Overseeing the external audit function: Evidence from audit committees’ reported activities

Recently, in response to calls for more transparency, many firms have begun reporting the activities undertaken by their audit committees in overseeing the work of the external auditor. We use a composite measure of audit committees’ reported oversight activities for a sample of S&P 1500 firms and examine the extent to which these reported activities are associated with audit quality. We find that when firms’ audit committees report exerting strong oversight, they have higher audit quality as proxied by audit fees, discretionary accruals, the likelihood of meeting or beating earnings benchmarks, and restatements. We also find that the market reacts positively to reports indicating strong oversight, consistent with perceptions of higher audit quality. This study extends prior literature on audit committees by introducing a new comprehensive measure of audit committees’ reported oversight activities and sheds light on how these activities map into audit quality.

Theoretical and Practical Guidance for Incorporating Auditor-Client Communication in Experimental Research

In this paper, we provide theoretical and practical guidance on experimental design choices when incorporating auditor-client communication in audit research. We structure our discussion around Social Presence Theory, noting how elements of social presence impact theoretical predictions and the related experimental design. We then compare non-interactive, highly-controlled paper/computer-based studies with studies that involve automated interaction, interaction with an actor, or interaction between participants. We provide a discussion of best practices and pitfalls related to these different experimental design choices, including theoretical and logistical considerations, as well as recent innovations in this area. While our methodological discussion is nested in auditor-client communication research, these methods and logistical considerations are applicable to most accounting experiments designed to address research questions steeped in social psychology (i.e., contexts of human interaction).

How Does an Audit or a Forensic Perspective Influence Auditors’ Fraud-Risk Assessment and Subsequent Risk Response?

This study examines whether priming auditors with a forensic perspective improves their fraud-risk assessments and subsequent audit-plan responses. We contribute to the literature by investigating a potential improvement in fraud detection that encourages auditors to take a forensic specialist’s perspective, while retaining the audit tenets of efficiently identifying and responding to risk. We prime auditors with a forensic perspective and compare their fraud performance to unprimed auditors in both low- and high-risk contexts, finding primed auditors assess fraud-risk significantly higher in all fraud-risk environments. In a high-risk environment, primed auditors propose a more appropriate audit-plan response. Relevant to fraud detection, these audit-plan modifications were consistent with those determined by a panel of audit and forensic experts. They exhibit a sensitivity in the low-risk environment, whereby their risk response is similar with that of the unprimed auditors. Finally, we find perspective-taking affects risk response through its influence on risk assessment.

Is there a Dark Side to Societal Trust in Auditors’ Going Concern Assessments?

Amidst heightened concern among U.S. and international regulators, is the need to examine reasons why auditors are not issuing going-concern opinions (GCOs) to financially distressed clients who seem to warrant such opinions. We examine societal trust as one such reason, finding a lower incidence of GCOs with high societal trust. Moreover, we find that high societal trust is associated with fewer GCO Type I misclassifications, but more GCO Type II misclassifications. In addition, the association between societal trust and GCOs does not disappear for severely distressed clients, suggesting that auditors do not adequately perceive clients that warrant GCOs when the clients are in high trust countries, and illuminating a dark side to societal trust. Moreover, low litigation risk and auditor-management relationship longevity exacerbate this dark side of societal trust. Our study highlights how societal trust can have beneficial effects across multiple economic contexts while posing problems in the auditing context.

Accounting Firm Association Membership and Audit Firm Growth

In this study, we explore a topic of primary concern to small audit firms – attracting public audit clients. A potential avenue available to small audit firms to enhance their visibility and legitimacy among potential public audit clients is to join an association of accounting firms (ACAP 2008; GAO 2008). We examine whether small audit firms with accounting association membership have greater public clientele growth than their peer audit firms without association membership. We find that member firms experience public clientele growth as measured by number of clients and revenues audited. We find that this growth is impacted by both gaining new entrants to the audit market and winning over clients from competitors. Further, we find that the reputation of associations positively affects the clientele growth seen by member firms. In additional analyses, we also find some evidence of private client growth of association members using LexisNexis® Company Dossier data.

