internal audit adds value through improving the control and monitoring environment within organizations to detect and self‐report fraud. These results also suggest that keeping the internal audit function within the organization is more effective than completely outsourcing that function.     

Auditor Independence: A Nonparametric Test of Differences Across the Big‐5 Public Accounting Firms

This small sample study provides additional evidence on the unsettled question of auditor independence: Does the provision of non‐audit services by an auditor compromise independence resulting in a poor quality audit? We also examine whether these findings vary across the “Big‐5” public accounting firms. Most prior studies addressing this question, using parametric approaches and various measures of audit quality, have reported conflicting results. Contrary to these studies, we use a non‐parametric approach and the probability of GAAP violation as a new measure of audit quality to address this question. Using data from a sample of Fortune 500 companies for the year 2000, we find that firms whose auditors provide substantial non‐audit services tend to have a higher propensity to violate GAAP. At the firm‐level analysis, we find that these results are more likely driven by few of the Big‐5 public accounting firms. For the remaining firms, the association between non‐audit services and quality of audit could not be established, primarily because of small sample size and lack of power in the test. Our main finding is consistent with other recent studies that provide evidence that the rendering of significant non‐audit services by auditors creates conflict of interest resulting in poor quality audits. Furthermore, our result of differences in these levels of association among the Big‐5 accounting firms represents a new finding, and suggests that there is a need for controlling them separately in research studies examining auditor independence.