Review of Post‐CLERP 9 Australian Auditor Independence Research

The Corporate Law Economic Reform Program (Audit Reform & Corporate Disclosure) Act 2004 (CLERP 9) added substantial new provisions pertaining to auditor independence, and followed in the wake of financial reporting scandals during 2000 to 2003. Many of the regulatory changes were framed in the earlier Ramsay Report, which drew on independence concerns raised in the academic literature. This review paper reviews Australian academic research investigating auditor independence, framed by our conceptual understanding of auditor independence, to assess what we have learned about the impact of CLERP 9 on auditor independence. Our review of Australian auditor independence research published post‐CLERP 9 reveals little evidence of the impact of the regulatory changes on auditor behaviour (independence in fact) and perceptions (independence in appearance). We conclude there are substantial needs for further research on the impact of the CLERP 9 amendments on auditor independence and any enduring independence issues. We identify particular areas for future research that may better inform policy development and argue that the prospect of high‐quality relevant research will increase if regulatory agencies, the accounting profession and audit practitioners engage more with academics in the research process. We identify several ways in which this might occur.     

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 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.     

Costs and Returns on Graduates of the University of Bradford

Global repercussions of the Enron scandal and particularly the enactment of the Sarbanes–Oxley Act (SOX) in the USA, resulted in significant changes in the UK regulatory regime for audit and corporate governance, including an increased role for audit committees and independent inspection of audit firms. UK-listed company chief financial officers, audit committee chairs (ACCs) and audit partners were surveyed in 2007 to obtain views on the impact of 36 economic and regulatory factors on audit quality post-SOX. Four hundred and ninety-eight usable responses were received, representing a response rate of 36%. All groups rated various audit committee interactions with auditors among the factors most enhancing audit quality. However, International Standards on Auditing (ISAs) and the audit inspection regime, aspects of the ‘standards-surveillance-compliance’ regulatory system, are viewed as less effective. Exploratory factor analysis reduces the 36 factors to nine independent dimensions: economic risk; audit committee activities; risk of regulatory action; audit firm ethics; economic independence of auditor; audit partner rotation; risk of client loss; audit firm size and, lastly, ISAs and audit inspection. Post-SOX regulations have introduced additional dimensions to the factors influencing audit quality. Respondents commented that aspects of the changed regime are largely process and compliance driven, with high costs for limited benefits, a finding consistent with regulatory over-reaction.     

Perceived auditor independence and audit firm fees

Regulations requiring the disclosure of fees paid to an auditor for audit and non-audit services (NAS) respond to concerns that such payments are potentially detrimental to auditors' actual or perceived independence. Although empirical studies have failed to produce unequivocal evidence of detrimental effects on auditor independence, the actions of regulators, audit firms and companies are consistent with the belief that economic bonding generated by fees can impair perceived levels of auditor independence.

Using a sample of UK companies over a six year period to March 2006, we study perceived impairment of auditor independence by examining the relationship between levels of total relative fees (combined audit and NAS fees payable by a company to its auditor as a proportion of the audit firm's UK income) and market value. This paper's methodological innovation is its use of a valuation framework in this setting. A further contribution lies in dropping the assumption of linearity found in most prior empirical studies. We provide evidence that shareholders perceive a threat to auditor independence only at high total relative fee levels. At lower levels, total relative fees are positively related to company value. These results suggest that disclosure of NAS and audit fees are of relevance to investors, as is information about auditor income. Our results support the view that regulation by reference to the threshold at which total relative fees are perceived negatively is more consistent with investor preferences than prohibition of the supply of NAS by auditors to their audit 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.     

Independence and the State Auditor in Britain: A Constitutional Keystone or a Case of Reified Imagery?

The principles of state audit, in particular conceptions of independence, adhered to today in the major Westminster democracies originated in the British state audit reforms of the nineteenth century. State auditors prior to the nineteenth century were not expected to be independent of the executive. Instead, state audit was recognized as an executive function to be under the direct control of the executive. For a brief period in the mid-nineteenth century, parliament was able to take advantage of a succession of weak governments to redirect the loyalties of state audit from the executive to the legislature. Although parliament wanted to be served by a state auditor who would keep it informed of executive spending, it did not alter the dominance of the Treasury over state audit. The executive sought to sustain through a discourse of independence the perception that the controls exercised by the executive over the state auditor did not constitute either a threat to audit independence or result in capture of state audit by the executive. The discourse constructed the image of state audit as a function which was able to work unimpeded and independent of the executive despite a legislative framework which contained significant financial, procedural and staffing controls.     

