Discussion of “Does the Identity of Engagement Partner Matter? An Analysis of Audit Partner Reporting Decisions”

The authors of this provocative study apply commonly used audit quality surrogate measures to a large and unique set of financial and other data on statutory audits of small private companies in Sweden. The paper has received unparalleled attention by the financial press and the PCAOB for its presumed support for regulatory intervention in standards for U.S. public company audits. In this Discussant Comment, I review the paper's content, analyze its predictive validity, and discuss its multiple implications plus, following Conference instructions, I provide constructive suggestions for improvements. Based on predictive validity analysis, I conclude that engagement partner assignment strategy is an important and acknowledged omitted variable that affects the study's internal validity via both the independent variable (partner's prior performance measure) and the dependent variable (borrower's cost of debt capital). The omission also affects construct validities and, if audit firms are applying a plausible assignment strategy, then interpretation of the study's main results would be reversed. Finally, the lack of a standards intervention noted by the authors and the extreme size and other differences between audits of Swedish private companies and U.S. public companies impair external validity and generalization to the U.S. intervention. As to improvements, I suggest that the authors (i) ask Swedish lenders to validate their presumed use of partner performance ratings in determining a borrower's interest rate, and (ii) ask Swedish Big 4 audit firms to provide a few internal partner performance ratings for comparison with the external performance measures used in the study. This two‐pronged, multimethod approach might confirm or deny critical assumptions underlying the present study and may substantively inform standards setters, evidence‐based standards, and fellow researchers about the validity of commonly applied surrogates for audit quality and the study's stated conclusion.     

What is the Relationship Between Audit Partner Busyness and Audit Quality?

Contemporaneous studies generally find a negative relationship between audit partner busyness (APB), measured as the number of clients in an audit partner's portfolio, and audit quality. Their argument is that a busy partner does not devote sufficient time to properly audit his average client. Contrary to these studies, we argue that when busyness is optimally chosen by the partner, in equilibrium, there is no causal relationship between APB and audit quality. Using Australian data for the 1999–2010 period, we show that APB is not reliably linked to audit quality, consistent with this equilibrium theory. We argue that causality can be ascribed to the APB‐audit quality relationship when accounting scandals exogenously shocked the Australian audit market during the 2002–04 period and APB likely deviated from optimum levels. Supporting this disequilibrium view, we find that higher APB reduces a partner's propensity to issue first‐time going‐concern opinions during this period. Our evidence highlights the importance of the equilibrium condition in testing empirical associations between audit outcomes and endogenous auditor attributes, and shows that the detrimental effect of APB on audit quality is not as pervasive as contemporaneous studies suggest.     

Does Audit Committee Accounting Expertise Help to Promote Audit Quality? Evidence from Auditor Reporting of Internal Control Weaknesses

In this study, we examine whether audit committee accounting expertise helps to promote audit quality by motivating auditors to conduct diligent internal control audits and make appropriate internal control assessments because audit committee accounting expertise safeguards auditors from dismissal following adverse internal control opinions. Among clients with existing and likely internal control material weaknesses (as proxied by future restatements of audited financial statements), we find a greater likelihood of adverse internal control audit opinions when the audit committee has greater accounting expertise (measured by the proportion of accounting experts on the audit committee). Among all clients, we find a lower likelihood of subsequent auditor dismissal following an adverse internal control audit opinion when the audit committee has greater accounting expertise. In further analyses, we find that this lower likelihood of subsequent auditor dismissal occurs when at least two audit committee members possess accounting expertise. We also find some evidence that CFO influence (but not CEO influence) over the audit committee negates the increased likelihood of adverse internal control opinions when internal control material weaknesses likely exist, as well as the decreased likelihood of auditor dismissal following adverse internal control opinions. These findings have important implications for regulators and corporate nominating committees interested in promoting audit committee effectiveness.     

Energy Dependence in Developing Countries: Does the Level of Income Matter?

This paper re-examines the causal relationship between energy consumption and economic growth in four developing countries. The four countries include two lower-middle income economies, Ghana and Cote d’Ivoire, and two upper-middle income economies, Brazil and Uruguay. The study attempts to answer one critical question: Is the causal relationship between energy consumption and economic growth sensitive to a country’s level of income? In order to account for the omission-of-variable bias, the study incorporates exports as an intermittent variable between energy consumption and economic growth—thereby creating a simple multivariate model. Using the auto-regressive distributed lag (ARDL)-bounds testing procedure, our results show that while energy consumption Granger-causes economic growth in upper-middle income countries, in lower-middle income countries it is economic growth that drives energy consumption.     

