Investors’ Expectations of the Improvement in the Credibility of Audit Opinions following PCAOB Inspection Reports with Identified Deficiencies

ABSTRACT: Following high-profile accounting scandals (e.g., Enron), Congress passed the Sarbanes-Oxley Act, which established the Public Company Accounting Oversight Board (PCAOB). The PCAOB conducts regular inspections of audit firms and issues inspection reports that describe audit deficiencies identified during the inspections. One purpose of these reports is to improve public confidence in auditor credibility. We conduct a between-subjects experiment to provide initial evidence concerning investors’ perceptions of audit opinion credibility following PCAOB inspections. While we find an overall increase in perceptions of the credibility of future audit opinions, the degree to which perceptions increase is a function of three salient characteristics of PCAOB reports. Specifically, we find that investors anticipate more (less) improvement in the credibility of future opinions when: (1) inspections contain high (low) severity deficiencies; (2) firms respond to the reports with concessions (denials); and (3) for small (large) firms. Further, investors’ assessment of the credibility of the firm’s response to the PCAOB report is higher for concessions than denials; response credibility fully mediates the effect of response type (concession or denial) on the perceived improvement in the credibility of future opinions. Therefore, the inspections may be a useful tool for improving the perceived credibility of audit opinions under certain conditions. Implications include the possibility that firms should consider carefully the nature of their responses and the PCAOB should consider establishing outreach programs to investors to educate them about its regulatory role.

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Audit Research after Sarbanes-Oxley

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2005.24.s-1.5 ◽

2005 ◽

Vol 24 (s-1) ◽

pp. 5-30 ◽

Cited By ~ 96

Author(s):

Mark L. DeFond ◽

Jere R. Francis

Keyword(s):

Audit Quality ◽

Scientific Evidence ◽

Academic Research ◽

Securities And Exchange Commission ◽

Institutional Changes ◽

Compelling Evidence ◽

Negative Consequences ◽

High Profile ◽

Sarbanes Oxley ◽

Accounting Scandals

The scrutiny auditing received following Enron's failure and the accounting scandals at Worldcom and other companies provides compelling evidence that auditing matters and is important. What is unclear, however, is whether auditing was sufficiently “broken” in the first place to warrant the radical reforms and changes effected by the Sarbanes-Oxley Act of 2002 (SOX). While there have been some high profile corporate failures and accounting scandals, the number of demonstrated audit failures as evidenced by successful litigation or U.S. Securities and Exchange Commission (SEC) sanctions is quite small and approaches an annual failure rate of close to zero. In addition, our interpretation of the academic research suggests that many of the “solutions” embodied in SOX are not only unlikely to solve the profession's alleged problems; they may well have serious unintended negative consequences. So the disconnect is large between the scientific evidence on audit quality and institutional changes premised on the assumption that auditing is broken. This paper attempts to stimulate research into some of the important questions implicitly raised by SOX regarding the audit profession's potential failings. An outline of our primary observations and suggestions are presented in the paper's Introduction.

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Auditor Conservatism after Enron

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2010.29.1.267 ◽

2010 ◽

Vol 29 (1) ◽

pp. 267-278 ◽

Cited By ~ 60

Author(s):

Dorothy A. Feldmann ◽

William J. Read

Keyword(s):

Financial Statement ◽

Going Concern ◽

Corporate Scandals ◽

Sarbanes Oxley ◽

Audit Firms ◽

The Media ◽

Time Periods ◽

Audit Opinions ◽

Auditor Conservatism

SUMMARY: Corporate scandals and the resulting passage of the Sarbanes-Oxley Act (SOX) in 2002 significantly affected the auditing profession. The quality of financial statement audits was called into questioned and the media and regulators held audit firms responsible. Several studies found evidence of an increase in the issuance of going-concern opinions after the passage of SOX relative to earlier time periods (Geiger et al. 2005; Nogler 2008; Myers et al. 2008). Auditors, it appears, behave more conservatively when the profession is in the headlines. We replicate and extend this research to determine whether the heightened conservatism continues or whether it fades as time passes. We examine audit opinions issued 12 months or less prior to a bankruptcy filing for 565 companies from 2000–2008. Our findings indicate that while the proportion of going-concern modifications increases sharply in 2002–2003 compared to 2000–2001, it declines in the periods that follow, ultimately returning to its pre-Enron level.

