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.     

ISA 570: Italian Auditors’ and Academics’ Perceptions of the Going Concern Opinion

This study aims to identify which of the indicators used to assess whether an entity may not be able to continue as a going concern are regarded by Italian partners in auditing firms and Italian accounting and finance academics as being the most important. The indicators and ratios are those pursuant to auditing standard ISA 570 Going Concern, the literature and professional practice. ISA 570 does not suggest a hierarchy of these indicators, because they are only examples of events or conditions that, individually or collectively, may cast significant doubt on the entity's ability to continue as a going concern (GC), nor does it suggest specific ratios. To this end, an online survey was administered to partners in auditing firms and to the university faculty of Accounting and Finance. The paper contributes to enriching previous literature by providing insights into how Italian auditors and Italian financial reporting scholars prioritise GC indicators suggested by ISA 570. The results have the potential to help auditors and directors focus on the most relevant indicators in a GC assessment.     

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.     

The Impact of the Corporate Control Market on IPO Decisions

Entrepreneurs who take their firm public during an active corporate control market face an increased risk of losing control through a takeover. I examine the extent to which the threat of takeover impacts IPO firms’ decisions and find that an active takeover market in an IPO firm's industry increases the probability that the firm incorporates in a state with state‐level antitakeover provisions. IPO firms backed by venture capital investors and reputable underwriters are less likely to incorporate in a state offering antitakeover provisions. A closer examination of equity carve‐outs suggests that control is not a first‐order consideration for some IPO firms.     

The emerging growth company status on IPO: Auditor Effort,Valuation, and underpricing

The Securities Act of 1933 governs the going public process and the accompanying registration statement submissions to the Securities and Exchange Commission (SEC). The Jumpstart Our Business Start-ups (JOBS) Act of 2012 created several accommodations under the SEC securities laws for a new group of companies referred to as “emerging growth companies” (EGCs). We examine the associations between auditor effort, initial public offering (IPO) offer prices, and investors’ perceptions of the registrants’ intrinsic value (underpricing) and EGCs’ registration statements utilizing accommodations to reduce financial statement information disclosure. Our finding that auditor effort is reduced suggests that the potential for increased auditor risk for EGCs future financial statements could be higher because of issues related to financial statements not included in the registration statements. We also find a negative (positive) association between EGC filing and IPO offer prices (underpricing). Our results suggest potential unintended consequences associated with EGCs and that auditor effort might not be sufficient to reduce the possibility of future financial statement failures.     

Auditors’ going‐concern‐modified opinions after 2001: measuring reporting accuracy

An important change in auditors’ reporting behaviour in the period after the high‐profile corporate collapses in 2001 is that auditors were more likely to issue going‐concern (GC)‐modified audit opinions. Comparing company failure rates subsequent to receiving a first‐time going‐concern (FTGC)‐modified audit opinion in the pre‐ and post‐2001 periods, we find a consistent type 1 error (misclassification) rate (the rate of survival among companies issued an FTGC opinion). Results are indicative of auditors maintaining GC reporting accuracy when comparing the 1995–1996 and 2004–2005 periods. This conclusion is supported after considering the impact of mitigating circumstances surrounding companies that received an FTGC‐modified audit report and survived.     

An Investigation of Auditors’ Judgments When Companies Release Earnings Before Audit Completion

The majority of U.S. public companies release annual earnings prior to the completion of audit fieldwork. We investigate this phenomenon in a controlled experiment with audit partners and senior managers. We find that releasing earnings before completion of the audit pressures auditors to adopt the goals of management, thereby reducing the likelihood of post‐announcement audit‐adjustment recommendations. We also examine the effect of audit committee (AC) strength in improving auditors’ judgments after annual earnings are released. When ACs are actively involved in accounting issues and proactively communicating with auditors—characteristics currently lacking in most ACs—the negative effects on auditors’ judgments are completely mitigated. Our study provides evidence on potential unintended consequences of early release of earnings and the importance of investing in high‐quality ACs to mitigate adverse effects of client pressures on audit judgment and financial reporting quality.     

