scholarly journals Archival evidence on bias in auditors' assessment of client risk and the consequences for audit fees and auditor changes

2016 ◽  
Author(s):  
◽  
Nicholas Hallman
Keyword(s):  
Audit Fees ◽  
Financial Statement ◽  
Contrast Effects ◽  
Audit Process ◽  
Audit Pricing ◽  
Risk Levels ◽  
Actual Risk ◽  
Client Risk ◽  
Client Acceptance

As part of planning and performing financial statement audits, auditors are required to make judgments regarding client risk. These judgments permeate the audit process, driving decisions regarding client acceptance, audit pricing, the extent of audit testing, and the nature of auditors' written opinions. Although auditors may aim to assess each client's risk independently, prior research suggests individuals' draw on their idiosyncratic experiences and environments for benchmarks against which to contrast the case at hand. These "contrast effects" can result in judgments that deviate from those that would be reached using normative principles and may cause bias in auditors' assessment of client risk. Consistent with this theory, the archival evidence presented in this paper shows that, after controlling for clients' actual risk levels, auditors perform more (less) conservative audits and charge higher (lower) audit fees when clients appear riskier (less risky) in the context of other clients audited by the same practice office. Moreover, clients subject to increased (decreased) conservatism and higher (lower) audit fees due to auditors' biases are more (less) likely to switch auditors during the following period.

Client Acceptance and Engagement Pricing following Auditor Resignations in Family Firms

2016 ◽  
Vol 35 (4) ◽  
pp. 137-158 ◽  
Author(s):  
Samer Khalil ◽  
Mohamad Mazboudi
Keyword(s):  
Ownership Structure ◽  
Family Firms ◽  
Audit Fees ◽  
Audit Pricing ◽  
Pricing Decisions ◽  
Big 4 ◽  
Professional Manager ◽  
Financial Restatements ◽  
The Family ◽  
Client Acceptance

SUMMARY This paper investigates whether auditors' client acceptance and pricing decisions following the resignation of the incumbent auditor in family firms are significantly different from those in non-family firms. Relying on the auditing literature (client acceptance and audit pricing) and using insights from the agency theory, we document that successor auditors incorporate a firm's ownership structure into their acceptance and pricing decisions following the resignation of the incumbent auditor. Big 4 auditors are more likely to serve as successor auditors following auditor resignations in family firms as opposed to non-family firms. The changes in audit fees following auditor resignations in family firms, however, are significantly smaller than those in non-family firms. These results hold when we account for whether a family firm is managed by a founder, a descendant, or by a professional manager, and when we use the percentage of shares held by the family members as another proxy for family ownership. Additional analysis further demonstrates that the likelihood of financial restatements in family firms in the post-resignation period are significantly lower than those in non-family firms. Overall, our findings suggest that Big 4 auditors perceive family firms from which the incumbent auditors resigned as being less risky than their non-family counterparts.

Characteristics of Managerial Tone Priced by Auditors: Evidence Based on Annual Letters to Shareholders of Large U.S. Firms

2019 ◽  
Vol 39 (2) ◽  
pp. 139-161
Author(s):  
Adam Greiner ◽  
Lorenzo Patelli ◽  
Matteo Pedrini
Keyword(s):  
Source Credibility ◽  
Audit Fees ◽  
Data Availability ◽  
Evidence Based ◽  
Change Analysis ◽  
Audit Pricing ◽  
Client Risk ◽  
The Relationship ◽  
Jel Classifications ◽  
Corporate Disclosures

SUMMARY We examine the relationship between audit pricing and managerial tone as a proxy of source credibility. Prior research shows that source credibility influences auditors' perceptions of client risk. Textually analyzing annual letters to shareholders, we find that characteristics of managerial tone that reflect impaired source credibility are associated with higher audit fees. Additional tests, including a change analysis and controls for other managerial characteristics, future client performance, and aggressive accounting choices, corroborate and build on our inferences that managerial tone proxies for source credibility. Our study extends literature that uses corporate disclosures to measure managerial characteristics by showing that auditors price source credibility reflected in managerial tone. These findings are important because they empirically confirm that source credibility affects auditors' assessments of engagement risk and that analysis of tone can inform researchers, auditors, and investors who seek to enhance effectiveness and objectivity in assessing source credibility based on managerial tone. JEL Classifications: G21; G34; M41. Data Availability: The data in this study are available from public sources indicated in the paper.