Early Earnings Releases and the Role of Accounting Quality

More than half of U.S. public companies announce earnings before audit completion. We examine how accounting quality, as a measure of the ex-ante reliability of earnings, affects the decision to release earnings early. Using four proxies for accounting quality, we show that firms with higher accounting quality are more likely to release earnings before a completed audit, and that the association is stronger when market demand for timely earnings is high. We provide evidence that accounting quality remains important in the timing of earnings release even after controlling for other factors which affect earnings reliability, such as managerial ability, auditor tenure, and financial reporting problems in a prior period. Overall we emphasize the role of accounting quality in the complex process of when to release earnings relative to audit completion, and suggest that the importance of the audit in the earnings release decision varies based on firm-specific accounting quality.

Confirmation Bias and Auditor Risk Assessments: Archival Evidence

Judgment and decision making research suggests that auditors’ judgments are negatively affected by the use of heuristics. However, there is little research investigating whether such biases survive the quality control processes that regulators and audit firms implement to mitigate them. We investigate this by identifying a setting where one such bias – confirmation bias – is likely to manifest. Consistent with confirmation bias influencing observable audit outcomes, we find that auditors with previous experience auditing a client with a history of low risk followed by an increase in risk do not adequately respond to the higher level of risk. This effect is mitigated when the risk increase is likely large enough to violate auditors’ reasonableness constraint and when the client is highly visible or has strong external monitors. Our study complements prior experimental research by providing archival evidence that auditors’ use of heuristics has a significant effect on auditor judgments.

Disclosure of interim review reports: Do interim going concern conclusions have information content?

This paper examines the information content of interim review assurance in the Australian mandatory disclosure setting. First, we find a strong negative market reaction to interim going concern conclusions (IGCC) contained in the review of interim financial statements. Second, we find no significant difference between the market reaction to IGCCs and annual going concern opinions (AGCO) received at the annual report audit. Finally, we show IGCCs are significant predictors of subsequent AGCOs, and provide incremental information from the previous annual report audit opinion. Overall, these results contribute to the literature on the benefits of mandatory interim assurance by showing that going concern conclusions contained in interim financial statements provide investors with new and relevant information.

External Factors and the Pricing of Audit Services: A Systematic Review of the Archival Literature using a PESTLE Analysis

Client- and auditor-related attributes are well-documented determinants of audit pricing but the number of empirical archival studies investigating the effects of external factors on audit pricing has grown rapidly in recent years. We extend the traditional framework used to classify audit fee research by adding a novel structure that focuses on political, economic, social, technological, legal, and environmental/ecological factors (a PESTLE analysis). We provide a systematic review of the literature on external factors and audit pricing, and we suggest opportunities for future research. Our review reveals that audit researchers focus on legal factors in terms of regulatory changes, and we find increased attention to political, economic, and social factors. However, despite increased public scrutiny, technological and environmental/ecological factors remain under-researched. Overall, our review demonstrates the importance of considering external factors to gain a more complete understanding of the audit pricing framework, especially in terms of global and regional variations.

Using LIWC to Analyze Participants’ Psychological Processing in Accounting JDM Research

This paper provides methodological guidance for judgment and decision-making (JDM) researchers in accounting who are interested in using the Linguistic Inquiry Word Count (LIWC) text analysis program to analyze research participants’ written responses to open-ended questions. We discuss how LIWC’s measures of psychological constructs were developed and validated in psycholinguistic research. We then use data from an audit JDM study to illustrate the use of LIWC to guide researchers in identifying suitable measures, performing quality control procedures, and reporting the analysis. We also discuss research design considerations that will strengthen the inferences drawn from LIWC analysis. The paper concludes with examples where LIWC analysis has the potential to reveal participants’ deep, complex, effortful psychological processing and affective states from their written responses.