01 Auditing

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    Auditor Effect on Merger and Acquisition Outcomes: Evidence from Targets' Auditor-Provided Nonaudit Services
    ( 2020-08-16) Gao, Xinghua ; Jia, Yonghong ; Wang, Qian
    We study the role of auditors in the market for corporate control by examining the relation between nonaudit services (NAS)-related auditor independence and acquisition outcomes. We find that a target's NAS purchases from its incumbent auditor are associated with a lower deal premium, more time and effort taken for due diligence verification, and a higher likelihood of using stock as a method of payment. These relations are more pronounced in situations where the target is more incentivized to manage earnings and the auditor face less risk to acquiesce to client pressure. We also find a negative relation between the target's NAS purchases and the actual deal quality measured by post-acquisition divestiture and goodwill impairment. Overall, our evidence indicates that audit quality affects multiple aspects of an acquisition deal and that the NAS provision compromises auditor independence.
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    Does Audit Regulation Improve the Underlying Information Used by Managers? Evidence from PCAOB Inspection Access and Management Forecast Accuracy
    ( 2020-08-15) Christensen, Brant ; Lei, Lijun ; Shu, Qing ; Thomas, Wayne
    Survey evidence and academic research raises the possibility that audit regulation can impact not only the information contained in external financial reports but also the internal information used by management (International Federation of Accountants, 2018; Libby, Rennekamp, & Seybert, 2015). We investigate this issue by examining the improvement in management forecast accuracy around initiation of the Public Company Accounting Oversight Board's (PCAOB) international inspection program. Consistent with managers having improved information, we find that managers issue more accurate forecasts following PCAOB inspection access. Further, this improvement in forecast accuracy is more pronounced in countries with stronger legal institutions, supporting the intended effect of legal institutions to facilitate enacted regulations. Our study uses a multi-country setting to provide evidence that audit regulation benefits an important internal stakeholder—managers.
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    Do Audit Firms Care about Media Coverage? An Investigation of Audit Firm Response to News Coverage
    ( 2020-08-14) Cowle, Elizabeth ; Rawson, Caleb ; Rowe, Stephen
    We examine how auditors respond to news coverage of their firm and evaluate the extent to which national news outlets function as a watchdog over audit firms. We find that when media coverage includes issues specific to the audit opinion (i.e., restatements, adverse internal control opinions, fraud), audit firms respond by increasing audit attention (increased fees, reporting delay, and late filings). We find that this is amplified among clients with issues similar to those discussed in the media coverage. In contrast, we find that when news coverage does not relate to audit reporting decisions, firms decrease fees and issue audit opinions sooner. Additional analyses reveal that audit firms respond to high levels of news coverage at peer firms, suggesting that firms try to preemptively manage their reputation even when they are not under direct media scrutiny, and negative news has significant costs for firms' client growth and retention. Collectively, our evidence suggests that the news media functions as an effective informal oversight mechanism of auditing firms by driving increased auditor attention and improved audit quality.
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    The effect of partner digitalization expertise on audit fees
    ( 2020-08-14) Maghakyan, Arpine ; Jarva, Henry ; Niemi, Lasse ; Sihvonen, Jukka
    We document a fee premium for audit partners who have gained expertise in digitalization by specializing in highly or similarly digitalized clients. Overall, our evidence is consistent with the view that the digitalization of a client's business and information systems provides audit partners an opportunity to differentiate themselves as experts in digitalization and earn a fee premium. In our sample of listed and private firms in Finland, we find a fee premium of 13—35%. For U.S.-listed companies, we document a fee premium of 63—65%. This study contributes to archival research on auditor expertise and audit pricing by showing that expertise in digitalization is separate from industry-specific and generic knowledge accumulated by years in the profession, enhancing our understanding of the nature of auditing in the current audit environment.
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    Audit Engagement Review: Evidence from Audit Report Errors
    ( 2020-08-14) Beyer, Brooke ; Draeger, Michelle ; Rapley, Eric
    Reviewing the work of the engagement team is a critical aspect of financial statement auditing but is generally unobservable to external stakeholders. This can create challenges for assessing audit quality for individual audit engagements. This study's objective is to introduce and investigate an archival measure that proxies for audit engagement review: audit reports containing errors. We examine audit report errors because the audit report represents the auditor's primary communication with financial statement users and is subject to a rigorous review process. We first provide evidence that typical factors that influence audit engagement review are associated with audit report errors. Specifically, we find that errors are more likely to be present in audit reports when time pressure exists and less likely for clients that are of greater importance. Next, we examine whether our measure for review is associated with audit quality. Results suggest that errors in audit reports are positively associated with financial reporting misstatements (as measured by subsequent out-of-period adjustments). Collectively, our evidence suggests that audit reports containing an error is a suitable archival proxy for (ineffective) audit engagement review.
