A study of whistleblowing among trainee auditors

Over the last number of years whistleblowers have been gaining prominence. This paper investigates some of the factors that influence the propensity or willingness to blow the whistle among trainee auditors. Three categories of factors are examined: audit firm organisational structures, personal characteristics of whistleblowers and situational variables.A survey of 240 final year students of the Institute of Chartered Accountants in Ireland was undertaken. Trainee auditors (just about to sit their finals) were asked about their confidence in internal and external reporting structures in their firms. Using four scenarios, audit trainees were questioned on their willingness to challenge an audit partner's inappropriate response to concerns raised during the audit. Finally, audit trainees were asked about the influence of legal protection on their likelihood of whistleblowing.Results indicate that where firms have adequate formal structures for reporting wrongdoing, trainee auditors are more likely to report wrongdoing and have greater confidence that this will not adversely affect their careers. Training increases this confidence. Trainee auditors also express a willingness to challenge an audit partner's unsatisfactory response to wrongdoing. Significant differences were found in attitudes depending on whether the reports of wrongdoing were internal or external. The willingness to report wrongdoing externally reduces for older (aged over 25) trainees.     

Accounting misstatements following lawsuits against auditors

This study investigates whether an auditor's experience of litigation in the recent past affects subsequent financial reporting quality. At the audit firm level, we find accounting misstatements occur significantly less (more) often after audit firms are sued (not sued). At the audit office level, the negative association between past litigation and future misstatements is stronger for offices who were directly implicated in the litigation than for the non-accused offices of sued audit firms. Therefore, the litigation experiences of both audit firms and audit offices are incrementally significant predictors of future financial reporting quality.     

Audit firm's Confucianism and stock price crash risk: Evidence from China

This study examines the association between audit firm's Confucianism and stock price crash risk. We postulate that Confucian moral standards predict a mixed relationship between audit firm's Confucianism and stock price crash risk. Using a large sample of listed firms in China during 2006–2018, we find that audit firm's Confucianism is positively related with client's future stock price crash risk, implying that Confucianism of audit firm aggravates client's bad news hoarding behavior. The effect is more pronounced for client without female auditors and/or with closer personal relationship with auditors. Mechanism analysis shows that audit firm's Confucianism exacerbates crash risk by worsening audit quality and information transparency. Political discipline and external monitoring help to alleviate the negative influence of audit firm's Confucianism on stock price crash risk.     

Political connection and cost of debt: Some Malaysian evidence

This paper investigates the association between Malaysian politically connected (PCON) firms and the cost of debt. We extend previous research that finds Malaysian PCON firms are perceived as being of higher risk by the market, and by audit firms, by providing evidence that lenders also perceive these firms as being of higher risk. We also find that PCON firms have a significantly (1) higher extent of leverage, (2) higher likelihood of reporting a loss, (3) higher likelihood of having negative equity, and (4) higher likelihood of being audited by a big audit firm. We suggest that PCON firms are charged higher interest rates by lenders as a result of efficient contracting given their higher inherent risks. Additionally, we find that CEO duality present in PCON firms is perceived by lenders as being more risky, and that a higher proportion of independent directors on the audit committee mitigate this perceived risk.     

Audit technology and preferences for auditing standards

This paper investigates factors associated with audit firm positions on Auditing Standards Board issues during the three-year period ending during 1984. The major finding is that firms with relatively structured audit technologies tend to favor proposed statements while firms with relatively unstructured technologies do not. Audit firm size is not associated with firm position. Also, Big 8 firms favoring proposed statements have lower staff-to-partner ratios and concentrate less in auditing. The staff-to-partner ratio is negatively associated with technology. The results' implications for auditing profession organization studies and auditing and financial reporting research are investigated.     

How individual auditor characteristics impact the likelihood of audit failure: Evidence from China

Audit failure imposes a severe loss on investors and damages market participants' confidence in financial reporting quality. This study investigates the impacts of individual auditor characteristics on the likelihood of audit failure. Chinese regulators mandate listed firms to disclose the engagement auditors' identity. Furthermore, the information regarding individual auditor characteristics in China is also publicly available. Utilizing this unique setting, we examine the relationship between individual auditor characteristics and the likelihood of audit failure in China during the period from 2000 to 2009. We document that individual auditors with more auditing experience are less likely associated with audit failure. We also find a weaker negative relationship between auditor education level and audit failure. Our study has important implications for both auditors and regulators by shedding lights on the determinants of audit failure and by providing guidance to the human resource management in audit firms.     