Corporate Governance and Efficiency: Evidence From U.S. Property–Liability Insurance Industry

This study examines the relation between corporate governance and the efficiency of the U.S. property–liability insurance industry during the period from 2000 to 2007. We find a significant relation between efficiency and corporate governance (board size, proportion of independent directors on the audit committee, proportion of financial experts on the audit committee, director tenure, proportion of block shareholding, average number of directorships, proportion of insiders on the board, and auditor dependence). We also find property–liability insurers have complied with the Sarbanes‐Oxley Act (SOX) to a large extent. Although SOX achieved the goal of greater auditor independence and might have prevented Enron‐like scandals, it had some unexpected effects. For example, insurers became less efficient when they had more independent auditors because the insurers were unable to recoup the benefits of auditor independence.     

The pricing of audit and non-audit services in a regulated environment: a longitudinal study of the UK life insurance industry

This paper studies the relationship between audit and non-audit service fees paid to the statutory auditor by UK life insurance firms, utilising an extensive panel-data sample set for the period 1999–2009. Consistent with a knowledge spillover (impairment of independence) hypothesis, we predict and find that audit fees are positively (negatively) associated with actuarial (tax service) fees. Additionally, our results indicate that regulatory changes enforced after 2004 deterred UK life insurance firms from purchasing non-audit services that are perceived to impair auditor independence. Finally, we find evidence concerning the inter-temporal determination of audit fees.     

New Auditors’ Decisions for Released Firms from the Mandatory Auditor Designation Rule: Evidence From South Korea

This study examines the effect of the mandatory designation rule on audit fees charged and audit hours rendered by auditors for firms released from the mandatory auditor designation rule in the Korean audit market. Under the mandatory auditor designation rule, which took effect in 1991, problematic firms are assigned new auditors by the Financial Supervisory Service. Previous studies suggest that this regulation positively affects the quality of audits by promoting auditor independence. Thus, this study hypothesises that firms that have been subjected to mandatory auditor designation improve the quality of their financial reporting, and that auditors hired after the mandatory designation period account for reduced audit risks when determining audit fees and audit hours. This study shows that audit fees and audit hours of firms released from the mandatory auditor designation rule are lower than those of other initial audit engagements. Taken together, this study's findings reinforce the notion that auditors’ perceptions of changes in audit risk yield corresponding changes in the audit fees they charge and audit hours they render.     

Does Opinion Shopping Impair Auditor Independence and Audit Quality?

This study investigates how companies' threats to dismiss auditors and their engagement in opinion shopping influence auditor independence and audit quality, which in turn affect misstatements in financial statements. It also examines how outsiders' reactions to auditor switching influence opinion shopping. The results indicate that neither the predecessor auditor's nor the successor auditor's independence is compromised by dismissal threats and opinion shopping. Further, the successor auditor's audit quality exceeds the predecessor auditor's audit quality. In addition, auditor switching decreases potential understatements and increases potential overstatements in financial statements, and the capital market's and the successor auditor's reactions to auditor switching reduce the benefits of opinion shopping to companies. Additionally, the study sheds some light on the potential effects of both the Sarbanes‐Oxley's restriction on non‐audit services and mandatory auditor rotation or retention. The paper also derives a rich set of empirical implications.     

中国上市公司初始审计的定价折扣考察——来自审计师变更的经验证据

初始审计的定价折扣具有重要的与审计独立性相关的公共政策含义。本文基于DeAngelo(1981)和Dye(1991)关于初始审计定价折扣的竞争性理论预期,利用2002——2004年我国审计市场的数据对初始审计的定价行为与特征进行了较为细致的实证考察。经验结果支持中国证监会关于审计费用的强制性公开披露政策,准租金和低价折扣引起的潜在的审计独立性问题会随着审计费用的公开披露而得到消除或减轻。本文还具有重要的监管含义:对审计师变更的监管应着重关注那些大型上市公司在小型会计师事务所之间进行变更的行为。     

Financial crisis and the silence of the auditors

Against the backdrop of the current financial crisis, this paper seeks to stimulate debates about contemporary auditing practices. It notes that many financial enterprises have sought state support within a short period of receiving unqualified audit opinion. Auditors collected large amounts in audit and non-audit fees. The events raise questions about the value of company audits, auditor independence and quality of audit work, economic incentives for good audits and the knowledge base of auditors.     

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.     

Non-audit services provided to audit clients,independence of mind and independence in appearance: latest evidence from large UK listed companies

This paper investigates whether the provision of non-audit services (NAS) to audit clients impairs auditor independence of mind and independence in appearance. The main contributions of this paper are in terms of its timeliness with respect to regulatory changes, the simultaneous examination of both forms of auditor independence and the methodological innovation whereby it uses a variable derived from the level of abnormal audit fees as a moderating variable in order to capture the direct impact of the NAS fee level on auditor independence as well as how its influence is moderated by the level of unexpected audit fees. Our results indicate that auditor independence of mind is compromised by the size of NAS fees, particularly for clients who pay below the level of expected audit fee. The stock market perceives that auditor independence is compromised by NAS fees but, at the same time, additional tests indicate that there are benefits that accrue from NAS and, in particular, the relation between return and non-discretionary net income is increasing in NAS fees. The balance of evidence suggests that the European Union is correct in undertaking some reform of the auditing market.     