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    Do Charitable Auditors Deliver Better Audit Quality? -- Evidence from Chinese CPAs
    ( 2020-08-13) Liu, Jiaxin ; Wang, Yakun ; Zhou, Yu
    This paper investigates the relationship between auditor's participation in charity and their audit outcomes. Using audit-partner level charitable activity records of Chinese CPAs, we find that auditors who engage in charitable activities are associated with significantly better audit quality. Specifically, we examine engagement auditors and review auditors separately and find that engagement auditors with records of charitable activities demonstrate lower discretionary accruals, and are more conservative in issuing modified audit opinion. While firms with review auditors who engage in charitable activities are associated with lower frequency of meeting or beating analyst forecast and occurrence of restatements. Our results hold after controlling for other individual-level auditor characteristics such as gender, age, and education background as well as audit firm fixed effects.Additional test suggests that the results for engagement auditors are driven by female auditors rather than male auditors. Taken together, our results suggest that individual auditor's charity activity is associated with audit quality as it reflects auditor's intrinsic motivation of ethical conduct.
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    Economic Consequences of Auditor Reputation Loss: Evidence from the Auditor Inspection Scandal
    ( 2020-08-12) McKenna, Francine ; Pevsner, Mikhail ; Sheneman, Amy ; Zach, Tzachi
    We examine whether the 2017 audit inspection scandal affected KPMG's client relationships and audit quality. Using the trial transcripts, we construct a novel dataset of KPMG clients whose audit engagements were compromised by information leakage from the PCAOB (Transcript Sample). We then examine KPMG's response to this regulatory data theft scandal. Our findings suggest an increased departure rate following the public revelation of the scandal of clients in the Transcript Sample but not in the broad portfolio of KPMG clients. While KPMG's audit fees do not appear to have changed, we find a reduction of KPMG's non-audit fees, which is concentrated in the Transcript Sample clients. Finally, we find that the quality of loan loss provisions of banking clients in the Transcript Sample decreased after the scandal. Overall, our results suggest the audit inspection scandal has imposed costs on both KPMG and its PCAOB-inspected clients whose identities were exposed.
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    Auditor Information Spillovers and Company Operating Performance: Evidence from Targeted Auditor Switches
    ( 2020-08-12) Kleppe, Tyler
    In this study, I examine whether companies realize operational benefits from making "targeted auditor switches" (i.e., engaging a new auditor recently dismissed by a competitor company). While prior work provides evidence consistent with companies perceiving that auditor information spillovers are costly, there is sparse extant evidence as to whether auditors actually do transfer operational information across companies. I find that companies that switch to a competitor's former auditor realize significant subsequent improvements in operating performance and that the association between targeted auditor switches and improvements in operating performance varies predictably with several across- and within-market factors. In addition, I document systematic movement in local audit markets consistent with a recognition of the value of auditors' operational knowledge. Finally, I find that companies that make targeted switches pay a significant audit fee premium to the incoming auditor and that this premium does not appear to be attributable to these companies hiring higher-quality auditors. Collectively, my findings suggest that operational information can be transferred across companies via external auditors and that companies' concerns over sharing an auditor with a competitor are based on real information spillover costs.
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    Are Financial Statement Audits Too Coarse? Evidence from Audits of Technology Service Companies
    ( 2020-08-11) Schoenfeld, Jordan
    A modern firm has many types of stakeholders, each of whom typically interacts with a different part of the firm's business model. Theory predicts that while some stakeholders may benefit from financial statement audits, these audits may be too coarse for other stakeholders. As a result, there may be demand for supplemental audits of other parts of the firm ("non-financial audits"). This study provides some of the first systematic evidence on such audits in the setting of corporations that process financial data at technology services companies such as cloud computing providers. Using hand-collected data from public companies, I find that the large audit firms are often hired to issue a special class of audit reports meant for the corporate customers of technology services companies. A company's business-model exposure to providing technology services is predictive of its decision to receive these audits, and the scope of these audits includes customer-relevant internal controls over data security and processing integrity. These audits are also associated with a large increase in audit-related fees that is highly economically significant when compared to the fees for other corporate accounting services. These findings highlight the economic significance of non-financial audits in our attempts to understand the audit fee environment.
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    Audit Leadership Diversity and Audit Quality
    ( 2020-08-10) Zimmerman, Aleksandra ; Seidel, Timothy ; Lisic, Ling Lei ; Truelson, J. Mike
    We examine whether a culture emphasizing diversity in accounting firms, as embodied by the diversity of local offices' audit leaders, influences audit quality. An organizational culture that emphasizes diverse perspectives and experiences can have a permeating influence on the execution of all local audits, particularly with respect to judgment and decision-making. We develop a composite measure of audit office partner diversity by capturing and combining variations among the following audit office partner characteristics: gender, age, ethnicity, education, client base, and expertise. Our results indicate that greater diversity in audit office partners is associated with higher audit quality among office clientele, incremental to characteristics of the client, the geographic area, the audit office, and the engagement partner, including engagement partner, client, and MSA fixed effects. These findings underscore the importance of an audit office culture that values diversity and provide important practical implications.