The Impact of Disclosures of Internal Control Weaknesses and Remediations on Investors' Perceptions of Earnings Quality

We hypothesize and find that firms making SOX‐mandated disclosures of material weaknesses in internal control over financial reporting (ICOFR) exhibit lower investor‐perceived earnings quality (IPEQ) than nondisclosers. We measure IPEQ using e‐loading, a market‐returns–based representation of earnings quality developed by Ecker, Francis, Kim, Olsson, and Schipper (2006). Firms do not exhibit decreases in IPEQ after initially disclosing material weaknesses. This is consistent with investors having anticipated ICOFR strength based on observable firm characteristics. However, firms exhibit increases in IPEQ after receiving their first clean audit reports that confirm the remediation of previously disclosed weaknesses. This indicates that, although investors do not find initial weakness disclosures to be incrementally informative, SOX motivates firms to remediate weak controls and provides a venue for credible remediation disclosures, thus enhancing investors' perception of financial reporting reliability. These findings are consistent with the existence of regulatory benefits associated with SOX's internal control disclosure and audit requirements.     

FINANCIAL STATEMENT USERS‘ PERCEPTIONS OF FACTORS AFFECTING THE ABILITY OF AUDITORS TO RESIST CLIENT PRESSURE IN A CONFLICT SITUATION

This study investigates the perceived effects of four factors on the likelihood that an auditor will acquiesce to the demands of a client when a dispute arises over a significant financial reporting issue. A repeated measures experiment was conducted using 49 security analysts and 69 bankers as subjects. Analysis of Variance results indicate that an auditor is perceived as being more likely to acquiesce to his client's demands when the accounting issue in dispute is not dealt with clearly by an accounting standard. Auditors also are viewed as being more likely to acquiesce when: (1) competition in the audit environment is aggressive; (2) the audit firm is small; and (3) the audit firm provides management consulting services to its audit client.     

Investor perceptions of the earnings quality consequences of hiring an affiliated auditor

The Sarbanes–Oxley Act (SOX) requires that firms wait 1 year before hiring an individual employed as a member of the external audit team. SOX’s intent is to reduce the perceived loss of auditor independence due to affiliated hiring. SOX also requires fully independent audit committees and disclosure of directors with financial expertise. Using a sample of financial executive hires during the pre-SOX period, we find that earnings response coefficients (ERCs) decline following hires of individuals recently employed by the firm’s external auditor, but ERCs do not decline following hires not recently employed by the external auditor. We also find smaller ERC declines following affiliated hires for firms with audit committee compositions consistent with subsequently imposed SOX requirements. Further investigation using measures of earnings quality suggests that differences in ERC changes are attributable to perceived, rather than real, changes in earnings quality following affiliated hires.     

Consulting revenue sharing,auditor effort and independence,and the regulation of auditor compensation

The joint provision of audit and non-audit services by audit firms to their audit clients has posed a threat to auditor independence. To mitigate the independence problem, the US Securities and Exchange Commission (SEC) issued a regulation (SEC, 2003) that prohibits audit partners from receiving compensation for the sale of non-audit services to their audit clients. This study examines the effects of this regulatory change on the effort and reporting decisions of audit partners. We show that partners in an audit firm strategically change the firm’s liability-sharing rule. As a consequence, the regulation restores truthful reporting but has an undesirable negative effect on audit effort. The effect of the regulation on the welfare of the economy (defined as the total payoff to both audit firms and their clients) hinges on the tradeoff between the benefit of the regulation, which is derived from the inducement of truthful reporting, and the cost of the regulation, which results from less diligent audit work. We show that the regulation is more likely to increase the welfare in a strong legal regime (where the legal liability cost of auditor litigation is high) than in a weak legal regime.     

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.     