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.     

The impact of MAS on perceived auditor independence-some evidence from Denmark

The Enron case has highlighted that the provision of management advisory services (MAS) can endanger auditor independence. Recently, a number of changes have not only been made to the relevant international and US regulations, but also to the Danish regulations in this area. Theoretical research explains the emergence of non-independence and demonstrates that the provision of MAS can decrease independence. According to the economic model of DeAngelo, the existence of client-specific quasi-rents impairs auditor independence. The provision of MAS increases quasi-rents and thus, is a threat to independence. Antle used an agency theoretical approach. Information asymmetries between auditor and client could lead to a moral hazard risk, i.e. the auditor could give up independence from client's management and accept payments for withholding detected errors and irregularities. The client's management could also use MAS to legally compensate the auditor for giving away independence.A large number of empirical studies have investigated the influence of MAS on the perceived independence of the auditor. Most of these studies were performed in English speaking countries and the majority found a negative impact. Sociological research reveals cultural differences between English speaking and Nordic countries, e.g. concerning the dimension ‘masculinity’. Thus, an empirical investigation of the impact of MAS on perceived auditor independence in Denmark is promising. It was found that shareholders, bank loan officers and journalists perceive a negative effect on auditor independence if MAS are provided. The recent liberalization in Denmark is inconsistent with this finding. Furthermore, it was shown that the type of MAS influences the degree to which auditor independence is perceived to be impaired. Thus, independence rules related to MAS should be differentiated. Additionally, the study ascertained that perceived auditor independence does not increase if MAS are provided by a separate department of the audit firm. An internal separation of the auditing and the consulting function within the same audit firm is not viewed as being beneficial in Denmark.     

Audit committee quality,auditor independence,and internal control weaknesses

In this paper we investigate the relation between audit committee quality, auditor independence, and the disclosure of internal control weaknesses after the enactment of the Sarbanes-Oxley Act. We begin with a sample of firms with internal control weaknesses and, based on industry, size, and performance, match these firms to a sample of control firms without internal control weaknesses. Our conditional logit analyses indicate that a relation exists between audit committee quality, auditor independence, and internal control weaknesses. Firms are more likely to be identified with an internal control weakness, if their audit committees have less financial expertise or, more specifically, have less accounting financial expertise and non-accounting financial expertise. They are also more likely to be identified with an internal control weakness, if their auditors are more independent. In addition, firms with recent auditor changes are more likely to have internal control weaknesses.     

Non‐Audit Service Fees and Financial Reporting Quality: A Meta‐Analysis

Auditing as a corporate governance mechanism has attracted considerable research attention. Because of the information asymmetry between corporate managers and outside shareholders, auditors are hired to provide independent assurance that financial statements are prepared following generally accepted accounting principles. The credibility of such assurance depends on the independence, both in fact and in appearance, of the auditor. Over the years, however, the independence of auditors has come under increased scrutiny because of their joint provision of both audit and non‐audit services. A sizable literature on the impact of non‐audit fees on financial reporting quality has developed. The evidence from this literature, however, remains inconclusive. This paper provides a meta‐analysis of the available literature by assessing (a) the net effect of non‐audit fees on financial reporting quality, and (b) whether there is homogeneity in the financial reporting quality proxies used in the extant literature. Findings suggest that the level of client‐specific non‐audit fees is associated with reduced financial reporting quality. However, the underlying studies used to conduct this meta‐analysis are not homogenous.     

Field Dependence Cognitive Style as a Moderating Factor in Subjects' Perceptions of Auditor Independence

This paper reports the findings of a laboratory experiment designed to assess the moderating role of field dependence cognitive style in the effects of management consultancy services and qualified audit reports on subjects' perceptions of auditor independence. Using an ANOVA repeated-measures experimental design, 22 accountants were administered a questionnaire which contained four scenarios, each representing one of four possible combinations of levels of the two exogenous variables. To measure levels of confidence in the auditors' independence in each of the scenarios, subjects were requested to respond to a seven-point scale. In addition, subjects were classified as field dependent or field independent on the basis of the Group Embedded Figures Test. Results showed that field dependence cognitive style interacted to moderate the effects of management consultancy services and qualified audit reports on subjects' perceptions of auditor independence. The findings suggest that cognitive style is an important moderating variable that affects subjects' perceptions of auditor independence.