Does Audit Market Concentration Harm the Quality of Audited Earnings? Evidence from Audit Markets in 42 Countries*

Audit regulators around the world have expressed concern over market dominance by Big 4 accounting firms and the potential adverse effect it may have on the quality of audited financial statements. We use cross‐country variation in the audit market structure of 42 countries to examine two separate aspects of Big 4 dominance: (1) Big 4 market concentration as a group relative to non–Big 4 auditors; and (2) concentration within the Big 4 group in which one or more of the Big 4 firms is dominant relative to the other Big 4 firms. We find that in countries where the Big 4 (as a group) conduct more listed company audits, both Big 4 and non–Big 4 clients have higher quality audited earnings compared to clients in countries with smaller Big 4 market shares. In contrast, in countries where there is a greater concentration within the Big 4 group, we find that Big 4 clients have lower quality audited earnings compared to countries with more evenly distributed market shares among the Big 4. Thus concentration within the Big 4 group appears to be detrimental to audit quality in a country and of legitimate concern to regulators and policymakers. However, Big 4 dominance per se does not appear to harm audit quality and is in fact associated with higher earnings quality, after controlling for other country characteristics that potentially affect earnings quality.     

Does an Audit Judgment Rule Increase or Decrease Auditors' Use of Innovative Audit Procedures?

The current audit environment encourages auditors to conduct defensive auditing procedures in lieu of using new, innovative, and potentially more effective audit procedures, due to concerns these procedures may be second-guessed in litigation or by audit inspectors such as the PCAOB. As a result, auditors may prefer traditional “generally accepted” procedures over innovative procedures that are potentially more effective. We test recent proposals that an Audit Judgment Rule (AJR) encourages the use of innovative, and potentially more effective, audit procedures analogous to the similar Business Judgment Rule that affords legal protections to corporate directors. Under an AJR, litigators or audit inspectors could not second-guess auditor judgments, even if they perceive that alternate judgments would have ordinarily been reached, provided the auditor's judgment was made in good faith and in a rigorous manner. However, the AJR's requirements that auditors must defend the rigor of their innovative judgments could potentially backfire and lead auditors to select more traditional procedures. Under the framework of goal activation theory, we conduct an experiment with audit managers and seniors and find that an AJR makes auditors less likely to select innovative audit procedures, particularly when audit risk is high. They do so despite believing the innovative procedures to be more effective than the traditional procedures. Findings from a supplementary experiment with experienced auditors further suggest that national office affirmation of the reasonableness of the procedures does not help overcome this effect. Overall, our findings suggest that an AJR may have the unintended consequence of further increasing auditors' focus on more traditional, and potentially less effective, audit procedures.     

Fiscal Faux Pas?: An Analysis of the Revenue Implications of Trade Liberalization

This paper examines the argument that trade liberalization depresses tax revenue/GDP ratios in developing countries. This occurs because the structural characteristics associated with developing countries limit their ability to make the transition from trade to domestic taxes. Using a panel of 80 developing and industrialized countries over 1970–98, the econometric analysis carried out employs a fixed-effects regression framework to examine the evidence. The results indicate that low-income and upper middle-income countries have experienced declining tax revenues as a result of falling income and trade tax revenues and that structural characteristics have been significant in explaining the decline.     

Does Generation Matter to Entrepreneurship? Four Generations of Entrepreneurs

This study for the first time addresses generation effects on eight entrepreneur types across four U.S. generations: Traditionalists, Boomers, Gen‐Xers, and Millennials. It adopts hierarchical age‐period‐cohort (HAPC) models using multilevel mixed‐effects logistic regression models with random period effect controls and the same‐age comparison between two neighboring generations. The empirical study relies on monthly Current Population Survey data across 11 years (2006–2016). When controlling for age, period, path dependency, seasonality, and other demographic and socioeconomic factors, no generational differences are identified for workers' entrepreneur propensity, mirroring entrepreneurs' misfits; for entrepreneur‐type propensities, limited generation differences are identified: the odds for Gen‐Xers to be novice (vs. non‐novice) entrepreneurs are 10% higher than Boomers for the ages of 44 and 51; the odds for Boomers to be opportunity (vs. necessity) entrepreneurs are 2.3 times higher than Traditionalists for the ages 63–70. The limited generational difference is consistent with prior literature using HAPC.     

