We define higher audit quality as greater assurance of high financial reporting quality. Researchers use many proxies for audit quality, with little guidance on choosing among them. We provide a ...framework for systematically evaluating their unique strengths and weaknesses. Because it is inextricably intertwined with financial reporting quality, audit quality also depends on firms’ innate characteristics and financial reporting systems. Our review of the models commonly used to disentangle these constructs suggests the need for better conceptual guidance. Finally, we urge more research on the role of auditor and client competency in driving audit quality.
•We define higher audit quality as greater assurance of high financial reporting quality.•We provide a framework for systematically choosing among the commonly used audit quality proxies and evaluating their results.•We review the commonly used audit quality models and conclude that more conceptual guidance is needed to disentangle audit quality from firms’ innate characteristics and financial reporting systems.•We encourage future researchers to continue expanding our knowledge of client demand-side factors, and further explore additional factors related to both auditor and client competencies.
A large auditing literature concludes that Big N auditors provide higher audit quality than non-Big N auditors. Recently, however, a high-profile study suggests that propensity score matching (PSM) ...on client characteristics eliminates the Big N effect Lawrence A, Minutti-Meza M, Zhang P (2011) Can Big 4 versus non-Big 4 differences in audit-quality proxies be attributed to client characteristics?
Accounting Rev.
86(1):259–286. We conjecture that this finding may be affected by PSM’s sensitivity to its design choices and/or by the validity of the audit quality measures used in the analysis. To investigate, we examine random combinations of PSM design choices that achieve covariate balance, and four commonly used audit quality measures. We find that the majority of these design choices support a Big N effect for most of the audit quality measures. Overall, our findings show that it is premature to suggest that PSM eliminates the Big N effect.
This paper was accepted by Suraj Srinivasan, accounting
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We test whether mandatory IFRS adoption affects firm-level "crash risk," defined as the frequency of extreme negative stock returns. We separately analyze nonfinancial firms and financial firms ...because IFRS is likely to affect their crash risk differently. We find that IFRS adoption decreases crash risk among nonfinancial firms, especially among firms in poor information environments and in countries where IFRS adoption results in larger and more credible changes to local GAAP. In contrast, IFRS adoption has no effect on crash risk for financial firms, on average, but decreases crash risk among firms less affected by IFRS's fair value provisions, and increases crash risk among banks in countries with weak banking regulations. Overall, our results are consistent with the increased transparency from IFRS adoption broadly reducing crash risk among nonfinancial firms, but more selectively among financial firms, and with financial regulations playing a complementary role in implementing IFRS among financial firms.
We investigate whether Public Company Accounting Oversight Board (PCAOB) inspections affect the quality of internal control audits. Our research design improves on prior studies by exploiting both ...cross-sectional and time-series variation in the content of PCAOB inspection reports, while also controlling for audit firm and year fixed effects, effectively achieving a difference-in-differences research design. We find that when PCAOB inspectors report higher rates of deficiencies in internal control audits, auditors respond by increasing the issuance of adverse internal control opinions. We also find that auditors issue more adverse internal control opinions to clients with concurrent misstatements, who thus genuinely warrant adverse opinions. We further find that higher inspection deficiency rates lead to higher audit fees, consistent with PCAOB inspections prompting auditors to undertake costly remediation efforts. Taken together, our results are consistent with the PCAOB inspections improving the quality of internal control audits by prompting auditors to remediate deficiencies in their audits of internal controls.
Proponents of IFRS argue that mandating a uniform set of accounting standards improves financial statement comparability that in turn attracts greater cross-border investment. We test this assertion ...by examining changes in foreign mutual fund investment in firms following mandatory IFRS adoption in the European Union in 2005. We measure improved comparability as a credible increase in uniformity, defined as a large increase in the number of industry peers using the same accounting standards in countries with credible implementation. Consistent with this assertion, we find that foreign mutual fund ownership increases when mandatory IFRS adoption leads to improved comparability.
► Foreign mutual fund ownership increases in the EU after mandatory adoption of IFRS. ► The increase in mutual fund ownership is larger when IFRS adoption improves comparability. ► Both implementation credibility and increased uniformity are important factors leading to improved comparability. ► The effects of improved comparability do not increase domestic mutual fund ownership. ► The effects of improved comparability on foreign fund ownership are primarily driven by foreign global funds, as opposed to foreign regional, country, and other funds.
We find that auditors of more conservative clients charge lower fees, issue fewer going concern opinions, and resign less frequently, consistent with more conservative clients imposing less ...engagement risk on their auditors. Using path analysis, we find evidence that both inherent risk and auditor business risk explain these associations. Also consistent with conservatism reducing auditor business risk, we find that client conservatism is associated with fewer lawsuits against auditors and with fewer client restatements. Taken together, our results are consistent with auditors viewing client conservatism as an important determinant of engagement risk that, in turn, affects auditor-client contracting decisions. Our findings should be of interest to auditors who actively manage client risk and to standard-setters who recently dropped conservatism as a desired attribute of financial reporting quality.
