The Effect of Lame Duck Auditors on Management Discretion: An Empirical Analysis

2016 ◽  
Vol 35 (3) ◽  
pp. 51-73 ◽  
Author(s):  
Cory A. Cassell ◽  
Linda A. Myers ◽  
Timothy A. Seidel ◽  
Jian Zhou
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Discretionary Accruals ◽  
Auditor Independence ◽  
Data Availability ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Client Relationship ◽  
Manager Behavior ◽  
Lame Duck

SUMMARY We identify instances in which the auditor-client relationship has been terminated but the auditor continues to complete a subsequent quarterly review. We refer to these instances as “lame duck auditor” quarters, and we contrast financial reporting quality in these quarters with that in non-lame duck auditor quarters. Using discretionary accruals and financial statement misstatements as proxies for financial reporting quality, we find that financial reporting quality is higher in lame duck auditor situations, suggesting that lame duck auditors perform more stringent quarterly reviews. We attribute these results to improvements in auditor independence and/or heightened reputation concerns. We perform a number of tests to alleviate concerns that our results are attributable to fundamental differences between clients with lame duck auditors and clients with non-lame duck auditors and to alleviate concerns that our results are attributable to changes in manager behavior rather than changes in auditor behavior. Collectively, our results provide insights that are relevant to regulators, auditors, and other stakeholders who are interested in the factors that affect auditor independence and financial reporting quality. Data Availability: The data used are publicly available from the sources cited in the text.

Does Auditor Explanatory Language in Unqualified Audit Reports Indicate Increased Financial Misstatement Risk?

2014 ◽  
Vol 89 (6) ◽  
pp. 2115-2149 ◽  
Author(s):  
Keith Czerney ◽  
Jaime J. Schmidt ◽  
Anne M. Thompson
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Positive Association ◽  
Financial Statements ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Accounting Principles ◽  
Client Relationship ◽  
Financial Misstatement ◽  
Audit Reports

ABSTRACT According to auditing standards, explanatory language added at the auditor's discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client's financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000–2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) “emphasis of matter” language that discusses mergers, related-party transactions, and management's use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.

Corporate Social Responsibility and Financial Reporting Quality:Evidence from Restatements

2020 ◽  
Author(s):  
Yi-Hung Lin ◽  
Hua-Wei (Solomon) Huang ◽  
Mark E. Riley ◽  
Chih-Chen Lee
Keyword(s):  
Financial Reporting ◽  
Negative Relationship ◽  
Reporting Quality ◽  
Financial Statements ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Csr Reporting ◽  
Corporate Social ◽  
Reporting Environment ◽  
The Relationship

We find a negative relationship between aggregate CSR scores and the probability that firms restated financial statements over the period 1991-2012. We then break that period into three sub-periods in order to determine whether the relationship holds for all three sub-periods. During the sub-periods of 1991-2001 and 2002-2005, the negative CSR score - restatement probability relationship holds. The negative relationship disappears in the 2006-2012 sub-period. Additional analyses indicate CSR scores are significantly higher in the 2006-2012 sub-period, suggesting the disappearance of the relationship between aggregate CSR scores and financial statement quality may relate to changes in CSR assessments and the CSR reporting environment. Our findings update the literature linking CSR scores and financial reporting quality and identify the need for further research as to the reasons the link between these constructs disappeared.

An Analysis of Forced Auditor Change: The Case of Former Arthur Andersen Clients

2007 ◽  
Vol 82 (3) ◽  
pp. 621-650 ◽  
Author(s):  
Jennifer Blouin ◽  
Barbara Murray Grein ◽  
Brian R. Rountree
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Discretionary Accruals ◽  
Financial Statement ◽  
Auditor Rotation ◽  
Auditor Change ◽  
Mandatory Rotation ◽  
Audit Team ◽  
Arthur Andersen ◽  
Selection Of

This study examines former Arthur Andersen clients and provides evidence on the factors involved in their selection of new auditors after Andersen's collapse. Using a unique dataset that identifies whether former Andersen clients followed their audit team to a new auditor, findings reveal companies with greater agency concerns were more likely to sever ties with their former auditor, whereas those with greater switching costs were more likely to follow their former auditor. We also investigate the effect of the forced auditor change on financial statement quality in an effort to provide insight into the mandatory auditor rotation debate. Using performance-adjusted discretionary accruals as a proxy for reporting quality, our results fail to reveal significant improvements for companies with extreme discretionary accruals that severed ties with Andersen, which is inconsistent with the notion that mandatory rotation improves financial reporting.

