The Importance of Account Relations when Responding to Interim Audit Testing Results*

Auditors are expected to plan and adapt audit programs in response to changes in risk associated with each client. Results in the existing research have been mixed regarding whether auditors respond to changes in risk. Two possible explanations for the lack of responsiveness to changes in risk found in the existing research are that auditors succumb to profit pressure, and that researchers only analyze responses in the risky accounts without considering related accounts. This paper experimentally tests how auditors respond to changes in risk of material misstatement identified by means of interim audit testing results. The response to changes in risk of material misstatement is analyzed using planned audit hours across related financial statement accounts and at varying levels of profit pressure. Results indicate the following primary findings: (a) auditors respond to changes in risk of material misstatement by increasing planned audit hours in accounts related to the risky account, and (b) profit pressure does not affect the auditor's response to changes in risk. These results indicate that the relations between accounts must be considered in order to identify the auditors' response to changes in risk of material misstatement. In addition, the results are consistent with audit firms decreasing the emphasis on profit pressure due to the current importance that the market places on audit quality.     

Auditors’ Joint Engagements and Audit Quality: Evidence from Italian Private Companies

This study examines the effect of auditors’ collaboration in joint audit engagements on knowledge transfer, auditor expertise, and audit outcomes. I employ a unique sample of Italian private companies whose financial statements are jointly audited by three individual auditors and use measures from the network literature to capture the intensity of interactions between these auditors. I find a positive association between several audit quality proxies and auditors’ collaboration in multiple joint engagements. My results suggest that auditors develop knowledge and contacts through collaboration which potentially leads to higher audit quality. Overall, my findings suggest that joint engagements facilitate knowledge transfer and increase auditor expertise.     

Do Clients Get What They Pay For? Evidence from Auditor and Engagement Fee Premiums

Despite the intuitive appeal, prior research finds mixed evidence on whether higher audit fees translate to superior audit quality. Under the assumption that product differentiation between auditors is based, in large part, on the level of financial statement assurance, we propose more refined measures of excess audit fees that separate auditor premiums from other fee premiums. Consistent with our conjecture, we identify significant variation in audit pricing across auditors (i.e., auditor premiums) that relates positively to audit quality. Conversely, we find no evidence that higher engagement‐specific fee premiums (i.e., fee model residuals) are positively related to proxies for audit quality. Additional tests indicate that our results do not simply reflect premiums attributable to auditor characteristics evaluated in prior research (e.g., Big 4 membership, office size, and industry expertise). In fact, our findings suggest that the positive association between auditor premiums and audit quality is better captured at the auditor level than it is at the auditor “tier,” office, auditor‐industry, or engagement levels. In sum, our results suggest that auditors charging higher fees, on average, deliver superior levels of financial statement assurance, but engagement‐specific fee premiums do not reflect quality‐enhancing audit effort. These contrasting results provide a possible explanation for the mixed findings in prior research.     

The Use and Characteristics of Foreign Component Auditors in U.S. Multinational Audits: Insights from Form AP Disclosures*

This paper investigates the common, yet previously opaque, practice of using foreign audit firms (component auditors) to conduct portions of audit work for U.S. public companies. U.S. regulators have expressed concern for the transparency and quality of audits using component auditors. Employing data disclosed in the newly mandated PCAOB Form AP, we find that component auditor use is largely structural, determined by the size and complexity of clients' multinational operations. We do not find that the mere use of component auditors is detrimental to audit outcomes, but rather the amount of work conducted by component auditors is associated with lower audit quality (i.e., higher likelihood of misstatement), higher likelihood of nontimely reporting, and higher audit fees, which collectively suggest that component auditor engagements are associated with adverse outcomes. Furthermore, we find that only the work performed by less competent component auditors and those facing geographic and cultural/language barriers, including significant geographic and cultural distance, weak rule of law, and low English language proficiency, is associated with adverse audit outcomes. Overall, these findings provide initial archival evidence that the use of certain component auditors on U.S. multinational audits is associated with audit coordination issues, which suggests that PCAOB Form AP disclosures provide relevant information.     

