Non-audit services, auditor quality and the value relevance of earnings

This paper tests the hypothesis that there is an inverse relation between non-audit services (NAS) provided by a firm auditor and the value relevance of earnings(measured as the earnings response coefficient) and that this relation is weaker for firms with Big 6 auditors. The hypothesis is based on anecdotal evidence and previous research that suggests that the provision of NAS by the external auditor is likely to adversely affect investors’ perceptions of the credibility of financial reports, and that Big 6 auditors, because of reputational capital and litigation costs,are likely to mitigate the adverse effects of NAS. Results using 840 firm-year observations of Australian companies document a statistically significant inverse relationship between NAS and the value relevance of earnings, and this inverse relationship is weaker for Big 6 auditors, therefore supporting the hypothesis.

The effect of auditor quality on financing decisions

We present a model and provide empirical evidence showing that auditor quality affects the financing decisions of companies, and that higher audit quality reduces the impact of market conditions on client financial decisions and capital structure. Consistent with our analytical predictions, we find that companies audited by Big 6 firms are more likely to issue equity as opposed to debt than are those audited by small audit firms. We also find that companies audited by Big 6 auditors are able to make larger equity issues than are those audited by small auditors, but the difference narrows when market conditions improve. Additional results show that the debt ratios of companies decrease less in response to favorable market conditions when auditor quality is high, at least over the medium term.

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.

Busy auditors, ethical behavior, and discretionary accruals quality in Malaysia

The required professional and ethical pronouncements of accountants mean that auditors need to be competent and exercise due care and skill in the performance of their audits. In this study, we examine what happens when auditors take on more clients than they should, thus raising doubts about their ability to maintain competence and audit quality. Using 2803 observations of Malaysian companies from 2010 to 2013, we find that auditors with multiple clients are associated with lower earnings quality, proxied by total accruals and discretionary accruals. Our results demonstrate that associating client firms’ reported discretionary accruals with individual auditors, rather than their firms or offices, is important in determining audit quality. Moreover, we demonstrate that the disclosure of auditors’ signatures on their reports is useful for assessing auditor quality at the individual level, thus contributing to the debate on the usefulness of having auditor identities on reports.

Busy auditors, ethical behavior, and ciscretionary accruals quality in Malaysia

The required professional and ethical pronouncements of accountants mean that auditors need to be competent and exercise due care and skill in the performance of their audits. In this study, we examine what happens when auditors take on more clients than they should, thus raising doubts about their ability to maintain competence and audit quality. Using 2803 observations of Malaysian companies from 2010 to 2013, we find that auditors with multiple clients are associated with lower earnings quality, proxied by total accruals and discretionary accruals. Our results demonstrate that associating client firms’ reported discretionary accruals with individual auditors, rather than their firms or offices, is important in determining audit quality. Moreover, we demonstrate that the disclosure of auditors’ signatures on their reports is useful for assessing auditor quality at the individual level, thus contributing to the debate on the usefulness of having auditor identities on reports.

Ownership concentration, foreign shareholding, audit quality, and stock price synchronicity : evidence from China

This paper investigates the effects of largest-shareholder ownership concentration, foreign ownership, and audit quality on the amount of firm-specific information incorporated into share prices, as measured by stock price synchronicity, of Chinese-listed firms over the 1996–2003 period. We show that synchronicity is a concave function of ownership by the largest shareholder with its maximum at an approximate 50% level. Further, we find that synchronicity is higher when the largest shareholder is government related. We also find that foreign ownership and auditor quality are inversely associated with synchronicity. Finally, we show that the amount of earnings information reflected in stock returns is lower for firms with high synchronicity.

Auditor disaffiliation program in China and auditor independence

SUMMARY: This study examines whether the disaffiliation program introduced by the Chinese government improved auditor independence and whether auditor quality affects this relationship. Auditor independence is measured in terms of the likelihood of receiving a qualified report and the level of earnings management (measured by noncore operating income). The results show that the likelihood of receiving qualified audit opinions for listed companies significantly increased, and noncore operating earnings significantly decreased, after auditors were disaffiliated. However, companies audited by auditors without any affiliation also showed an increase in the likelihood of receiving qualified opinions and a decrease in noncore operating earnings, possibly because of the increased surveillance by the regulatory bodies that accompanied the act of disaffiliation. The results also show that the association between the disaffiliation program and the likelihood of receiving qualified audit opinions is stronger for small auditors than for large auditors, possibly because of the initial lower audit quality of small auditors. Auditor size, however, did not significantly affect the association between the disaffiliation program and noncore operating earnings.

