Auditor selection : what influences decisions by listed companies?

Major business failures, including Enron and WorldCom in the United States and Harris Scarfe and HIH in Australia, and related alleged audit failures, have put the choice of auditor on the agenda. The choice of the right auditor has economic consequences for an auditee and implications for corporate governance. Factors important to explaining auditor choice are discussed, including institutional factors (pertaining to the auditee and auditor) and newer emerging criteria as well as networking between directors and auditors. Relevant research and the policy implications for good corporate governance of auditor choice in publicly listed companies are explored.

The market for financial report audits : regulation of and competition for auditor independence

The independence of auditors and the quality of financial report audits generally are rarely tested except in circumstances of corporate failure when alleged sub-optimality is present. Often auditors have good defences as to their expertise or competency, but rarely do they have equally convincing defences for the independence of their audit. A major issue for the regulation of auditor independence is that the threats to independence are often subtle and difficult to measure. This paper argues that firms undertaking financial report audits need to be transparent and competitive in respect of auditor independence. Two models that adopt this premise are proposed.

Auditor independence: regulation, oversight and inspection

Much of what auditors do is unobservable. Indeed, what goes on in an audit has been described as ‘secret audit business’. Audits in this context are of financial reports and those financial reports are the representations of the management of those companies, not the auditors. The audits of financial reports are of value in that they provide a competent and independent (of auditee management) attestation of the validity of those management representations. This attestation lowers the ‘information risk’ for the users of these financial reports. There has been a marked increase in activity to regulate matters relating to independence. The proposals outlined in CLERP 9 are one example of this. The requirements in the United States under the Sarbanes-Oxley Act are a further example.

Audit firms operate in a highly regulated yet highly competitive market. Evidence exists to suggest that audit firms are active competitors in respect of audit pricing and competency, including specialist industry expertise. Until recently, there has been little or no observable evidence that audit firms compete in respect of independence. The issues as they relate to audit independence are complex. One issue is that threats to independence are frequently subtle and difficult to observe and measure. Hence, controlling the decisions that relate to them cannot rely solely on regulation which itself inevitably relies on crude definitions and imprecise measures. Additionally, further regulation may not achieve the desired end without other processes being but in place in tandem.

This paper argues that:

1. auditors of certain classes of companies (in particular, those that are publicly traded) should be provided with incentives or requirements to have observable processes on independence
2. the means of observability should be in the form of an inspection and review process focussing on issues critical to the audit, such as independence
3. expert persons not having a current or past financial interest in the firm or in the commercial outcomes of the review should be used in the inspection and review process
4. the review process should have wide-ranging powers of inspection to examine the policies, processes, structures and ‘culture’ of audit firms
5. the report of the inspection and review should be made public, unedited and in full, and in a timely fashion. The primary objectives of this proposal are to (1) make more transparent to the market for information the characteristics of the audit firms and their process to ensure audit independence, and (2) provide a rigorous oversight of independence decision-making by persons who have no commercial interest in the outcome of the decision.

Auditor independence and the nexus with corporate governance-quo vadis?

"Where were the auditors?" Yet again, the independence of the auditor has come under close, critical scrutiny with ongoing collapses of large listed companies, which have global implications for the proper functioning of investment markets. The most recent collapse being that of ENRON in the United States of America, (USA).

"Who are the auditors?" The nexus of auditor independence with corporate governance is examined drawing on Foucault's notion of the relationships between power I knowledge and ethics in the construction of ethical identity. In the face of declining public confidence and demands for more stringent regulation, the tensions between greater self-regulation of auditors by the accounting profession and moves by governments to impose more stringent legislation I regulation, including the creation of public oversight bodies is apparent. This paper presents a comparative analysis of recent developments internationally, with particular reference to South Africa and Australia, intended to more rigorously enforce auditor independence and improve corporate governance. Five key areas identified by various Commissions and regulatory bodies that are regarded as posing significant threats to auditor independence are highlighted. Recommendations for changes to independence requirements in professional codes of ethics and corporate legislation, intended to safeguard auditor independence and to enhance investor protection, are critically examined. It is argued that the "new" independence recommendations while providing more detailed guidance for dealing with the independence threats fail to introduce any new concepts and may be found as ineffective as the plethora of earlier regulations. (This paper represents work in progress, which is intended to spark debate, and accordingly, the authors invite comment from readers to develop further aspects of research into this critical area).

