Auditor objectivity as a function of auditor negotiation self-efficacy beliefs

This study empirically examines whether an auditor's perceived ability to negotiate discretionary accounting issues with clients (auditor negotiation self-efficacy) is related to auditor objectivity, and whether an auditor's negotiation self-efficacy has a greater impact on her objectivity when the auditor's accuracy motive (professional identity) is strong rather than weak. We tested the hypotheses using a cross-sectional survey design and obtained 146 responses from among 800 surveyed experienced Swedish auditors. The findings indicate that auditors with higher negotiation self-efficacy were more likely to make decisions on a material and discretionary accounting issue contrary to their clients' desires compared to auditors with lower self-efficacy. The relationship between negotiation self-efficacy and auditor objectivity was not moderated by professional-identity strength. These research findings suggest that recruiting and training auditors to increase their negotiation self-efficacy may be an effective method to enhance auditor objectivity without the problems inherent in other methods, such as auditor rotation. Our sample was obtained in Sweden, which allows long auditor tenures. We caution that, although our analysis controlled for auditor tenure, the effect of auditor negotiation self-efficacy may not be generalizable to countries that limit tenure through regulation.     

The Impact of Audit Quality Indicators on the Timeliness of Goodwill Impairments: Evidence from the German Setting

This study investigates whether goodwill impairments are perceived as timely and whether specific auditor characteristics affect the perceived timeliness. It therefore contributes to central questions in accounting research: is managerial discretion over accounting numbers (accounting choice) good or bad for stakeholders and does audit quality have an impact on this relationship? It is motivated by the IASB's post-implementation review on business combinations and the Goodwill and Impairment project based on it, the ongoing debate on the decision usefulness of impairment testing, and the question whether auditors have an impact on firms’ reporting of impairment losses. Based on a sample of German listed firms for the period 2006 to 2013, the results indicate that goodwill impairments are not recognized in a timely manner and delayed by at least one to two years. Moreover, the findings suggest that the recognition of impairment losses is influenced by auditor characteristics. In particular, firms seem to report goodwill impairments in a more timely fashion when they are audited by a Big 4 auditor, whereas the timeliness seems to decrease with a higher non-audit fee ratio and a longer auditor tenure. Moreover, additional analyses indicate that higher audit fees lead to more timely impairments.     

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.     

Determinants and consequences of voluntary switches to Chinese auditors in Hong Kong

Hong Kong market regulators have permitted 12 large Chinese accounting firms to audit the financial statements of Chinese firms that cross list in Hong Kong (i.e., H-share firms) since 2010. This paper examines the characteristics of H-share firms that voluntarily replaced their Hong Kong (HK) auditors with Chinese auditors, and the market reaction to auditor switches following this policy. We find that 38 out of 147 H-share firms voluntarily switched to Chinese auditors during 2011–2013. Switching firms are larger in size and are less likely to use Big4; they also have less need for external financing, a longer cross listing history, and a lower percentage of foreign revenue. We also find that investors negatively react to the auditor switches from HK non-Big4 to China non-Big4, but do not react to the auditor switches from HK Big4 to China Big4. This suggests that investors perceived lower audit quality for China non-Big4.     

The effects of trust, client importance, and goal commitment on auditors' acceptance of client-preferred methods

The purpose of this study is to extend our understanding of the factors that impact auditor judgment and decision-making. Specifically, we investigate how two factors, client importance and auditor trust, impact auditors' directional goal commitment and decision-making at the transaction level. We find no impact of client importance on the auditors' goal commitment or acceptance of a client preferred accounting treatment. However, we find that trust in client's management is positively related to the commitment to the goal of supporting the client's preferred method of recognizing revenue. Further, we find that auditors' goal commitment is positively related to their acceptance of a client preferred accounting treatment.     

Acceptance of Accounting Standards

When financial statements are audited, a client and auditor may disagree about an accounting disclosure. While the disclosure of such a disagreement may increase the information content of a statement it may also be socially undesirable in that it signals a difference in views about the state of the reporting enterprise. This in turn may increase agency costs and introduce uncertainty about the state of the firm. In this paper we focus on public policy implications concerning auditor-client disagreements and examine the ex ante probability that such cases will occur. We find that accounting standards that allow two accounting options may be optimal in reducing frequency of disagreements among auditors and between standard-setters and their constituencies, and possibly also between clients and their auditors. The New Zealand model of compliance with accounting standards may be preferable to that practiced in the US.     

