The civil justice system and going concern audit reports: Comments on “Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong”

Lam and Mensah [Lam, K., Mensah, Y.M., 2006. Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong. J. Account. Public Pol. 25 (6), this issue] provide some valuable insight on auditors’ choice of going concern audit reports in an environment where the civil justice system affords, from the standpoint of the plaintiff, fewer remedies and is more difficult to file a complaint than it is in the US. Hence, from the auditor’s standpoint, this environment can appropriately be described as a “low litigation risk environment”. In this comment, I first question whether a disclaimer of an opinion is any indication of either a quality audit or professionalism. Secondly, three alternative explanations for the empirical regularities are discussed. The Gatekeeper Story suggests auditors are simply not willing to risk reducing their reputational capital by acquiescing to clients that are not likely to survive their own financial distress. The Herding Story suggests that, when auditors are faced with uncertainties or a gap in the authoritative literature, auditors will herd together to form a common response that mimic one-another. The Value of Incumbency Story holds that as the value of incumbency declines with the client’s inability to survive, auditors will have fewer incentives to incur the incremental costs to gather sufficient competent evidential matter necessary to support an unqualified opinion.     

Explaining auditors’ propensity to issue going‐concern opinions in Australia after the global financial crisis

We document an increase in auditors issuing going‐concern opinions in Australia over a prolonged period since the Global Financial Crisis that is not fully explained by changes in client risk. Overall, our evidence is consistent with auditors reporting more conservatively with the increased level of scrutiny from Australian Securities and Investments Commission inspections and other increased regulation, and in particular, the negative attention following the 2011–2012 inspections. As a result, auditor reports with reference to going‐concern issues have become less informative regarding future corporate failure.     

Information content, audit reports and going-concern: an Australian study

Research conducted on the information content of going concern ‘modified’ reports in the USA and UK indicates that a modified audit report does not appear to have information content to users if the going concern contingency is disclosed in the notes to the financial statements. In the present study, we provide evidence from Australia. We examine whether modification/qualification by an auditor in Australia (an ‘Emphasis of Matter’ and an ‘Except for’ report, respectively) has information content to a user. The results indicate that for a company in a state of financial distress, the modification, in either form, does not appear to significantly enhance either perceptions of risk or decision-making.     

Improving Experienced Auditors’ Detection of Deception in CEO Narratives

We experimentally study the deception detection capabilities of experienced auditors, using CEO narratives from earnings conference calls as case materials. We randomly assign narratives of fraud and nonfraud companies to auditors as well as the presence versus absence of an instruction explaining that cognitive dissonance in speech is helpful for detecting deception. We predict this instruction will weaken auditors’ learned tendency to overlook fraud cues. We find that auditors’ deception judgments are less accurate for fraud companies than for nonfraud companies, unless they receive this instruction. We also find that instructed auditors more extensively describe red flags for fraud companies and more accurately identify specific sentences in narratives that pertain to underlying frauds. These findings indicate that instructing experienced auditors to be alert for cognitive dissonance in CEO narratives can activate deception detection capabilities.     

Preparers’ control‐risk assessments under alternative audit‐review processes

This study investigates the impact of a decomposed audit‐review process on audit preparers’ control‐risk assessments, taking audit experience into consideration. Using an experiment, it manipulates the audit‐review type (decomposed review versus non‐decomposed review) and preparers’ audit experience level (more experienced versus less experienced). Analysis of data collected from two mid‐tier audit firms supported the author’s predictions. First, working‐paper preparers assessed control risk more accurately in a decomposed than in a non‐decomposed review. Second, less‐experienced auditors benefitted more from a decomposed review than more‐experienced auditors.     

Independent audit committee members’ board tenure and audit fees

An independent audit committee is an audit committee on which all members are independent directors. This study examines whether independent audit committee members’ board tenure affects audit fees. On the basis of the prior literature, we formulate an unsigned hypothesis. This is because on the one hand, long board tenure audit committee members (defined as members with board tenure of 10 or more years) have greater incentives to protect their reputational capitals by purchasing increased audit effort, which positively affects audit fees. On the other hand, audit pricing reflects audit committee quality. Long board tenure audit committee members may have less need for increased audit effort because they can effectively oversee the financial reporting process themselves, which negatively affects audit fees. We find that audit fees are negatively associated with the proportion of long board tenure directors on the independent audit committee, consistent with the notion that audit committee members’ long board tenure results in lower audit effort.     

Auditors’ going concern reporting accuracy during and after the global financial crisis

Motivated by concerns that one of the reasons for the Global Financial Crisis (GFC) is poor quality auditing, this study examines the accuracy of going concern modifications for a sample of United States (U.S.) companies in the pre-GFC (2005–2006), GFC (2007–2008), and post-GFC (2009–2010) periods. The results show that the type I misclassification is lower during the GFC but not different in the post-GFC period compared with the pre-GFC period. The type II misclassification is not significantly different in the GFC and post-GFC periods compared with the pre-GFC period. Additionally, the results suggest that non-Big 4 auditors, compared with Big 4 auditors, have become more conservative on clients’ going concern problems in the post-GFC period, which reduces their type II misclassification.     