Auditors’ Economic Incentives and the Sensitivity of Managerial Pay to Accounting Performance

The use of managerial incentives to manage earnings in order to enhance accounting performance‐based compensation is greater when auditors have economic incentives to compromise their independence. Hence, compensation committees face more difficulties in determining cash compensation when earnings quality declines. This study investigates whether boards of directors can mitigate the agency problems between managers and shareholders by being aware of the opportunistic earnings management encouraged by auditors’ economic incentives and actively adjusting performance‐based compensation for the reduced earnings quality. To this end, it examines how auditors’ economic incentives affect the sensitivity of managerial pay to accounting performance. The findings show a negative association between the client's economic importance to the auditor and the sensitivity of managerial pay to accounting performance, with this association more pronounced for firms that opportunistically inflate earnings, suggesting that boards mitigate agency problems by actively intervening to modify performance‐based compensation schemes for the reduced earnings quality. Additional analyses show that board effectiveness in determining compensation depends on its characteristics. These results suggest the urgent need to oblige companies to establish compensation committees, particularly in countries that lack such a mandatory requirement or where few companies have such committees.     

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.     

财务重述对会计师事务所解聘的影响研究

本文通过检验财务重述后客户解聘会计师事务所的情况以及事务所变更方向是否受到财务重述的影响,扩展了以往相关文献的研究内容。本文发现在财务重述后的一年内,事务所被解聘的频率在财务重述公司中要高于未发生财务重述的公司。此外,本文检验了财务重述对事务所变更方向的影响。尽管未发现财务重述与事务所变更方向之间存在显著关系,但发现与舞弊相关的重述公司在财务重述后将事务所变更为更具有声誉的事务所,而与差错相关的重述公司在财务重述后将事务所变更为更为顺从的事务所。本文的结论表明差错类重述公司在财务重述后解聘原事务所以试图寻求更为顺从的事务所,而舞弊类重述公司在财务重述后解聘事务所旨在恢复其受损的声誉。     

The Importance Of Inherent Risk Factors: Auditors‘ Perceptions

This research project investigated auditors' perceptions of the importance of inherent risk factors in assessing inherent risk for accounts receivable and inventory. Sixty-eight auditors completed a questionnaire listing 42 inherent risk factors and six control risk factors. The auditors were required to: identify whether each factor was an inherent risk factor; indicate whether the factor affected their assessment of inherent risk at the financial statement or account balance (class of transactions) level; indicate whether the factor was associated with high or low inherent risk; and assess how important the inherent risk factor was in their assessment of inherent risk. In general, the auditors perceived variables pertaining to the characteristics of management and the history of errors to be the major determinants of inherent risk.     

The Effect of Auditor Style on Reporting Quality: Evidence from Germany

This paper examines whether the ‘style’ of individual auditors influences financial reporting quality in Germany. Audit quality in Germany should be uniformly high, because of strong reputational needs, strict controls on operating procedures, and quality enforcement mechanisms. An audit partner's style should not affect this quality level. However, our results do not support this expectation. Exploiting a unique dataset comprising the names of the audit engagement and review partners of listed German companies, we find that audit engagement partners in Germany have a significant influence on audit quality, beyond firm‐ and office‐level factors. In contrast, audit review partners do not have a consistent significant influence on audit quality. We measure audit quality by the level of a firm's abnormal accruals and its propensity to meet or beat an earnings target. We also find that the 2005 adoption of a new audit quality enforcement system that includes ‘naming and shaming’ does not reduce the influence of audit partner style on financial reporting quality.     

The ‘SKADE LITorSET’ Expert System for Corporate ‘Litigate or Settle’ Decisions

The ‘SKADE LITotSET’ system is a blackboard-based expert system that makes ‘litigate or settle’ decisions in the product liability area. It has three knowledge sources: Legal, Manager and Insurance Adjuster. The combined expertise from each of these is required to solve the ‘litigate or settle’ problem. The control component co-ordinates the interaction between the various knowledge sources on the blackboard. Based on the latest changes to the data on the blackboard, it selects and executes the next knowledge source. The model reproduces the decision makers' opportunistic reasoning processes by the interaction between the various knowledge sources through the blackboard. The results of analyses of a hypothetical case through a series of experiments with the ‘SKADE LITorSET’ system indicate that the blackboard is an appropriate model for development of expert systems in the ‘litigate or settle’ decision domain. The initial success with the blackboard approach suggests that further work needs to be done to see whether more complex models can be built to incorporate a broader range of determinants of settlement decisions.     

Auditors’ Liability,Investments, and Capital Markets: A Potential Unintended Consequence of the Sarbanes‐Oxley Act

To restore investors’ confidence in the reliability of corporate financial disclosures, the Sarbanes‐Oxley Act of 2002 mandated stricter regulations and arguably increased auditors’ liability. In this paper, we analyze the effects of increased auditor liability on the audit failure rate, the cost of capital, and the level of new investment. We focus on a setting in which, with imperfect auditing, a firm has better information than investors about its prospects and seeks to raise capital for new investments in a lemons market. The equilibrium analysis derives corporate reporting and investing choices by the firm, attestation opinions by the auditor, and valuation by rational investors. Three empirically testable predictions emerge: although increasing auditor liability decreases the audit failure rate and the cost of capital for new projects, it also decreases the level of new profitable investments.     