Auditor specialization,accounting information quality and investment efficiency

This study is examined how the auditor specialization moderates the effect of accounting information quality on investment efficiency, i.e., whether the effect of accounting information quality on investment efficiency is increasing or decreasing with the presence of the specialist auditor.The reached result reveals that the accounting information quality appears to help decrease the overinvestment problem. Similarly, the auditor specialization has been discovered to help greatly in improving investment efficiency, while reducing the underinvestment problem. We further find that the accounting information quality and the auditor specialization are two mechanisms with some degree of substitution in enhancing investment efficiency. The accounting information quality is positively associated with investment efficiency for firms whose auditor is an industry specialist.In addition, to check the robustness of the main results, this paper investigates the causal relationships between investment efficiency, auditor specialization and accounting information quality from the dynamic simultaneous-equation models.     

Auditor specialization, perceived audit quality, and audit fees in the local government audit market

Prior governmental research implies a positive relation between auditor specialization and audit quality, but the effect of specialization on audit fees is mixed. However, no single governmental study investigates the effect of auditor specialization on both audit quality and audit fees. Also, prior studies focus on either large- or small audit firms and often employ indirect proxies for audit quality. We study the effects of auditor specialization on perceived audit quality and audit fees. Our data represent both Big 5 and smaller audit firms and include three market-based measures of specialization. We survey 241 Florida local government finance directors and find that specialization is positively associated with perceived audit quality but not with audit fees. We also find that Big 5 auditors, often used as a proxy for higher audit quality in prior research, are not uniformly associated with increased perceived audit quality but consistently charge higher audit fees. Our results confirm a relation between measures of audit firm specialization and audit quality and raise questions regarding audit firm size and audit quality in the municipal sector. Our findings suggest that engaging specialized auditors may be good policy for many local governments.     

Audit Committee Financial Expertise,Litigation Risk,and Auditor‐Provided Tax Services*

The Sarbanes‐Oxley Act (SOX) greatly expanded audit committees' oversight responsibilities by requiring that they preapprove all non‐prohibited non‐audit services (NAS). Using data from 2003 to 2011, we find that tax NAS are significantly lower when accounting financial experts (ACT‐FEs) serve on the audit committee, suggesting that ACT‐FEs consider auditor independence risk, perceived and/or real, more than other members, including supervisory experts, to the point of not accepting any tax NAS, not even compliance. However, in firms with higher ex ante litigation risk, ACT‐FEs approve relatively more tax NAS than other members, suggesting that they accept the costs of a perceived lack of auditor independence from tax NAS in return for the potential benefits of increased financial reporting quality arising from tax NAS. Our analysis by subperiod (2003–2006 vs. 2007–2011) shows that this result is significant only in the second period. ACT‐FEs' differential evaluation of the trade‐off between the benefits and costs of joint audit and tax NAS provision between the two periods suggests the need for additional research in later post‐SOX years.     

Common auditors and internal control similarity: Evidence from China

This study investigates how important common auditors are to internal control similarity between two firms. Based on a less concentrated audit market in China, we find that firm-pairs with common auditors enforce a similar internal control system. This inference holds after accounting for other social connections, examining internal control components, using alternative measures of internal control, adopting finer industry classifications, constructing alternative internal control similarity, running auditor switch tests, and addressing endogeneity problems. Additional analyses indicate that auditor style and information sharing serve two underlying mechanisms to undergird the documented relationship. Finally, our evidence suggests that high-centrality firms in auditor networks are associated with better financial reporting.     

Accounting manipulations and political costs: Tooth & Co Ltd, 1910–1965

Positive accounting theory posits that political costs influence accounting choices by large firms. Most studies rely on cross‐sectional analyses of large samples using coarse data. We employ rich archival data to analyse the profit measurement and disclosure practices of Tooth & Co, a large Australian brewing company, from 1910 to 1965. This period provides considerable variation in scope and incentives to manipulate reported profit. Reporting discretion changed significantly from early voluntary disclosure through to the extensive scheduled disclosure requirements of the Companies Act 1961. Varying incentives include changes in excise duties levied on beer production, and dramatic company growth and market dominance resulting from takeovers of competitors and vertical integration. We examine the pattern of reported profit in relation to internal records and the pattern of accruals. We find that Tooth's profit‐smoothing practices and understatements were perceived by management as important in justifying dividend policy, while systematic understatements of reported profit were used to avoid potential political costs associated with high profitability and market dominance. The most significant relative increases in profit understatement are shown to occur where dividend policy and political cost motivations coincide.     