Effect of Concession‐Timing Strategies in Auditor–Client Negotiations: It Matters Who Is Using Them

In this study, we examine how norms about the use of negotiation strategies by different parties in an auditor–client negotiation influence the relative efficacies of these negotiation strategies. We conduct an experiment with experienced auditors/financial managers as participants, who enter into a negotiation on an income‐decreasing audit adjustment with a hypothetical client/auditor who uses a strategy where the same concessions are given either at the start, gradually, or the end of the negotiation. We find that the concession‐end strategy is more effective than the concession‐start strategy when used by auditors; however, the reverse is true when these same strategies are used by financial managers. The concession‐gradual strategy leads to superior outcomes when used by either auditors or clients. We also provide evidence that auditors’ and financial managers’ perceptions of the norms relating to the use of these strategies correspond to what we propose in our theory.     

The Consequences of Audit‐Related Earnings Revisions

In this study, we investigate the consequences that auditors and their clients face when earnings announced in an unaudited earnings release are subsequently revised, presumably as a result of year‐end audit procedures, so that earnings as reported in the 10‐K differ from earnings as previously announced. Specifically, we examine whether the likelihood of an auditor “losing the client” is greater following such revisions, and whether the likelihood of dismissal is influenced by revisions that more negatively impact earnings, that cause the client to miss important earnings benchmarks, by greater local auditor competition, or by auditor characteristics. We also examine audit pricing subsequent to audit‐related earnings revisions for evidence of pricing concessions to retain the client. Finally, we examine whether client executives experience a greater likelihood of turnover following an audit‐related earnings revision. Consistent with expectations, we find that auditor dismissals are more likely following audit‐related earnings revisions. We also find that dismissals are more likely when revisions cause clients to miss important benchmarks and when there is greater local auditor competition. Among nondismissing clients, we find that future audit fees are lower when the effect of the revision on earnings is more negative, consistent with auditors offering price concessions to retain clients when revisions are more displeasing. We also find a greater likelihood of future chief financial officer (CFO) turnover as the effect of the revision worsens. Our findings offer important insights into the consequences that auditors face when balancing their responsibility for high audit quality and client satisfaction, as well as into the consequences that CFOs face when releasing inflated but not fully audited earnings.     

Do Auditors Accurately Predict Litigation and Reputation Consequences of Inaccurate Accounting Estimates?

To effectively manage audit risk, auditors must correctly predict the potential litigation and reputation consequences associated with inaccurate accounting estimates. Accurate predictions are critical because underestimation of negative consequences leads to excess legal exposure and overestimation leads to overauditing. Our paper examines whether auditors correctly anticipate these litigation and reputation outcomes. We provide manager‐ and partner‐level auditors with case facts from an auditor negligence lawsuit and ask them to predict the proportion of juries that will return verdicts against their firm. We then compare auditors' predictions to the actual verdicts we observe when we provide the same set of case facts to mock jurors who deliberate as part of juries. We find that auditors overestimate the likelihood of negligence verdicts, especially when audit quality is relatively high. Our supplemental measures help explain the reasons for this overestimation: auditors tend to underestimate jurors' perceptions of audit quality and willingness to attribute inaccurate estimates to situational factors. Finally, we examine auditors' predictions about how a news article about the litigation will affect their reputation with the general public. Similar to our litigation results, we find that auditors tend to overestimate the article's negative impact on auditor reputation. Collectively, our findings suggest that auditors overestimate litigation and reputation consequences resulting from inaccurate accounting estimates. This overestimation is consequential as it leads to inefficient allocation of audit resources.     