Do sin firms engage in real activities manipulation to meet earnings benchmarks?

2020 ◽  
Vol 28 (3) ◽  
pp. 535-551
Author(s):  
Suzanne M. Ogilby ◽  
Xinmei Xie ◽  
Yan Xiong ◽  
Jin Zhang
Keyword(s):  
Financial Reporting ◽  
Earnings Quality ◽  
Abnormal Returns ◽  
Reporting Quality ◽  
Production Costs ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Content Type ◽  
Earnings Benchmarks ◽  
Real Activities Manipulation

Purpose Recent literature suggests that sin firms (firms in tobacco, gambling and alcohol industries) have lower institutional ownership, fewer analysts following, higher abnormal returns and higher financial reporting quality. This study aims to investigate empirically how sin firms engage in real activities manipulation (RAM) to meet earnings benchmarks in comparison to non-sin firms. Design/methodology/approach The authors examine two types of RAM, namely, Cutting discretionary expenditures including research and development (R&D), SG&A and advertising to boost earnings. Extending deep discount or lenient credit terms to boost sales and/or overproducing to decrease COGS to increase gross profit. Consistent with Roychowdhury (2006), the authors use abnormal discretionary expenditures as the proxy for expenditure reduction manipulation and abnormal production costs as the proxy for COGS manipulation. Findings The results for the abnormal discretionary expense model suggest that sin firms do not engage in RAM of advertising, R&D, SG&A expense to just meet earnings benchmarks. The results for the production costs model suggest that sin firms do not engage in COGS manipulation to just meet earnings benchmarks. The results are robust after controlling accrual-based earnings management (AEM). Overall, in this setting, these results suggest that managers of sin firms engage less in RAM to meet earnings benchmarks. Originality/value The findings are of interest to investors, auditors, regulators and academics with respect to financial statement analysis and earnings quality.

The Impact of Mandatory IFRS Adoption on Audit Fees: Theory and Evidence

2012 ◽  
Vol 87 (6) ◽  
pp. 2061-2094 ◽  
Author(s):  
Jeong-Bon Kim ◽  
Xiaohong Liu ◽  
Liu Zheng
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Audit Fees ◽  
Data Availability ◽  
Financial Reporting Quality ◽  
Financial Reporting Standards ◽  
Ifrs Adoption ◽  
Audit Fee ◽  
European Union Countries ◽  
The Impact

ABSTRACT: This study examines the impact of International Financial Reporting Standards (IFRS) adoption on audit fees. We first build an analytical audit fee model to analyze the impact on audit fees for the change in both audit complexity and financial reporting quality brought about by IFRS adoption. We then test the model's predictions using audit fee data from European Union countries that mandated IFRS adoption in 2005. We find that mandatory IFRS adoption has led to an increase in audit fees. We also find that the IFRS-related audit fee premium increases with the increase in audit complexity brought about by IFRS adoption, and decreases with the improvement in financial reporting quality arising from IFRS adoption. Finally, we find some evidence that the IFRS-related audit fee premium is lower in countries with stronger legal regimes. Our results are robust to a variety of sensitivity checks. Data availability: Data are available from public sources identified in the paper.

