01 Auditing (AUD)
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ItemInside Audit Firms( 2022)We develop and test hypotheses about compensation policy and auditor retention in accounting firms. Our analyses use de-identified employment and compensation data to investigate the entire pay distribution within accounting firms. Accounting firms all have low retention rates but exhibit differing pay structures. Big 4 firms give similar raises within each cohort, while non-Big 4 give substantial raises to a few top performers. Auditors often "move up" to Big 4 firms, but relatively few move the other way. Audit fees are consistently related to compensation structure. Overall, our results suggest that compensation policies in professional accounting firms affect auditor behavior.
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ItemStaggered Audit Partner Rotations and Audit Quality( 2022)We examine whether staggered audit partner rotations, where partners overlap their experience on clients, are positively associated with audit quality. We use dual signature audit opinions to compare audits where partners are rotated on a staggered basis to those where both partners are rotated simultaneously. Consistent with knowledge continuity management theory, staggered rotations are associated with more audit adjustments that correct clients’ pre-audited earnings, fewer financial restatements, fewer regulatory misconduct sanctions against auditors, and lower discretionary accruals. These results are present regardless of whether staggered rotations occur voluntarily or due to mandatory partner rotation rules. Our findings support audit firms’ assertion that overlapping partner experience on audits is beneficial and increases financial reporting reliability.
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ItemDeconstructing the PCAOB: Using organizational economics to assess the state of a regulator( 2022)Using the principles of organizational economics in this study we assess the quality of the organizational architecture of the Public Companies Accounting Oversight Board (PCAOB). In particular, we use the Four Pillar Framework developed in Brickley et al. (2000) to understand why—according to the SEC’s Chairman Gensler and other stakeholders—the PCAOB may not have entirely realized its mission of investor protection. Our analysis is enabled by the transcripts of the 2019 criminal trial U.S. vs. Middendorf and Wada (i.e., PCAOB-KPMG “steal the inspection data” scandal), which for the first time exposed the inner workings of the PCAOB. Our analysis of the transcripts is augmented by other publicly available documents. Our primary conclusion is that the functioning of the PCAOB has been significantly hampered by misalignment of its tasks (in particular in relation to the SEC), sub-optimally designed performance measurement and employee compensation, and weaknesses in the PCAOB’s organizational culture. These misalignments created an environment susceptible to PCAOB employee criminal misconduct which enabled the PCAOB-KPMG “steal the inspection data” scandal and other Board governance and leadership challenges.
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ItemCommunication during the Pandemic: Use of videoconferencing in Audit Committee-Auditor Communication( 2022)Using Korean listed firms’ mandatory disclosure on the communication method for meetings between the Audit Committee and auditors from 2019 to 2020, we find that videoconferencing leads to weaker audit quality. We measure the degree of videoconferencing by the proportion of videoconferencing in the total number of meetings between the Audit Committee and auditors. We provide preliminary results on whether changes in communication methods affect audit quality. Our results are robust to change analyses, balanced sample analyses, including auditor fixed effects, and using an alternative measure of audit quality and videoconferencing. We find that Audit Committee independence or expertise does not affect the relationship between videoconferencing and audit quality but holding more formal Audit Committee meetings during the year mitigates the negative impact of videoconferencing on audit quality. Our paper contributes to the literature on information processing of Audit Committees.
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ItemDo Critical Audit Matters Provide Decision-Relevant Information to Investors? Evidence from Merger and Acquisition Announcements( 2022)PCAOB AS 3101 requires the auditor to communicate any critical audit matters (CAMs), identified during the planning or performance of the audit, in the audit report. Prior research has investigated the informativeness of CAM disclosures using short window, event study methodologies centered around the initial CAM disclosure in the 10-K and finds minimal evidence that CAMs alter investors’ decisions. We depart from the extant research to investigate whether and to what extent a specific CAM – the business combination CAM – influences investors’ perceptions of mergers and acquisition news. We predict and find that investors react more negatively to merger and acquisition announcements when the audit report preceding the announcement contains a business combination CAM. Our results suggest that CAMs provide decision-relevant information to investors about the risks involved in the acquisition, which is used to value subsequent transactions.