Customer-Base Concentration: Implications for Audit Pricing and Quality

2018 ◽  
Vol 31 (1) ◽  
pp. 129-152 ◽  
Author(s):  
Gopal V. Krishnan ◽  
Panos N. Patatoukas ◽  
Annika Yu Wang
Keyword(s):  
Audit Quality ◽  
Audit Fees ◽  
Customer Relationships ◽  
Data Availability ◽  
Audit Process ◽  
Audit Pricing ◽  
External Auditors ◽  
Customer Base ◽  
Conventional View ◽  
Audit Fee

ABSTRACT What are the implications of major customer dependency, i.e., the degree of a supplier firm's dependency on its major customers, for external auditors? While the conventional view emphasizes the negatives of major customer dependency for client business risk, we find that suppliers with more concentrated customer bases spend less on audit fees. The evidence is consistent with reduced audit effort due to efficiency gains in the audit process, especially when suppliers with more concentrated customer bases share the same auditors with their long-standing major customers. The audit fee discount we identify does not imply that audit quality declines with customer-base concentration. In fact, we find that suppliers with more concentrated customer bases are less likely to experience material restatements of previously audited financial statements. Taking the external auditors' perspective, our study provides new managerial insights on the costs and benefits of major customer relationships for supplier firms. Data Availability: All data are available from sources identified in the text.

Client Risk Management: A Pecking Order Analysis of Auditor Response to Upward Earnings Management Risk

2012 ◽  
Vol 32 (2) ◽  
pp. 147-169 ◽  
Author(s):  
Gopal V. Krishnan ◽  
Lili Sun ◽  
Qian Wang ◽  
Rong Yang
Keyword(s):  
Risk Management ◽  
Earnings Management ◽  
Internal Control ◽  
Audit Fees ◽  
Risk Management Strategy ◽  
Audit Pricing ◽  
Pecking Order ◽  
Order Analysis ◽  
Auditor Resignation ◽  
Client Risk

SUMMARY: This study examines Big N auditors' client risk management strategy in response to the risk of upward (i.e., income-increasing) earnings management in the post-SOX era. Specifically, we empirically study the relation between clients' signed discretionary accruals and subsequent audit pricing and auditor resignation decisions. We find that audit fees and resignations are positively associated with the risk of upward earnings management. We document a pecking order of auditor responses and find that auditors are more likely to respond in the order of charging higher abnormal audit fees if the trade-off between upward earnings management risk and return is within an acceptable level, and then resign if the risk is more severe and exceeds the auditors' tolerance level. Our results are robust to alternative accruals measures, controlling for clients' internal control quality and corporate governance characteristics.

scholarly journals The Effects of State-Level GAAP Regulation on Municipal Audit Markets, Reporting Quality, and Audit Fees

2019 ◽  
Vol 8 (1) ◽  
pp. 36-74
Author(s):  
Alfred A. Yebba ◽  
Randal J. Elder
Keyword(s):  
Reporting Quality ◽  
State Level ◽  
Audit Fees ◽  
Small Sample ◽  
Financial Statement ◽  
Audit Pricing ◽  
Disclosure Regulation ◽  
Market Positioning ◽  
Material Weaknesses ◽  
One Year

ABSTRACT We examine the effects of financial statement disclosure regulation on auditor market concentration, reporting quality, and audit pricing. We compare auditor industry concentration levels for municipalities reporting under the Single Audit Act in the state of Michigan, which requires GAAP reporting, with concentration rates in Pennsylvania, which has unregulated reporting. We find an association between a comprehensive GAAP disclosure policy and auditor concentration. The disclosure-regulated state also has higher demand for auditor specialization and reporting quality, as evidenced through lower reporting of material weaknesses and shorter reporting lags. Specialist auditors in both environments are associated with greater reporting of control exceptions, but specialization is only associated with shorter reporting lags with disclosure regulation. Using a small sample of survey data for one year, we find evidence that audit pricing is lower in the regulated state, and that specialist pricing varies based on regulation and each specialist audit firm's market positioning.

CEO Financial Background and Audit Pricing

2016 ◽  
Vol 30 (3) ◽  
pp. 325-339 ◽  
Author(s):  
Rachana Kalelkar ◽  
Sarfraz Khan
Keyword(s):  
Financial Reporting ◽  
Chief Executive Officers ◽  
Work Experience ◽  
Audit Committee ◽  
Reporting Quality ◽  
Chief Executive ◽  
Audit Fees ◽  
Fixed Effect Model ◽  
Audit Pricing ◽  
Advantages And Disadvantages