Types of Nonaudit Fees and Financial Reporting Quality

2007 ◽  
Vol 26 (1) ◽  
pp. 133-145 ◽  
Author(s):  
Hua-Wei Huang ◽  
Suchismita Mishra ◽  
K. Raghunandan
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Related Services ◽  
Weak Evidence ◽  
Earnings Benchmarks ◽  
Partitioned Data ◽  
Single Category ◽  
Using Data

Ashbaugh, LaFond, and Mayhew (ALM 2003), using data from proxy statements filed in 2001, fail to find that nonaudit fees are associated with biased financial reporting. The SEC (2002, 2003) has asserted that combining all types of nonaudit service fees in a single category would confuse financial statement users, and that audit-related services represent “services that accountants, in effect, must perform for their audit clients” (SEC 2002, 2003). In this paper, we replicate and extend ALM (2003) by using the more finely partitioned data that is required to be disclosed by SEC registrants after FRR No. 68 (SEC 2003). We find some weak evidence that biased financial reporting (in the form of abnormal accruals) is less likely when the tax and other nonaudit fee ratios are high; we do not find an association between high nonaudit fee ratios and meeting or just beating earnings benchmarks. Overall, we fail to find a systematic association between nonaudit service fees and biased financial reporting; thus, our results reinforce the findings of ALM (2003).

Does Sharia compliance affect the financial reporting quality? An evidence from Muslim majority countries

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Gökberk Can
Keyword(s):  
Financial Reporting ◽  
Robustness Analysis ◽  
Supervisory Board ◽  
Reporting Quality ◽  
Discretionary Accruals ◽  
Financial Reporting Quality ◽  
Financial Instruments ◽  
Content Type ◽  
Financial Reporting Standards ◽  
Muslim Majority

Purpose Sharia compliance states that the compliant company operates not only under regulations but also to the restrictions and permission of Islam. This study aims to reveal whether Sharia compliance enhances the financial reporting quality. Design/methodology/approach The sample is constructed from 15 Muslim majority countries, 2,300 companies for the periods between 2005 and 2017 with 23,810 firm*year observations. Financial reporting quality is measured with discretionary accruals and audit aggressiveness. Discretionary accruals is the absolute of Kothari, Leone and Wasley’s (2005) “performance matched discretionary accruals model.” Audit aggressiveness is calculated with Gul, Wu and Yang’s (2013) model. Findings This study reveals the behavioral differences in financial reporting quality between Sharia-compliant and non-compliant companies. According to the analyzes, Sharia compliance increases the financial reporting quality by decreasing the discretionary accruals and audit aggressiveness. This result is supported by the robustness tests. Practical implications Sharia compliance is not limited to business activity, financial restrictions and supervisory board for Sharia-compliant companies. It also enhances the companies’ financial reporting quality. Robustness analysis also showed that the International Financial Reporting Standards (IFRS) increases the financial reporting quality by reducing discretionary accruals and audit aggressiveness. Originality/value This study contributes to the accounting literature by providing an insight on the use of Islamic financial instruments. The empirical results also show that the use of IFRS and Islamic financial instruments decreases the discretionary accruals and audit aggressiveness.

The Role of Financial Reporting Quality in Mitigating the Constraining Effect of Dividend Policy on Investment Decisions

2013 ◽  
Vol 88 (3) ◽  
pp. 1007-1039 ◽  
Author(s):  
Santhosh Ramalingegowda ◽  
Chuan-San Wang ◽  
Yong Yu
Keyword(s):  
Financial Reporting ◽  
Firm Value ◽  
Dividend Policy ◽  
Investment Decisions ◽  
Reporting Quality ◽  
Data Availability ◽  
Financial Reporting Quality ◽  
High Quality ◽  
Investment Projects

ABSTRACT Miller and Modigliani's (1961) dividend irrelevance theorem predicts that in perfect capital markets dividend policy should not affect investment decisions. Yet in imperfect markets, external funding constraints that stem from information asymmetry can force firms to forgo valuable investment projects in order to pay dividends. We find that high-quality financial reporting significantly mitigates the negative effect of dividends on investments, especially on R&D investments. Further, this mitigating role of financial reporting quality is particularly important among firms with a larger portion of firm value attributable to growth options. In addition, we show that the mitigating role of high-quality financial reporting is more pronounced among firms that have decreased dividends than among firms that have increased dividends. These results highlight the important role of financial reporting quality in mitigating the conflict between firms' investment and dividend decisions and thereby reducing the likelihood that firms forgo valuable investment projects in order to pay dividends. Data Availability: Data are available from public sources identified in the paper.

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