Auditor Independence,Non‐Audit Services,and Restatements: Was the U.S. Government Right?*

Do fees for non‐audit services compromise auditor's independence and result in reduced quality of financial reporting? The Sarbanes‐Oxley Act of 2002 presumes that some fees do and bans these services for audit clients. Also, some registrants voluntarily restrict their audit firms from providing legally permitted non‐audit services. Assuming that restatements of previously issued financial statements reflect low‐quality financial reporting, we investigate detailed fees for restating registrants for 1995 to 2000 and for similar nonrestating registrants. We do not find a statistically significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements, but we do find some such association for unspecified non‐audit services and restatements. We find a significant negative association between tax services fees and restatements, consistent with net benefits from acquiring tax services from a registrant's audit firm. The significant associations are driven primarily by larger registrants.     

Audit committee quality indices,reporting quality and firm value

We investigate the relation between audit committee (AC) quality indices, financial reporting, internal control quality and firm value using a US dataset for the period 2002–12. The indices are developed by linking firm value with principal component analysis (PCA) factors based on a broad set of 82 AC variables, some of which influence the quality of the AC, but are not addressed in prior literature. Significant AC factors include ‘overlapping directors’, ‘busyness’ and ‘foreign director’, and we use these factors to develop ‘high’ and ‘low’ AC quality indices. We show that low AC quality firms are more likely to manage earnings, be external auditor dependent with respect to non‐audit tax services, and switch to a lower quality auditor. Low AC quality firms are also more likely to have internal control concerns disclosed by predecessor auditors, including accounting issues, financial restatements, audit opinion concerns and deficiencies that undermine internal control effectiveness. Further, they are more likely to receive an audit report containing additional explanatory notes. Conversely, high AC quality firms are significantly less likely to have these concerns. Our findings highlight the value of using AC quality indices in delivering greater oversight of the financial reporting process.     

事务所规模、审计行业专长与事务所审计质量传染效应

发生审计失败事务所的审计质量系统性低于未发生审计失败事务所的审计质量,即会计师事务所的审计质量存在传染效应,但该传染效应受到事务所自选择问题的影响;大规模事务所在审计质量传染效应中占据主导地位;事务所行业专长未能抑制审计质量传染效应。     

Taxing audit markets and reputation: An examination of the U.S. tax shelter controversy

From 2002 to 2007, the nation's largest CPA firms faced allegations of illegal activity related to the sale of tax shelters: EY, KPMG and PwC paid fines; KPMG was investigated by a federal grand jury; and EY faced a criminal inquiry. These shelter events occurred shortly after the 2002 collapse of Arthur Andersen, when policy makers were concerned about audit market concentration. This is the first paper to provide a chronological summary of how the tax shelter controversy started and ended. We investigate the stock market reaction to tax shelter news developments between 2003 and 2005 to make inferences about the market's view of audit competition and CPA firm reputation. Our results are consistent with market concern over large audit firm concentration, evidenced by large negative returns for clients of all audit providers upon the KPMG grand jury investigation announcement. We also find that tax shelter activities impact both the reputation of the accounting profession and the individual CPA firms marketing tax shelter products.     

Audit committee diligence around initial audit engagement

Studies focusing on governance mechanisms argue that auditor monitoring is one of several governance mechanisms that exist in the firm, and these mechanisms supplement each other. Extending this argument, I examine whether firms support auditor monitoring with audit committee monitoring when auditor oversight is deemed to be weak. Prior auditing literature argues that audit quality is affected by auditors' lack of familiarity with their clients' activities. Since lack of auditor–client familiarity exists in the first year of auditor–client tenure, I examine whether firms increase their audit committee monitoring during the year of auditor change. For a sample of firms that changed auditors between 2006 and 2012, the findings show that audit committees meet more frequently in the first year of audit engagement. Further tests show that firms' past reporting behavior play a significant role in the demand for more audit committee meetings and the increase in the audit committee meetings in the initial year of auditor engagement positively affects reporting quality.     