The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty*

We present experimental evidence suggesting that critical audit matter (CAM) disclosures in the auditor's report involving areas of high measurement uncertainty forewarn users of misstatement risk. Specifically, in our first study with MBA students, financial analysts, and attorneys, we find that CAMs (i) lower premisstatement assessments of confidence in the financial statement area disclosed as a CAM, and (ii) lower assessments of auditor responsibility for a subsequently revealed misstatement in a CAM-related area. In our second study with student participants proxying as mock jurors, we find that the responsibility-mitigating effect of CAM disclosure is driven by CAM disclosures involving measurement uncertainty, as opposed to CAM disclosures involving categorical determinations. Combined, our findings help reconcile mixed evidence from prior research, supporting the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM-related material misstatements.     

Auditor Responses to Shareholder Activism

In this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions (ICOs) and first‐time going concern opinions (GCOs). Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors' concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse ICOs documented in our baseline tests reflects higher‐quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.     

Do Mutual Fund Investors Care About Auditor Quality?

We study the influence of perceived auditor quality on investment decisions by bond mutual fund investors. Audits of bond mutual funds require significant auditor expertise. Fund managers estimate daily the fair market values of holdings that are often opaque and illiquid. Managers can use their discretion to manipulate their fund's performance results. While it is known that investment flows into funds that report good past performance, little evidence exists about whether investors' confidence in the reliability of fund financial reports is influenced by auditor quality. Using hand‐collected data from SEC filings, we find that the positive association between reported performance and investment flows is stronger for funds with auditors who are industry specialists and are longer‐tenured, as well as for funds that pay higher audit fees. We do not find that auditor office size strengthens the association. We also find that the presence of industry‐specialist auditors, long‐tenured auditors, and higher audit fees lead to additional disclosure in the form of emphasis‐of‐matter. This study contributes to the streams of research investigating perceived audit quality, fund investment decisions, and auditing for financial services.     

Accounting Comparability,Audit Effort,and Audit Outcomes

Accounting comparability among peer firms in the same industry reflects the similarity and the relatedness of firms’ operating environments and financial reporting. From the perspectives of “inherent audit risk” and “external information efficiency,” comparability is helpful for auditors in assessing client audit risk and lowers the costs of information acquisition, processing, and testing. I posit that the availability of information about comparable clients helps improve audit efficiency and accuracy. Empirical results show that comparability is negatively related to audit effort (surrogated by audit fees and audit delay). Moreover, comparability is negatively associated with the likelihood of audit opinion errors. These findings are robust to different specifications of regression models, particularly for the “endogeneity” issues due to the possible reverse causality that auditor style might influence client firms’ comparability. In sum, the study shows that accounting comparability enhances the utility of accounting information for external audits.     

Independence Threats,Litigation Risk,and the Auditor's Decision Process*

This study examines the effect of independence threats and litigation risk on auditors' evaluation of information and subsequent reporting choices. Using a Web‐based experiment, I tracked auditors' information gathering and evaluation leading to a going‐concern reporting decision. Specifically, 48 audit managers assessed client survival likelihood, gathered additional information, and suggested audit report choices. I found that auditors facing high independence threats (fear of losing the client) evaluated information as more indicative of a surviving client and were more likely to suggest an unmodified audit report, consistent with client preferences. In contrast, auditors facing high litigation risk evaluated information as more indicative of a failing client and were more likely to suggest a modified audit report. In addition, the association between risk and report choice was fully mediated by final information evaluation. This suggests that it is unlikely that different reporting choices resulted from a conscious choice bias, but rather that motivated reasoning during evidence evaluation plays a key role in the effect of risk in auditor decision making.     