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ItemInternal Control Quality: The Role of Critical Audit Matters Reporting( 2022)We examine whether critical audit matter (CAM) reporting in audit reports improves issuers’ internal controls over financial reporting. We propose that increased scrutiny by auditors on CAM-related matters lead to early identification and remediation of material weaknesses in internal control (ICMW). Analyses show that compared to control companies, companies with CAM reporting experience a statistically significant decrease in both the likelihood of having an ICMW and the number of ICMWs. This result is driven primarily by account-level ICMWs rather than entity-level ICMWs. We also find that issuers with revenue-recognition CAMs have significantly fewer revenue-related ICMWs, suggesting that ICMWs related to revenue recognition are identified and remediated through the CAM evaluation process. For those that reported ICMW at year end, we find a positive and significant association between CAM reporting and the likelihood of disclosing ineffective internal control in SOX 302 reports. This finding supports that CAM reporting leads to early identification of internal control problems. Overall, our evidence suggests that by focusing auditor attention on areas of potential concern, CAM reporting leads to improvements in internal control quality. Our findings have important policy implications as they show that CAM reporting improves financial reporting quality by affecting auditor and management behavior.
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ItemDo consulting services affect audit quality? Evidence from the workforce( 2022)There is a long-standing question in the literature about whether and how consulting services in audit firms affect audit quality. We address this question by using a unique and comprehensive office-level dataset of employment profiles and skills, covering approximately 86% of all employees at large U.S. public accounting firms. We guide our empirical analyses with interviews with 15 audit partners, which reveal that consulting expertise is used in approximately 60%-80% of audit engagements, and the main rationale for such collaboration is knowledge sharing and improved audit quality. In our empirical analyses, we document a positive effect of consulting employees on audit quality. Specifically, one standard deviation increase in the share of consulting employees in an office results in a 2.7 percentage point reduction in restatements in that office. This effect is strongest when consulting employees have skills complimentary to auditors, including special industry skills, technical skills and management skills, supporting the knowledge sharing hypothesis. In addition, we demonstrate that the effect increases with of consulting employees’ tenure with a firm, does not diminish over time, is present for both Big4 and non-Big4 firms, and is more pronounced for larger, more complex and more important audit clients.
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ItemThe Relationship between Principles-based Accounting Rules and Audit Fees( 2022)This paper examines the relations between principles-based accounting standards and audit fees. Our empirical evidence suggests auditors charge a lower fee when firms’ standards are more principles based. Further analyses indicate this fee saving is more pronounced for firms with stronger corporate governance and firms in post-SOX era. Our result is consistent with the notion that principles-based accounting standards improve earnings quality and reduce auditor’s risk-related premium. The results add to the growing body of literature examining cost/benefit of principles-based accounting standards, as well as to the literature of the determinants of audit fees.
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ItemWhen Does Reliance on Technology Elevate Auditor Liability?( 2022)Audit firms continue to make large investments in audit technologies to enhance effectiveness and efficiency, while simultaneously creating the potential for elevated liability due to well-documented psychological aversions to use of technology in judgment and decision-making. We develop a framework that lays out a process for investigating and understanding the nascent research on how technology use affects auditor liability. As an initial study guided by this framework, we predict that reliance on technology will only result in elevated liability when the audit task is relatively subjective, thereby requiring professional judgment, and the effect will be larger when the undetected misstatement is due to management fraud (vs. error). We predict no effect on auditor liability for objective tasks requiring little to no judgment. Results from two experiments with jury-eligible individuals support these predictions as we only observe elevated liability for subjective audit tasks involving management fraud. In other words, jurors are generally receptive to reliance on technology, but do not view technology as an adequate replacement when auditors need to simultaneously exercise professional judgment and detect cues of management deception. Although more research is necessary, our study should give practitioners a degree of comfort that technology reliance will only elevate auditor liability under specific conditions and not elevate unilaterally due to the use of advanced technology during the audit.