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Public Accountants’ Perceptions Of The Acceptability Of Earnings Management Practices Through The Employment Of GAAP In The Post-Sox Period

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v26i1.277 ◽

2010 ◽

Vol 26 (1) ◽

Cited By ~ 1

Author(s):

John E. McEnroe

Keyword(s):

Earnings Management ◽

Management Practices ◽

Financial Statements ◽

Securities And Exchange Commission ◽

Font Size ◽

Generally Accepted Accounting Principles ◽

Sarbanes Oxley ◽

Accounting Scandals ◽

Audit Opinions ◽

Certification Requirements

Over fifteen years ago, Martens and McEnroe (1992) conducted a behavioral study involving earnings management through the use of Generally Accepted Accounting Principles (GAAP). Their findings indicated that auditors issued unqualified audit opinions on those financial statements and perceived little risk to litigation as a result. A decade later they conducted a similar study (Martens and McEnroe 2002) with the expectation that increased attention to earnings management by then chairman of the Securities and Exchange Commission (SEC), Arthur Levitt, would reduce auditors’ perceptions that the letter of GAAP is in itself an aegis or “safe harbor” against litigation. Although the authors found that auditors had become more conservative, they still issued unqualified opinions on financial statements in which transactions were reported in their form rather than their substance. Given the accounting scandals of Enron and WorldCom, among others, and the enactment of the Sarbanes-Oxley Act (SOX) in 2002, especially with its officers’ certification requirements, it was posited that auditors would exhibit a much more conservative approach than in either of the two previous studies. The results indicate that although auditors are more conservative than in the 1992 study, they still allow clients to engage in earnings management practices through the use of GAAP by issuing unqualified audit opinions on their financial statements.

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A Multicriterion Decision Support Methodology For Audit Opinions: The Case Of Audit Reports Of Distressed Firms In Turkey

International Business & Economics Research Journal (IBER) ◽

10.19030/iber.v10i12.6648 ◽

2011 ◽

Vol 10 (12) ◽

pp. 37 ◽

Cited By ~ 1

Author(s):

Burcu Adiloglu ◽

Bengu Vuran

Keyword(s):

Stock Exchange ◽

Manufacturing Sector ◽

Audit Report ◽

Audit Process ◽

Audit Opinion ◽

Accounting Scandals ◽

Distressed Firms ◽

Audit Opinions ◽

One Year ◽

Audit Reports

The audit report represents the most important part of the audit process and it is the sole communication medium between the auditor and the users of the financial statements. After accounting scandals, auditors responsibility for assessing the appropriateness of audit opinions has become the subject of much debate in the auditing profession and considerable research by academics. This increased attention is due to the fact that auditors appear to be reluctant to disclose audit opinions other than unqualified. Indeed, many companies in the year prior to bankruptcy receive an audit report in which going concern uncertainty is not disclosed. The research of this paper is designed to examine the relationship between the type of audit reports and firm failure. Logistic regression analysis is applied to test the model of audit opinion decision with a sample of financially distressed firms operating in manufacturing sector in Istanbul Stock Exchange (ISE) between the period of 1998-2006. The results reveal that the audit opinions of distressed firms indicate the auditors fail to issue appropriate audit opinions one year prior to failure.

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One Of The Prime Beneficiaries Of The Sarbanes Oxley Act Of 2002: The London Stock Exchange!

International Business & Economics Research Journal (IBER) ◽

10.19030/iber.v7i10.3301 ◽

2011 ◽

Vol 7 (10) ◽

Author(s):

RamMohan R. Yallapragada ◽

Alfred Toma ◽

C. William Roe

Keyword(s):