Auditors’ decision-making under going-concern uncertainties in low litigation-risk environments: Evidence from Hong Kong

This study examines the audit opinions issued by auditors in a low litigation-risk environment at a time of high economic uncertainty – that of Hong Kong in the period immediately after the Asian financial crisis of 1997. Empirical research using United States data has shown that, contrary to professional guidance which restricts the issue of “disclaimer of opinion” only to situations where existing uncertainties prevent the auditor from forming an opinion, auditors tend to use the “disclaimer” report (in the going concern context) to signal more extreme client firm’s distress. In the high litigation-risk environment of the US, researchers have attributed this tendency to the idea that “disclaimer of opinion” reports are used by auditors to provide some protection against potential legal liability. The results of this study provide evidence that, even in the low litigation-risk environment of Hong Kong, auditors still use “disclaimer” reports to signal more extreme client firm financial distress. Thus, the maintenance of a high litigation-risk environment does not appear to be a necessary pre-requisite for high quality audits.     

The impact of cumulative pressure on accounting students’ propensity to commit plagiarism: an experimental approach

Adopting aspects of Jones, T.M., 1991, Academy of Management Review 16 , 366–395 issue‐contingent model of ethical decision‐making to guide our choice of variables, we investigate perceptions of factors that affect student plagiarism. In an experimental setting, time pressure and assessment weighting are manipulated between‐subjects, whilst the severity of plagiarism is examined within‐subjects. Our findings confirm that time pressure and assessment weighting are positively related to perceptions of the likelihood of plagiarism and that plagiarism is perceived as more likely for less severe acts. Further, the likelihood of plagiarism increases as the cumulative pressure of both time deadline and assessment weighting increases.     

No System Is Perfect: Understanding How Registration‐Based Editorial Processes Affect Reproducibility and Investment in Research Quality

The papers in this volume were published through a Registration‐based Editorial Process (REP). Authors submitted proposals to gather and analyze data; successful proposals were guaranteed publication as long as the authors lived up to their commitments, regardless of whether results supported their predictions. To understand how REP differs from the Traditional Editorial Process (TEP), we analyze the papers themselves; conference comments; a survey of conference authors, reviewers, and attendees; and a survey of authors who have successfully published under TEP. We find that REP increases up‐front investment in planning, data gathering, and analysis, but reduces follow‐up investment after results are known. This shift in investment makes individual results more reproducible, but leaves articles less thorough and refined. REP could be improved by encouraging selected forms of follow‐up investment that survey respondents believe are usually used under TEP to make papers more informative, focused, and accurate at little risk of overstatement.     

International equity valuation: the relative importance of country and industry factors versus company‐specific financial reporting information

The relative importance of country‐ and industry‐specified factors vis‐à‐vis company‐specific financial statement–based information in explaining equity valuation multiples in an international setting is examined. Both country‐specific effects via previously identified variables and an indicator variable approach are analysed. While company‐specific factors are predominant in explaining cross‐sectional differences in valuation, country and industry factors have sizable incremental explanatory power over them; the latter are not independent, so their relative importance is influenced by how we adjust for this commonality. Using country indicators provides larger incremental explanatory power than using country‐specific factors, suggesting that previously identified factors may be measured with sizeable error or omitted factors are important.     

Prompting the Benefit of the Doubt: The Joint Effect of Auditor‐Client Social Bonds and Measurement Uncertainty on Audit Adjustments

We design an incentivized experiment to test whether measurement uncertainty elevates the risk that social bonds between auditors and reporters compromise audit adjustments. Results indicate that, when audit evidence is characterized by some residual uncertainty, the adjustments our auditor‐participants require are sensitive to whether auditors have an opportunity to form a modest but friendly social bond with reporters. In contrast, although auditors do not adjust fully even when misstatements are known with certainty, social bonding has no effect in this scenario. Accordingly, our experiment contributes beyond the main effects of social bonding and measurement uncertainty demonstrated in prior research by showing that these forces interact. A practical implication is that regulators and practitioners should consider both the technical and the social challenges facing audits of complex estimates.     

Governance regulatory changes,International Financial Reporting Standards adoption,and New Zealand audit and non‐audit fees: empirical evidence

This study examines the association between overseas and New Zealand governance regulatory reforms and New Zealand companies’ audit and non‐audit fees. Our models use temporal and International Financial Reporting Standards (IFRS) indicator variables to relate the timing of the fee changes to the incidence of the overseas and local reforms. We find that audit fees increased in New Zealand over 2002–2006. Such increases associate reliably with the transition to and adoption of NZ IFRS and not with earlier overseas governance reforms. Our study also documents a decrease in non‐audit fees over the same period, but we find no IFRS effect for non‐audit fees.