The Impact of R&D Intensity on Demand for Specialist Auditor Services*

The audit fee research literature argues that auditors' costs of developing brand name reputations, including top‐tier designation and recognition for industry specialization, are compensated through audit fee premiums. Audited firms reduce agency costs by engaging high‐quality auditors who monitor the levels and reporting of discretionary expenditures and accruals. In this study we examine whether specialist auditor choice is associated with a particular discretionary expenditure ‐ research and development (R&D). For a large sample of U.S. companies from a range of industries, we find strong evidence that R&D intensity is positively associated with firms' choices of auditors who specialize in auditing R&D contracts. Additionally, we find that R&D intensive firms tend to appoint top‐tier auditors. We use simultaneous equations to control for interrelationships between dependent variables in addition to single‐equation ordinary least squares (OLS) and logistic regression models. Our results are particularly strong in tests using samples of small firms whose auditor choice is not constrained by the need to appoint a top‐tier auditor to ensure the auditor's financial independence from the client.     

Evidence of Industry Scale Effects on Audit Hours,Billing Rates,and Pricing

Using a proprietary data set consisting of all private firm audit engagements in 2000 from one Big 4 firm in Belgium, we investigate (i) whether audit office industry scale is associated with a reduction of total, partner, and staff audit hours and thus with efficiency gains triggered by organizational learning from servicing more clients in an industry and (ii) whether the extent of efficiency pass‐on from the auditor to its clients depends on the audit firm's market power. We find that auditor office industry scale is associated with efficiency gains and a reduction of the variable costs (i.e., fewer total audit hours, partner hours, and staff hours), ceteris paribus. Our results also suggest that, on average, realized efficiencies are entirely passed on, as evidenced by a nonsignificant effect of auditor industry scale on the auditor's billing rate. Furthermore, we find that the extent of the efficiency pass‐on decreases with the market power of the audit firm in the industry market segment as we document a higher billing rate for auditors with high market power (versus low market power). In addition, we find that the lower audit hours associated with auditor industry scale do not compromise audit quality.     

Is Audit Committee Equity Compensation Related to Audit Fees?*

Section 301 of the Sarbanes‐Oxley Act (SOX) implicitly assumes that audit committees can independently determine audit fees. Critics of section 301 have questioned this assumption in particular, and the efficacy of section 301 more generally. In response, the SEC issued a concept release in 2015 calling for public disclosure of the process that audit committees follow for determining auditor compensation. Motivated by these calls and the widespread use of stocks and options to compensate firms' independent directors, we examine the relation between equity compensation granted to audit committee members and audit fees. Using a sample of 3,685 firm‐year observations during 2007–2015, we find a negative relation between audit committee equity compensation and audit fees, consistent with larger equity pay inducing audit committee members to compromise independence by paying lower audit fees. These findings are robust to controlling for endogeneity, firm size, alternative measures of equity compensation, alternative samples, and an alternative treatment of extreme values. We further show that larger equity compensation is associated with lower earnings quality. We also find that the negative effect of equity compensation on audit fees is stronger when city‐level audit market competition is high. However, this negative relation disappears when (i) firms face high litigation risk, (ii) auditors have stronger bargaining power, (iii) the audit committee includes a high proportion of accounting experts, and (iv) auditors are industry experts. Our results are relevant for regulators and investors.     

Board Gender Diversity,Auditor Fees,and Auditor Choice

We examine whether the presence of female directors and female audit committee members affect audit quality in terms of audit effort and auditor choice by using observations from a sample of U.S. firms, spanning the years 2001–2011. We find, after controlling for endogeneity and other board, firm, and industry characteristics, that firms with gender‐diverse boards (audit committees) pay 6 percent (8 percent) higher audit fees and are 6 percent (7 percent) more likely to choose specialist auditors compared to all‐male boards (audit committees). Our findings suggest that boards (audit committees) with female directors (members) are likely to demand higher audit quality, ceteris paribus.     