New York ◽

Stock Exchange ◽

The United States ◽

Stock Exchanges ◽

Public Confidence ◽

American Business ◽

London Stock Exchange ◽

Sarbanes Oxley ◽

Accounting Scandals ◽

Implementation Costs

In the late 1990s, financial markets in the United States (U S ) were rocked by accounting scandals in companies such as Enron and WorldCom. Public confidence in American business was at a low ebb. As a knee-jerk reaction to the scandals, the U S Congress hastily passed the Sarbanes-Oxley Act of 2002 (SOX) hoping to restore the lost image of the U S business firms. SOX rendered corporate governance and protecting corporate assets a matter of Federal mandates. Penalties for violation of the provisions of SOX include a maximum of 25 years of prison and/or a fine of twenty five million dollars. For small and mid-size firms, the implementation costs became prohibitive. The exorbitant implementation costs of Section 404 of SOX and the draconian criminal sanctions for senior management are driving companies to flee from The New York Stock Exchange to more favorable exchanges overseas. The London Stock Exchange appears to be the most benefited one from the passage of SOX. This paper presents the salient provisions of SOX, the havoc caused to the business firms by its implementation costs, and the present trend of flight of capital from American stock exchanges to overseas stock exchanges such as the London Stock Exchange.

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Recent Changes in the Association between Bankruptcies and Prior Audit Opinions

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2005.24.1.21 ◽

2005 ◽

Vol 24 (1) ◽

pp. 21-35 ◽

Cited By ~ 120

Author(s):

Marshall A. Geiger ◽

K. Raghunandan ◽

Dasaratha V. Rama

Keyword(s):

Paradigm Shift ◽

Recovery Period ◽

Client Characteristics ◽

Going Concern ◽

High Profile ◽

Sarbanes Oxley ◽

Reporting Decisions ◽

Audit Opinions ◽

Auditor Reporting ◽

The U.S

The intense legislative and media scrutiny after a series of high-profile corporate failures, coupled with the paradigm shift in the regulation of the auditing profession brought forth by the Sarbanes-Oxley Act, suggests that auditors' decisions would be more conservative in the period after December 2001. Based on analyses of 226 financially stressed companies that entered bankruptcy during the period from 2000 to 2003, we find that auditors are more likely to issue going-concern modified audit opinions in the period after December 2001. Since the post-December 2001 period coincides with recovery from a recession in the U.S., we also examine prior audit opinions for 93 companies entering bankruptcy in 1991 and 1992. We find that auditors were also more likely to issue prior going-concern modified audit opinions in 2002–03 than in the earlier recession recovery period. Following the technique used in Francis and Krishnan (2002), we document that the increase in going-concern modification rates for bankrupt companies after December 2001 is due to changes in auditor reporting decisions and not solely due to differences in client characteristics between the time periods studied.

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The auditor’s opinion modifications around domestic and global financial crises

Meditari Accountancy Research ◽

10.1108/medar-08-2017-0199 ◽

2018 ◽

Vol 26 (4) ◽

pp. 622-639 ◽

Cited By ~ 2

Author(s):

Banu Sultanoglu ◽

Can Simga Mugan ◽

Umut Sekerdag ◽

Adil Oran

Keyword(s):

Financial Distress ◽

Global Financial Crisis ◽

Client Characteristics ◽

Content Type ◽

Audit Opinion ◽

Audit Firms ◽

Audit Opinions ◽

Auditor Reporting ◽

The Global Financial Crisis ◽

Practical Implications

Purpose The purpose of this study is to investigate the effect of company characteristics such as the level of financial distress, client size and type of auditor on the propensity to issue modified audit opinions and to assess comparative differences in audit opinions during two significant economic crises in Turkey. Design/methodology/approach Logistic regression model is used to test the incremental contribution of each company characteristic on issuing the type of audit opinion for crisis periods. Additionally, to understand the reasons for differences in audit opinions between two types of crisis periods, the authors adopt Francis and Krishnan’s (2002) approach in which an auditor’s propensity to issue modified opinion may be jointly based on changes in client characteristics and auditor reporting strategies in that period. Findings The results indicate that there is a positive relationship between financial distress and the likelihood of receiving modified opinions in both crisis periods. Additionally, client size affects audit opinions negatively in both periods significantly. Auditors show higher propensity to issue a modified opinion during the domestic than the global financial crisis period, which could be explained by the changes in client characteristics more than their reporting strategy. Practical implications This study provides supportive evidence that the company characteristics including the financial distress can be very useful predictors for the auditors’ decisions while issuing their opinions. Originality/value The findings of different auditor behaviors during crises periods and possible reasons are the main contributions of this study for international and domestic regulators, investors, audit firms, academics and standard setters in emerging economies.