Comprehensive look at the re-examination of the re-valuation effect of auditor switch and its determinants in Malaysia : a post crises analysis from Bursa Malaysia

This study examines economic rational for auditor switch and its impact on share revaluation of 51 switched firms main board of Bursa Malaysia for the post crisis period (1997-2002). This study adopted both logistic regression model and event study methodology to examine the determinants of auditor switches and its impact to share price. Findings show that the auditor switch decision of Malaysian listed finns for post crisis period has been partly explained by audit report, turnover growth and firm's performance. While, findings suggest no significant evidence of wealth effect from auditor switch announcements once switches were divided along the line of auditor switch type, different findings emerged.

Audit quality, auditor compensation and initial public offering underpricing

We jointly study the impact of audit quality on auditor compensation and initial public offering (IPO) underpricing using a sample of Australian firms going public over the period 1996–2003. We find that quality (Big Four) audit firms earn significantly higher fees than non-Big Four auditors, and audit quality is positively associated with IPO underpricing. The positive relation between audit quality and underpricing is more pronounced for small issues, IPOs underwritten by non-prestigious underwriters, and those that are not backed by venture capitalists. Taken together, our results suggest that quality auditors serve as a signalling device that enhances post-issue market value of equity.

Internal auditor perceptions on audit committee interactions : a qualitative study in Malaysian public corporations

Audit committees (AC) and the internal audit function (IAF) are two key corporate governance mechanisms. The primary objective of this study is to provide insights into internal auditors' perceptions of their interactions with AC members in Malaysia. The paper thus contributes to the extant literature by providing additional evidence from a South-east Asian country which is recognised as being characterised with a high power distance culture and a developing capital market. The findings are based on in-depth interviews of the heads of the internal audit function (HIAFs) from 11 publicly listed companies. The results indicate infrequent informal communications and limited private meetings between the HIAFs and ACs, and a need for clear reporting lines. Further, ACs are seen to be held in high esteem for their authority and are expected to take on greater leadership in the inquiry of management's decision-making. These findings highlight the importance of the leadership role of ACs in supporting the IAF.

Auditor change during listing : effect on IPO premiums

The study investigates the relationship between auditing services provided to 213 listed firms over a period from 1996 to 2000 by reputable (or tier 1) and non-reputable (non-tier 1) audit firms and the initial returns at listing. We use market adjusted initial return to reflect the firm’s choice of auditor during the initial public offering (IPO’s). The findings show that there is an inclination for listed firms to engage tier 1 audit firms, probably due to management’s intention of signal the firm’s favorable private information and credibility and integrity of reported financial information and ultimately increasing their chances of getting listed. The findings alos show that there is no significant difference in the initial returns of IPO’s firms irrespective of the reputation of auditors. However, there is a significant difference in the initial return of main and second board firms at listing whether firms are either audited by Tier 1 or non-Tier 1 audit firms. Firms that had upward switch showed higher returns, inconsistent with the auditor reputation hypothesis. This results, however, could be biased by the large number of new firms that did not switch auditors at listing, probably due to lack of time to make changes before listing, and/or have engaged tier 1 auditors at incorporation in anticipation of listing. However, the findings showed significant higher returns for second board firms relative to main board firms. These results do not support the widely held view that firms that seek listing do switch auditors prior to their listing for positive market signalling. The results indicate that auditor’s reputation is not an important determinant of the IPO’s initial return.

Wealth effect of auditor switch during crisis and non-crisis period : the Malaysian experience

This study examines the auditor switch effect on share prices among listed companies in Malaysia, mainly the Second Board companies during economic crisis and the economic growth period. Data on companies listed on the KLSE that reported switching of auditors were gathered from the respective companies’ annual reports for the period of 1990 until 1999. Daily stock prices and the Second Board Index for an interval of 200 days windows were extracted from the KLSE Daily Dairy. The wealth effect of auditor’s switch was investigated using the market model event study methodology. The general findings of the study imply that it is consistent with the theory, the market reacts positively to news involving switching to higher prestige audit firms before the economic crisis but reacted negatively during the economic crisis. News involving switching to lower prestige auditors received negative reaction both before and during the crisis. This study postulate that the negative reaction to switches during the economic crisis (either to higher prestige or to lower prestige auditors) may be due to cost cutting exercise rather than obtaining qualified audit reports.