Accounting Policies in Agencies with Moral Hazard and Renegotiation

We emphasize the role of accounting policies, and their audit, in an earnings management setting. We use a two–period agency in which three frictions interact: the agent privately observes action (or effort) supply and output, and the initial contract is subject to renegotiation. This creates a setting in which both players' behavior is of concern, and, importantly, information rationing is efficient. Moreover, this information rationing is directly interpretable as being produced by an accounting policy whose application is ensured by an auditor.     

Early debt extinguishment transactions and auditor materiality judgments: A bounded rationality perspective

Critics have characterized bond refundings and in-substance defeasances as managerial tactics that artificially inflate reported earnings during periods of rising interest rates, and various accounting and auditing pronouncements suggest that such transactions be subjected to more stringent materiality criteria. Extending work that interprets audit judgment formation as a cognitive phenomenon, this study examines hypothesized relationships between materiality judgments and the size and nature of these debt transactions, client earnings trend, and experience of the auditor. Proceeding beyond this cognitive orientation, the study then interprets judgment formation as a social-behavioral phenomenon by examining the applicability of the bounded rationality perspective to auditing. The results obtained from an experiment involving 212 practitioners at the ranks of partner, manager and senior suggest that the size of item, earnings trend and nature of transaction influence materiality judgments, as mitigated by an auditor's experience. Further, quantitative and qualitative, interview-based evidence suggests the usefulness of viewing audit judgment processes as boundedly rational, social-behavioral phenomena.     

Internationalizing audit education

Audit education is typically offered only to accounting majors. We argue that auditing provides a way of thinking that could serve as a framework for an accounting curriculam. We describe two parts of a course content that could be incorporated into an existing auditing course or a begining accounting course. The first section emphasizes accountability; the second emphasizes the role of the auditor in the accountability process. The concepts are best taught within an international paradigm that permits examination of various institutional environments.     

Auditor Lobbying for Accounting Standards: The Case of Banks and Savings and Loan Associations

This study examines auditor lobbying on seven proposed US accounting standards which affect banks and savings and loan associations. Evidence is provided in support of the Watts and Zimmerman (1982, 1986) theory on auditor lobbying. Watts and Zimmerman (WZ) hypothesise that auditor lobbying is a function of the client-manager position and a set of wealth effect variables. These variables may provide an incentive for auditors to disagree with their clients on proposed accounting issues. The WZ model is modified by including an audit risk variable. Results show that the model is statistically significant and that the identified wealth and audit risk effects are significant explanatory variables of auditor lobbying behaviour.     

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.     

PCAOB international inspection access and debt contracting: Evidence from American Depositary Receipt firms

We examine whether the Public Company Accounting Oversight Board’s (PCAOB’s) international inspection access affects the usage of accounting-based debt covenants in bank loan contracts of American Depositary Receipt (ADR) borrowers. We show that there is an increase in the use of financial covenants in debt contracts after the auditor of an ADR borrower becomes subject to PCAOB inspections. We also document that lenders increase the usage of financial covenants only in loans to ADR borrowers domiciled in countries with weak home country intuitions, and the increase is more pronounced for ADR borrowers from countries without a local auditor regulatory oversight body. These findings suggest that PCAOB regulatory oversight enhances the perceived credibility of accounting numbers for debt contracting and serves as a substitute for the weak monitoring of auditors for ADR borrowers domiciled in countries with weak country institutions.     

The influence of auditor narcissism and moral disengagement on risk assessments of a narcissistic client CFO

Global capital markets rely heavily on independent and skeptical auditors as gatekeepers to provide assurance that corporate financial reports are free of material fraud. The rise of narcissism among the ranks of both client and audit professionals challenge this gatekeeper function. In addition, auditor moral disengagement may undermine auditor skepticism, further eroding public confidence in the integrity of financial reporting and the audit process. We conduct a quasi-experiment with 118 auditors from three international audit firms. In a simulated interview with a client CFO, we examine whether auditors underestimate risks of fraudulent financial statements due to the interactive effects of (1) client narcissism (manipulated verbally and nonverbally) and (2) auditor narcissism. We also examine the influence of auditor moral disengagement on client risk assessments. Results indicate that CFO verbal and nonverbal narcissism significantly influenced auditors’ assessment of management-related client risk. Moreover, auditor narcissism was found to interactively influence client risk inferences such that auditors higher in narcissism exhibited narcissistic tolerance (lower risk assessments) when the hypothetical CFO displayed high verbal narcissism. Auditor moral disengagement was negatively associated with client risk assessments. We discuss the implication of these findings on future audit judgment research, audit firm policy and training on maintaining auditor skepticism, and the audit oversight role of standard-setters.