We examine whether and how individual auditors affect audit outcomes using a large set of archival Chinese data. We analyze approximately 800 individual auditors and find that they exhibit ...significant variation in audit quality. The effects that individual auditors have on audit quality are both economically and statistically significant, and are pronounced in both large and small audit firms. We also find that the individual auditor effects on audit quality can be partially explained by auditor characteristics, such as educational background, Big N audit firm experience, rank in the audit firm, and political affiliation. Our findings highlight the importance of scrutinizing and understanding audit quality at the individual auditor level.
ABSTRACT Whether Big N auditors provide higher audit quality than non-Big N auditors remains a debate. We add new evidence to this debate by utilizing the setting of Big N auditors' acquisitions of ...non-Big N auditors. We identify 331 treatment firms that switched to Big N auditors due to the exogenous shocks imposed by Big N acquisitions. Our difference-in-differences analyses show that treatment firms' audit quality improves after switching to Big N auditors. In comparison, mergers or acquisitions among non-Big Ns have little impact on audit quality. Our cross-sectional analyses suggest the audit quality improvement among treatment firms is more likely due to Big N auditors' general competence rather than their industry-specific expertise. Finally, we find that treatment firms experience no significant market reactions around the announcements of Big N acquisitions, indicating that the capital markets may not attach any premium to the improved audit quality associated with Big N auditors. JEL Classifications: M41; M49.
ABSTRACT
We examine the effects of corporate networks involving common directors and auditors (i.e., connections creating single or double ties between companies) on two important monitoring roles: ...financial reporting quality and auditor dismissal decisions. We also investigate how shocks to the networks, in the form of the audit failing to detect misstatements, affect these networks' structure. The investigations are important because these networks can have significant effects on firm governance and may have different effects when they overlap. We have three primary findings about double‐tie networks: (i) there is no evidence that they improve overall financial reporting quality beyond the effect of single‐tie networks; (ii) they lower directors' willingness to dismiss the auditor, even when there is a signal of an audit failure within the network; and (iii) they allow audit‐quality problems to spread between companies. Our results demonstrate the importance of investigating multiple types of networks and how shocks travel through them. Our findings also lend credence to concerns that “cozy” relationships between directors and auditors diminish the link between poor audit quality and market‐imposed reputation penalties—specifically, auditor dismissals.
RÉSUMÉ
Qualité de l'information financière et décisions de licenciement des auditeurs dans les sociétés ayant des administrateurs et des auditeurs communs
Les auteurs examinent les effets des réseaux d'entreprises constitués d'administrateurs et d'auditeurs communs (c.‐à‐d. des connexions créant des liens uniques ou doubles entre les entreprises) sur deux rôles de contrôle importants : la qualité de l'information financière et les décisions de licenciement des auditeurs. Ils étudient également comment les chocs subis par les réseaux, sous la forme d'un audit ne détectant pas de fausses déclarations, affectent la structure de ces réseaux. Ces analyses sont importantes, car ces réseaux peuvent avoir des effets significatifs sur la gouvernance des entreprises et des effets différents lorsqu'ils se chevauchent. Les auteurs ont trois conclusions principales concernant les réseaux à double lien : (i) il n'existe aucune preuve qu'ils améliorent la qualité globale de l'information financière au‐delà de l'effet des réseaux à lien unique; (ii) ils réduisent la volonté des administrateurs de congédier l'auditeur, même lorsqu'il y a un signal d'échec de l'audit au sein du réseau; et (iii) ils permettent aux problèmes de qualité de l'audit de se propager entre les entreprises. Les résultats de l'étude démontrent l'importance d'étudier plusieurs types de réseaux et la façon dont les chocs les traversent. Ces résultats donnent également du crédit aux préoccupations selon lesquelles les relations « chaleureuses » entre les directeurs et les auditeurs affaiblissent le lien entre la mauvaise qualité de l'audit et les pénalités de réputation imposées par le marché, en particulier les licenciements des auditeurs.
This study examines the relation between the audit failures of individual auditors and the quality of other audits performed by these same auditors. Employing a Chinese setting where audit reports ...reveal the identities of engagement auditors, we find that auditors who have performed failed audits also deliver lower-quality audits on other audit engagements, with this "contagion" effect spreading both over time and to other audits performed by these same auditors in the same year. However, we find little evidence that an audit failure also casts doubt on the quality of audits performed by "non-failed" auditors who are same-office colleagues of a "failed" auditor. We further discover that the contagion effect is attenuated for female auditors, auditors holding a master's degree, and auditors with more auditing experience. Our results underscore the usefulness of disclosing the identity and personal characteristics of individual auditors to investors and regulators.
ABSTRACT
We investigate the joint effects of auditors' reporting choice and audit committee effectiveness on management disclosures about complex estimates. A new PCAOB standard requires auditors to ...report on Critical Audit Matters (CAMs): issues “communicated or required to be communicated to the audit committee” about accounts or disclosures that (1) “are material to the financial statements,” and (2) “involved especially challenging, subjective, or complex auditor judgment” (PCAOB 2017a, 11). Consistent with investor arguments, we find that audit committee effectiveness and more detailed CAM reporting encourage managers' disclosures of the risk underlying complex estimates. When the auditor's report is more informative about a complex estimate and the audit committee is more effective, management's related financial disclosures are more forthcoming. However, less informative auditor disclosures or more effective audit committees alone do not prompt greater management disclosure. Thus, expanded auditor reporting and more effective audit committees, together, can enhance the disclosures investors value.
Prior studies suggest that auditors with short tenure are associated with lower earnings quality because of the lack of client-specific knowledge and/or low balling. In this study, we examine whether ...industry specialization of auditors and low balling affect the association between auditor tenure and earnings quality. We find that the association between shorter auditor tenure and lower earnings quality is weaker for firms audited by industry specialists compared to non-specialists. In addition, we do not find results consistent with the low balling explanation.
Standard-setters worldwide have passed new audit reporting requirements aimed at making audit reports more informative to investors. In the UK, the new standard expands the audit reporting model by ...requiring auditors to disclose the risks of material misstatement (RMMs) that had the greatest effect on the financial statement audit. Using short window tests, prior research indicates that these disclosures are not incrementally informative to investors (Gutierrez et al. in Review of Accounting Studies 23:1543–1587, 2018). In this study, we investigate three potential explanations for
why
investors do not find the additional auditor risk disclosures to be informative. First, using long-window tests, we find no evidence that the insignificant short-window market reactions are due to a delayed investor reaction to RMMs. Second, using value relevance tests, we show that the insignificant market reactions are
not
due to auditors disclosing irrelevant information. Finally, we provide evidence suggesting that RMMs lack information content because investors were already informed about the financial reporting risks before auditors began disclosing them in expanded audit reports.
ABSTRACT
We examine the strategic effects of auditor tenure on the auditor's testing strategy and the manager's inclination to commit fraud. Most empirical studies conclude that longer tenure ...improves audit quality. Proponents of restricting tenure argue that longer tenure impairs auditor independence and a “fresh look” from a new auditor results in higher audit quality. Validating this argument requires testing whether the observed difference in audit quality between a continuing auditor and a change in auditors is less than the theoretically expected difference in audit quality without impairment. Our findings provide the guidance necessary for developing such tests. Our results show that audit risk (the probability that fraud exists and goes undetected) is lower in both periods for the continuing auditor than with a change in auditors. More importantly, we show that across both periods, expected undetected fraud is lower for the continuing auditor than with a change in auditors.
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