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Relationship Between Audit Opinion And Credit Rating: Evidence From Korea

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v32i2.9599 ◽

2016 ◽

Vol 32 (2) ◽

pp. 621 ◽

Cited By ~ 2

Author(s):

Myungki Cha ◽

Kookjae Hwang ◽

Youngjun Yeo

Keyword(s):

Credit Rating ◽

Empirical Test ◽

Credit Ratings ◽

Audit Opinion ◽

Credit Score ◽

Audit System ◽

High Profile ◽

Predictive Function ◽

Audit Opinions ◽

The Relationship

In this study, we investigate the relationship between credit ratings and audit opinions of financially distressed companies impending bankruptcy. Using Korean publicly-held firms for the years 2007 through 2014, we analyze 97 bankrupt companies with credit rating available before they file bankruptcy. Following prior research (Geiger et al., 2005), we find that the propensity to issue a going concern audit opinion is associated with the credit score issued by NICE immediately prior to the audit opinion date. We also compare credit ratings to audit opinions to investigate which of the two is more conservative and provides the earlier signal of bankruptcy. Through empirical test, we can conclude that audit system has more successfully predictive function in signaling preceding bankruptcy than CRAs' system with overly optimism. We argue that after a string of high-profile corporate failures such as Enron and Arthur Anderson’s bankruptcies, legislators portrayed auditors negatively and ultimately led to the enactment and more forced liabilities and thus auditors become more conservative. To remedy CRAs' failure by providing overly optimism, we suggest that like as auditors, CRAs' regulations should be more strengthened on their liability about issuing credit ratings.

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Local and Regional Audit Firms and the Market for SEC Audits

Accounting Horizons ◽

10.2308/acch.2004.18.4.241 ◽

2004 ◽

Vol 18 (4) ◽

pp. 241-254 ◽

Cited By ~ 22

Author(s):

William J. Read ◽

Dasaratha V. Rama ◽

K. Raghunandan

Keyword(s):

Audit Quality ◽

Liability Insurance ◽

Primary Reason ◽

Private Companies ◽

Congressional Hearings ◽

Sarbanes Oxley ◽

Insurance Costs ◽

Audit Firms ◽

Public Company ◽

Rules Changes

The period after the demise of Enron and Andersen has been tumultuous for the accounting profession. In congressional hearings and in responses to the SEC and GAO, auditors have stated that provisions of the Sarbanes-Oxley Act of 2002 (SOA) and related SEC rules changes would cause many local and regional audit firms to terminate audit work for SEC registrants. In this study, we provide empirical evidence about small audit firms and recent changes in the market for SEC audits. After examining all auditor resignations during 2000–2003, we find that 47 local and regional audit firms disclosed in Form 8-Ks filed in 2002–2003 that they were ceasing all SEC audits; only eight such firms that made this disclosure in 2000–2001. From interviews with audit partners of such firms, we find that the primary reasons for ceasing SEC audits is the perception of a more stringent oversight by the recently created Public Company Accounting Oversight Board (PCAOB), increased professional liability insurance costs, and increased scrutiny of SEC registrants. We also find that many local and regional audit firms that had no SEC audit clients in 2002 voluntarily registered with the PCAOB. Interviews with partners of such audit firms indicate that the primary reason for voluntarily registering with the PCAOB is to signal their audit quality to non-SEC registrants (private companies, nonprofits, etc.) and their stakeholders.

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Independence: The Fall Of Andersen And The Rise Of Sarbanes Oxley

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v3i7.2789 ◽

2011 ◽

Vol 3 (7) ◽

Author(s):

H. Francis Bush

Keyword(s):

Lower Percentage ◽

Font Size ◽

Related Services ◽

Sarbanes Oxley ◽

Audit Firms ◽

Audit Opinions ◽

Arthur Andersen ◽

Non Audit Services

In this study, the author examines the audit firms’ fees associated with audit services and audit-related services as a percentage of total fees charged to individual firms as reported to the SEC.  This study was motivated by discussion of the impacts on audit opinions of the amount of work beyond an audit for which an auditing firm contracts.  The results indicate that the fees that Arthur Andersen charged its individual clients indeed had a lower percentage of total fees associated with audit work.  Further, for the year 2002, on average, firms reported a higher percentage of fees from auditors were associated with audit work.  Firms that previously contracted with Arthur Andersen contracted significantly less non-audit services than their counterparts.

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