The Buffer Stock Model Redux? An Analysis of the Dynamics of Foreign Reserve Accumulation

Cointegration analysis suggests that the buffer stock precautionary model accounts for the optimal reserve demand in nine developing countries located in Asia and Latin America. The corresponding VECMs are further interpolated, using the permanent and transitory innovation decomposition procedure, in order to assess the relative impact of the time series on the convergence to equilibrium after a shock. Finally the (asymmetric) effect on the speed of convergence of positive/negative changes in signal variables—such as the excess reserves of the previous period, relative competitiveness and US monetary stance—is found to be significant, in line with mercantilistic and fear of floating motives for hoarding reserves.     

When Are Audit Firms Sued for Financial Reporting Failures and What Are the Lawsuit Outcomes?

We examine how often audit firms are sued in a large sample of accounting lawsuits that allege financial reporting failures. We find an insignificant relation between the likelihood of auditor litigation and restatements, but the likelihood of auditor litigation is strongly related to the types of alleged accounting deficiencies. We also find that the auditor's type influences the probability of the auditor being sued and the size of the payouts from auditor and nonauditor defendants. In particular, the Big N firms are approximately 7 percent less likely than non–Big N firms to be named as co-defendants, and the auditor's contribution to the plaintiff's payout is significantly larger when a Big N firm is sued. Overall, our findings suggest that auditors are rarely blamed when there are allegations of financial reporting failures, but the types of accounting deficiencies and the auditor's type significantly influence the probability of the audit firm being sued and the outcomes of the lawsuits.     

Impact of International Remittances on Schooling in the Philippines: Does the Relationship to the Household Head Matter?

We study the impact of international remittances on schooling in the Philippines, taking into account the school‐age individual's relationship to the household head. This consideration is important because employment opportunities abroad may be taken at the expense of the quality of child rearing. Our estimation results indicate that there are, indeed, significant negative guardian effects on school attendance and education expenditures when children with overseas parents are looked after by a relative other than a parent or grandparent. However, these negative effects tend to be outweighed by the positive impact of remittance flows from overseas.     

Surviving the Famine Unscathed? An Analysis of the Long‐Term Health Effects of the Great Chinese Famine

We study the long‐term health effects of the Chinese Famine of 1959–1961 on five cohorts of individuals exposed to it at different stages of their early lives. Based on a 2011 national survey, we use instrumental variables to estimate the impact of the Famine on various health and lifestyle indicators for the whole sample and for the female and male subsamples separately. We have found some negative effects of Famine exposure: (i) for the whole sample, Famine exposure reduced adult height for two out of five cohorts; (ii) for both the female and the male subsamples, Famine exposure reduced adult height in one cohort; and on the whole the reduction was larger for males. We have also found in the subsample that Famine exposure was associated with (i) a higher risk of having hypertension in one cohort for females; (ii) a higher likelihood of smoking in one male cohort; and (iii) a higher probability of consuming alcohol in one cohort for males. Finally, we have not found a statistically significant association between Famine exposure and the risk of being overweight or underweight, having diabetes or other chronic diseases, having depression.     

Japanese Joint Ventures in the UK: Does Product Classification Matter?

This paper investigates the factors that determine the choice of Japanese companies between part and full ownership of their UK subsidiaries. This choice may very well depend on the product classification of the firm. This study extends a previous paper which dealt only with aggregate manufacturing. Here the sample size has been increased and manufacturing split into consumption goods and investment goods industries. Also, the service sector has been included in the analysis. The result of the analysis suggest that the choice is governed by transaction costs considerations and that product classification does matter in the ownership strategy of Japanese MNEs in the UK.     

Targeting Teaching: Does the Medium Matter? Online versus Paper Coursework

If individuals process information differently when it is accessed electronically rather than on paper, then the transition from paper to electronic text may affect learning and retention. Using a randomized experiment, we compare learning outcomes of economics students who use electronic teaching tools with students who access the same material on paper. We find that students who submit homework online complete more assignments but have lower classroom attendance rates. However, there is no effect on exam scores. This suggests that while an electronic medium may enable instructional material to be accessed more easily, it does not significantly impact learning.