This discussion makes several observations regarding the earnings quality research reviewed in
Dechow, Ge and Schrand (2010) (DGS). I discuss some of the factors that led to the large growth in the ...earnings quality literature over the past two decades, and note a few of the important contributions from this literature. I also present what I view as several major challenges the literature faces as well as some avenues for future research. In addition, I discuss the difficulties in evaluating such a diverse body of literature, and comment on DGS’s major conclusions.
During the past decade, there has been a surge in auditing research that exploits Chinese data, much of which is published in top tier journals. China has been an attractive setting for auditing ...research due to the highly granular nature of the available data on public audits and the unique features of Chinese institutions. These advantages have allowed researchers to use Chinese data to study important auditing questions that US data is unable to address. But the popularity of Chinese data among researchers means that most of the obvious questions that lend themselves to the use of Chinese data are likely to be exhausted. In addition, newly mandated disclosures in the US and Europe are quickly making Chinese data much less unique than it used to be. Now that the "low hanging fruit" is gone, researchers who plan to use Chinese data will have to be more creative. This paper suggests some strategies, going forward, that are designed to further exploit the richness of Chinese data to address important questions in the auditing literature.
In their investigation of the new PCAOB Inspections, Lennox and Pittman Lennox, C., Pittman, J., 2009. Auditing the auditors: evidence on the recent reforms to the external monitoring of the audit ...firms. Journal of Accounting and Economics, forthcoming address one of the most important and controversial features of the recent shift from self-regulation to government regulation in the US audit markets. In this paper I attempt to place their investigations into the broader auditing and regulatory literature, critique what we learn and do not learn from their analysis, and make suggestions for future related research.
We find that non‐Big 4 audit offices with greater awareness of SEC enforcement are more likely to issue first‐time going‐concern reports to distressed clients; where SEC “awareness” is measured using ...(i) audit office proximity to SEC regional offices, and (ii) proximity to specific SEC enforcement actions against auditors. We also show that these non‐Big 4 audit offices issue more going‐concern opinions to clients who do not subsequently fail, indicating a conservative bias that reduces the informativeness of audit reports. This conservative reporting bias is also associated with higher audit fees and higher auditor switching rates. These findings are important because non‐Big 4 firms now audit 39 percent of SEC registrants and issue 88 percent of going‐concern audit reports. For Big 4 offices, we find some evidence that awareness of SEC enforcement may improve reporting accuracy by reducing Type II errors (failing to issue a going‐concern report to a company that fails), although the number of cases is small.
Connaissance des mécanismes d'application mis en œuvre par la SEC et décisions des auditeurs quant aux rapportsMark L. Defond, Jere R. Francis et Nicholas J. HallmanRésumé
Les auteurs observent que les bureaux d'audit n'appartenant pas aux Quatre Grands qui possèdent une meilleure connaissance des mécanismes d'application mis en œuvre par la SEC sont davantage susceptibles d'exprimer une première réserve quant à la continuité de l'exploitation à l’égard de clients en difficultés financières — la « connaissance » de ces mécanismes étant mesurée selon i) la proximité du bureau d'audit avec les bureaux régionaux de la SEC et ii) la proximité des bureaux d'audit avec la mise en œuvre de mesures d'application par la SEC à l'encontre d'auditeurs. Les auteurs constatent également que ces bureaux d'audit n'appartenant pas aux Quatre Grands expriment davantage de réserves quant à la continuité de l'exploitation à l’égard de clients qui ne déposent pas leur bilan par la suite, ce qui indique un parti pris de prudence qui réduit la valeur informative des rapports d'audit. Ce parti pris de prudence est également associé à des honoraires d'audit plus élevés et à des taux supérieurs de changements d'auditeurs. Ces constatations sont importantes puisque les cabinets n'appartenant pas aux Quatre Grands se chargent maintenant de l'audit de 39 pour cent des entités inscrites auprès de la SEC et sont responsables de 88 pour cent des réserves exprimées quant à la continuité de l'exploitation. Pour ce qui est des bureaux appartenant aux Quatre Grands, les auteurs relèvent certains données attestant que la connaissance des mécanismes d'application mis en œuvre par la SEC peut améliorer l'exactitude des rapports produits en réduisant les erreurs de type II (consistant à ne pas exprimer de réserve quant à la continuité de l'exploitation à l’égard d'une société qui dépose subséquemment son bilan), bien que le nombre de ces cas soit limité.
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