An examination of anonymous and non-anonymous fraud reporting channels

Interest in the role of the reporting channel on whistleblowing has been fostered by the passage of the Sarbanes-Oxley Act of 2002, which requires that audit committees of public companies establish and oversee an anonymous reporting channel for questionable accounting or auditing matters. But only limited information exists as to the likely effectiveness of such a channel as compared to a non-anonymous channel. The purpose of our paper is to report the results of an experimental study examining participants' intentions to report fraud using anonymous and non-anonymous reporting channels given information about the outcomes from a previous non-anonymous whistleblowing incident. The experiment manipulates the outcomes to both the previous whistleblower and to the transgressor. We find that while negative outcomes from the perspective of a previous non-anonymous whistleblower (either the occurrence of retaliation against that person or no negative repercussions to the previous transgressor) lowered participants' non-anonymous reporting intentions, these negative outcomes did not decrease participants' anonymous reporting intentions. But when, no such negative outcomes from the previous whistleblower's perspective have occurred, our participants' reporting intentions did not differ between the anonymous and non-anonymous channels.     

How do auditor rotations affect key audit matters? Archival evidence from South African audits

The expansion of the auditor's reporting duties with the introduction of critical or key audit matters (KAMs) has reignited interest in the determinants and consequences of the rules and regulations aimed at improving audit's functionality and quality. This paper expands on a growing body of work which investigates possible determinants of the KAMs being included in audit reports. It provides an original perspective on KAM identification and reporting in three ways. Firstly, the paper deals specifically with audit partner and firm rotations as possible KAM determinants. Secondly, hand-collected details are analysed to test for changes in the absolute number of KAMs as well as for KAMs added to or removed from audit reports to provide a more refined measure of how KAM disclosures are varying. Finally, data are gathered from South Africa to complement the empirical work which, to date, has largely focused on the U.S. and U.K. Our findings reveal a duality of stability and variability in how the requirement to report KAMs is being operationalised. A change in audit partner is not associated with changes in reported KAMs but changing audit firms appears to have a significant impact on the KAMs added to or removed from an audit report. The provisions of ISA 701 promote consistency in how KAMs are identified and disclosed by individual partners. However, ISA 701 cannot define and control every aspect of KAM determination. As a result, there is a degree of agency at the firm-level which allows for differences in how audit firms choose to implement the standard's provisions. Our study makes an important contribution by providing evidence of the complex interaction between standardisation of audit practice and sources of performative variability and may lend weight to the regulatory arguments in favour of mandatory firm rotation.     

Firm incentives,institutional complexity and the quality of “harmonized” accounting numbers

In this paper, we investigate how firm reporting incentives and institutional factors affect accounting quality in firms from 26 countries. We exploit a unique multicountry setting where firms are required to comply with the same set of international reporting standards. We develop an approach of cross-country comparisons allowing for differences between firms within a country and we investigate the relative importance of country- versus firm-specific factors in explaining accounting quality. We find that financial reporting quality increases in the presence of strong monitoring mechanisms by means of ownership concentration, analyst scrutiny, effective auditing, external financing needs, and leverage. Instability of business operations, existence of losses, and lack of transparent disclosure negatively affect the quality of accounting information. At the country level, we observe better accounting quality for firms from regulatory environments with stronger institutions, higher levels of economic development, greater business sophistication, and more globalized markets. More importantly, we find that firm-specific incentives play a greater role in explaining accounting quality than countrywide factors. This evidence suggests that institutional factors shape the firm's specific incentives that influence reporting quality. Our findings support the view that the global adoption of a single set of accounting standards in isolation is not likely to lead to more comparable and transparent financial statements unless the institutional conditions and the firm-specific reporting incentives also change.     

Determinants of going concern opinions and audit fees for development stage enterprises

Startup entities have been the focus of much political and academic interest recently. Development stage enterprises (DSEs), as defined by SFAS 7, are startup entities for which some publicly available information exists. New accounting standards have removed the DSE designation and related extra reporting requirements, and placed more responsibility on owners and managers to assess the ability of entities to continue as a going concern. We examined information from financial statements and audit reports of companies previously reporting as DSEs to investigate what increases the likelihood of receiving a going concern modification in auditors' opinions (GCO) and what affects audit fees. Our overall analyses indicate that the asset size of DSEs, negative working capital, and prior-year going concern modifications consistently influence going concern modifications to auditors' opinions. Managers should clearly consider these conditions when making their assessment of their companies' future going concern status. Our results indicate that the size of the audit firm did not influence the going concern modification decision, but Big4 auditors charge significantly higher fees than other auditors. Thus, managers/owners of DSEs should weigh the benefits of having a Big4 firm audit on their financial statements against the higher fees charged by those firms.