SYNOPSIS Accounting scholars theorize that audit price is a function of a client's audit and business risk. Existing research finds that the functional expertise of Chief Executive Officers (CEOs) in finance improves financial reporting quality (Matsunaga, Wang, and Yeung 2013), increases profitability, and reduces the likelihood of firm failure (Custodio and Metzger 2014). These factors suggest that auditors' engagement risk decreases when incumbent CEOs possess financial expertise, raising the likelihood that auditors will charge these firms lower fees. In this study, we examine whether CEOs' work experience in accounting- and finance-related jobs affects audit fees. Using a panel of U.S. firms between 2004 and 2013, we find that firms that have a financial expert CEO pay lower audit fees. Our results are robust to various specifications, including firm-fixed effect model and specifications that control for other CEO- and Chief Financial Officer (CFO)-specific and audit committee characteristics. Our findings thus add to the literature on the advantages and disadvantages of a functional background of top managers and how this background can create value for a firm through savings in audit fees.

Pricing Initial Audit Engagements: A Test of Competing Theories

1999 ◽  
Vol 74 (2) ◽  
pp. 201-216 ◽  
Author(s):  
Allen T. Craswell ◽  
Jere R. Francis
Keyword(s):  
United States ◽  
Product Quality ◽  
Audit Fees ◽  
The United States ◽  
Public Disclosure ◽  
Audit Pricing ◽  
Experience Goods ◽  
Economic Theories ◽  
Time Period

Two competing theories of initial engagement audit pricing are examined empirically. DeAngelo's (1981a) model predicts initial engagement discounts in all settings, while Dye's (1991) model specifically predicts discounting will not occur in settings where audit fees are publicly disclosed. Unlike the United States and most countries, audit fees are publicly disclosed in Australia. Our study examines initial engagement pricing in Australia during a time period when comparable U.S. studies report discounts of 25 percent (Ettredge and Greenberg 1990; Simon and Francis 1988). The Australian evidence finds initial engagement discounting only for upgrades from non-Big 8 to Big 8 auditors. Discounting for upgrades to Big 8 auditors is consistent with economic theories of discount pricing by sellers of higher-priced, higher-quality experience goods as an inducement to purchase when uncertainty about product quality is resolved through buying (experiencing) the goods. The evidence in our study is generally consistent with Dye's (1991) conclusion that public disclosure of audit fees precludes initial engagement discounting and the potential independence problems arising from such discounting.

How a Shared Auditor Affects Firm-Pair Comparability: Implications of Both Firm and Individual Audit Styles

2020 ◽  
Vol 39 (3) ◽  
pp. 133-160
Author(s):  
Lili Jiu ◽  
Bin Liu ◽  
Yuanyuan Liu
Keyword(s):  
Accounting Standards ◽  
Financial Statement ◽  
Professional Judgment ◽  
Audit Process ◽  
Personal Style ◽  
Audit Firm ◽  
Market Participants ◽  
Audit Firms ◽  
Audit Reports ◽  
Practical Implications

SUMMARY In this study, we examine the roles of audit firms and individual auditors in improving financial statement comparability. We conduct the study in the Chinese setting, in which the identities of signing auditors are revealed in audit reports and accounting standards are principle based. After controlling for audit firm style, we find that firm pairs with shared signing auditors have incrementally greater comparability. Our results indicate that individual auditors exhibit their own personal style in implementing accounting standards and exercising professional judgment in the audit process. Overall, our study underscores the association between individual auditors and comparability, with practical implications for market participants and policymakers.

scholarly journals Opportunities to improve the measurement of audit quality: a call for collaboration between the profession and academics

2016 ◽  
Vol 90 (9) ◽  
pp. 352-351 ◽  
Author(s):  
Jeroen van Raak ◽  
Ulrike Thürheimer
Keyword(s):  
Audit Quality ◽  
Audit Fees ◽  
Class Action ◽  
Financial Statement ◽  
Accrual Quality ◽  
Wide Range ◽  
External Stakeholders ◽  
Insight Into ◽  
Considerable Doubt

Audit research relies on a wide range of publicly available measures to examine which factors influence the quality of financial statement audits. While research to date has to rely largely on remote proxies due to a lack of access to proprietary data, there is considerable doubt about the validity of these proxies and the inferences drawn based on these proxies. In order to provide insight into the reliability of these measures, Rajgopal, Srinivasan & Zheng (2015) investigate whether commonly used proxies for audit quality (i.e. auditor size, abnormal audit fees, accrual quality, and the propensity to meet and beat analyst targets) are associated with deficiencies reported in SEC investigations and class-action lawsuits. Such alleged deficiencies reflect how external stakeholders assess audit performance. Their study indicates that the use of such proxies is highly problematic and that the performance of these measures, with the exception of auditor size, is poor.

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