Auditor Quality and the Accuracy of Management Earnings Forecasts*

In this study, we appeal to insights and results from Davidson and Neu 1993 and McConomy 1998 to motivate empirical analyses designed to gain a better understanding of the relationship between auditor quality and forecast accuracy. We extend and refine Davidson and Neu's analysis of this relationship by introducing additional controls for business risk and by considering data from two distinct time periods: one in which the audit firm's responsibility respecting the earnings forecast was to provide review‐level assurance, and one in which its responsibility was to provide audit‐level assurance. Our sample data consist of Toronto Stock Exchange (TSE) initial public offerings (IPOs). The earnings forecast we consider is the one‐year‐ahead management earnings forecast included in the IPO offering prospectus. The results suggest that after the additional controls for business risk are introduced, the relationship between forecast accuracy and auditor quality for the review‐level assurance period is no longer significant. The results also indicate that the shift in regimes alters the fundamental nature of the relationship. Using data from the audit‐level assurance regime, we find a negative and significant relationship between forecast accuracy and auditor quality (i.e., we find Big 6 auditors to be associated with smaller absolute forecast errors than non‐Big 6 auditors), and further, that the difference in the relationship between the two regimes is statistically significant.     

Investor Sentiment,Misstatements, and Auditor Behavior*

High investor sentiment has been linked with opportunistic managerial behavior in the face of more optimistic investors and analysts. We extend this line of work by documenting that the likelihood of misstatements is higher when sentiment is high. Although this would suggest elevated audit risk, we posit that a contemporaneous reduction in auditors' litigation cost could drive down audit fees and going concern opinion (GCO) reporting conservatism in order to please clientele. Consistent with this notion, we document that auditors charge lower fees and report GCOs less conservatively when sentiment is high. However, this reduction in reporting conservatism is unwarranted; results reveal that auditors are less likely to issue GCOs to clients which subsequently file for bankruptcy during high sentiment periods. We conduct additional tests to examine whether auditors' litigation costs indeed vary with sentiment and document that auditors are less likely to be sued and the market reacts less negatively to misstatement announcements when sentiment is high. Collectively, our findings suggest that, although misstatement risk is increasing with sentiment, auditors' litigation risk actually declines.     

PCAOB Inspections and the Differential Audit Quality Effect for Big 4 and Non–Big 4 US Auditors*

In this study, we investigate whether the increase in regulatory scrutiny epitomized by the initial PCAOB inspection impacted audit quality differentially for Big 4 and non–Big 4 auditors to better understand the consequences of PCAOB inspections for different audit firm types. Because of competing views on the effect of PCAOB inspections, the relation between PCAOB inspections and the audit quality differential between Big 4 and other auditors is an empirical issue. Empirically, we take the endogenous choice of auditor as a given and utilize a difference‐in‐differences specification that takes into account the staggered timing of the initial PCAOB inspection for different‐sized auditors in the United States. Our results suggest that the initial PCAOB inspection improved audit quality more for Big 4 auditors than for other annually inspected or triennially inspected non–Big 4 auditors. We also examine annually and triennially inspected non–Big 4 auditors separately, and find that the pre‐post Big 4/non–Big 4 differential audit quality effect is more pronounced for the triennially inspected non–Big 4 firms. In the larger context of the highly concentrated US audit market, our findings that PCAOB inspections accentuate the Big 4/non–Big 4 audit quality differential are of potential interest to public company audit clients contemplating an auditor change, investors interested in learning about the consequences of PCAOB inspections, regulators concerned about the Big 4 dominance of the US audit market, and academics investigating audit quality differences.     

制度背景、审计师特征与审计质量研究

利用2011-2015年的A股上市公司财务数据,以及中国注册会计师协会网站手工收集的注册会计师的信息,采用固定效应回归模型,考察审计师特征对审计质量的影响。研究发现,女性、高学历、合伙人和接受过会计专业教育的注册会计师主持项目的审计质量高。进一步研究发现,政府监管和媒体监督在审计师特征影响审计质量中发挥着正向调节作用,主要研究结论在一系列稳健性测试后依然成立。研究表明,审计师特征和制度背景是影响审计质量的重要因素,研究对会计师事务所、政府监管部门具有重要启发意义。