The Effect of Client Industry Agglomerations on Auditor Industry Specialization

Prior research on auditor industry specialization documents fee premiums for local audit offices that are industry specialists. This research assumes that the effects of specialization are uniform across markets. We examine industry specialization based on the economic theory of industry agglomeration (geographic areas with high industry concentration). Agglomeration economies can facilitate access to knowledge for auditors serving a specific industry in those locations. We find that industry specialists in agglomerations earn a fee premium in excess of specialists in other markets. We find that nonspecialist offices in agglomerations also earn fee premiums in that industry when compared to nonspecialists in other markets even when controlling for these groups’ absolute share of the national market. We also address whether or not this expertise can be shared among offices in an agglomeration specialist's firm. We find that audit offices that have easy connections to a within-firm office in an agglomerated market can earn a fee premium relative to more distant offices, suggesting a benefit from knowledge transfer. This fee premium accrues to offices that would not be considered a specialist using traditional market share measures in a given industry. These findings indicate that the benefit of industry specialization depends on more than local market share.     

An Empirical Investigation of the Influence of Qualitative Risk Factors on Canadian Auditors’ Determination of Performance Materiality*

This paper presents the results of a field experiment that tested the effects of various qualitative risk factors suggested by auditing standards and prior literature on practicing Canadian auditors’ estimates of performance materiality, a concept introduced by Canadian Auditing Standard (CAS) 320, in the audit of specific accounts in a financial statement audit. Ninety‐four practicing auditors responded to four scenarios and, based on “good” and “bad” versions of six qualitative risk factors, revised or not, as they deemed appropriate, initially established performance materiality for the audit of four different transaction streams/account balances. For all four scenarios, on average, the auditors revised, to a statistically significant degree, performance materiality, downward on the basis of “bad” information and upward on the basis of “good” information. Different combinations of transaction streams/accounts and risk factors were associated with different magnitudes of revision. However, at the level of individual participants, responses were quite varied. Some participants did not revise performance materiality and some even stated that performance materiality should not be revised based on risk‐related information. It may be that the concept of performance materiality as promulgated in CAS 320 and the relationship between overall materiality, performance materiality, and risk requires clarification to provide appropriate guidance for auditors to make performance materiality judgments.     

政治系统与法律系统对于技术风险的决策观察

德国社会学家尼古拉斯·卢曼的社会系统论和二阶观察理论所提供的社会建构论框架,有助于我们从技术、时间、知识、决策等维度厘清技术风险形成的复杂社会机制,促进我们对政治系统和法律系统中的技术风险管制活动进行反思性观察。政治系统通过政策性决策活动规划和控制技术风险的努力,本身也会导致决策风险,政治系统因此发展出令规制失灵而被社会遗忘的应对能力;法律系统内部发展出来的风险预防原则,其功能不在于增加社会的安全水平,而是作为一种程序性反应机制,吸收因科学技术后果的不确定性所导致的环境复杂性。     

The Real Effects of FAS 166/167 on Banks’ Mortgage Approval and Sale Decisions

We examine the real effects of FAS 166 and FAS 167 on banks’ loan‐level mortgage approval and sale decisions. Effective in 2010, these standards tightened the accounting for securitizations and consolidation of securitization entities, respectively, causing banks to recognize an estimated $811 billion of securitized assets on balance sheet. We find that banks that recognize more securitized assets exhibit larger decreases in mortgage approval rates and larger increases in mortgage sale rates. These effects significantly exceed those of banks’ off–balance sheet securitized assets, consistent with our results being driven by the consolidation of securitization entities rather than by securitization per se. We conduct tests that help rule out the financial crisis as an alternative explanation for our results. Further analyses suggest that mechanisms underlying the results include consolidating banks’ reduced regulatory capital adequacy, increased market discipline, and consequent desire not to recognize high‐risk mortgages on balance sheet.     

The Case for Intervening in Bankers’ Pay

This paper studies the default risk of banks generated by investment and remuneration pressures. Competing banks prefer to pay their banking staff in bonuses and not in fixed wages as risk sharing on the remuneration bill is valuable. Competition for bankers generates a negative externality, driving up market levels of banker remuneration and hence rival banks’ default risk. Optimal financial regulation involves an appropriately structured limit on the proportion of the balance sheet used for bonuses. However, stringent bonus caps are value destroying, default risk enhancing, and suboptimal for regulators who control only a small number of banks.