Role of corporate governance in mitigating the selective disclosure of executive stock option information

We examine the nature and extent of statutory executive stock option (ESO) disclosures by Australian listed companies over the 2001 to 2004 period, and the influence of corporate governance mechanisms on these disclosures. Our results show a progressive increase in overall compliance from 2001 to 2004. However, despite the improved compliance, the results reveal managements’ continued reluctance to disclose more sensitive ESO information. Factors associated with good internal governance, including board independence, audit committee independence and effectiveness, and compensation committee independence and effectiveness are found to contribute to improved compliance. Similarly, certain external governance factors are associated with improved disclosure, including external auditor quality, shareholder activism (as proxied by companies identified as poor performers by the Australian Shareholders’ Association), and regulatory intervention.

Perks and the informativeness of stock prices in the Chinese market

While the literature shows that perks can affect firm values positively or negatively, we argue that firms with higher perks are more likely to be associated with a lower quality of financial reporting, which, in turn, can affect the informativeness of stock prices. Based on hand-collected data on perks from Chinese listed firms, we find that firms with lower perks are associated with higher informativeness of stock prices (or lower R-square). Moreover, the positive association between perks and R-square is shown to be weaker for firms with higher financial reporting quality through audit and earnings quality measures.

Auditee religiosity, external monitoring, and the pricing of audit services

Based on prior studies which show that firms headquartered in high religiosity counties exhibit high level of business ethics, this study examines whether these firms are associated with low audit risk, and therefore low audit fees. In investigating this relationship, we draw a distinction between intrinsic and extrinsic religiosity of auditees. Using a sample of 25,872 U.S. observations from 2003 to 2012, we find that intrinsic religiosity of the auditees is associated with low audit fees after controlling for auditee extrinsic religiosity, social capital, firm-specific characteristics, and county-specific characteristics. Furthermore, we find that external monitoring (institutional ownership and leverage) weakens the negative relationship between auditee intrinsic religiosity and audit fees. Finally, we conclude that the effect of auditor religiosity on audit fees is a regional effect that may affect the relationship between audit fees and auditee intrinsic religiosity.

Auditor industry specialization, political economy and earnings quality: some cross-country evidence

Using cross-country data, we evaluate the impact of investor protection on the association between earnings quality and audits by industry specialists. Our findings show that the positive association between industry specialist auditors and earnings quality as documented in the literature is affected by the political electoral system, which reflects investor protection rights in a country. We document that audits by industry specialists are associated with higher earnings quality in countries with the proportional electoral system, reflecting weak investor protection. Our results also confirm Kwon et al.'s findings that overall there is a positive association between earnings quality and audits by industry specialists in countries with weak legal enforcement. Our findings, however, indicate that Kwon et al.'s results are valid only for countries with weak investor protection reflected by the proportional electoral system and not for countries with strong investor protection reflected by the majoritarian electoral system. These findings thus suggest that higher earnings quality of firms audited by industry specialists across countries can especially be expected when investor protection is low and legal enforcement is also weak. In addition, our research suggests that future cross-country studies could explicitly consider the role of the political electoral system of a country in evaluating corporate governance, management and accounting issues.

Audit pricing, reporting quality, and auditor switches in the post -SOX period

The Sarbanes-Oxley Act represents an important watershed event in the history and regulation of the accounting profession. In this dissertation, I develop arguments as to why we can expect differences in auditor behavior before and after SOX and empirically test if indeed there were differences in auditor behavior before and after SOX. My dissertation consists of three essays. For the three essays, I investigate issues related to auditor independence, audit pricing, the impact of auditor changes in the post-SOX period. The motivation for the first part of my research comes from the SEC's assertions that there are differences between types of non-audit services in terms of their potential to adversely impact auditor independence. The first part of my dissertation empirically validates the SEC's assertions that auditors would be more conservative in those instances where the tax and other non-audit services fee ratios are high but not when the audit-related fee ratio is high. The second part of my study examines if auditors are less likely to "low ball" their audit fees in the period after SOX than in the period preceding SOX. Legislators, regulators, and the media have expressed concerns that auditors "low ball" the fees for initial year audits and that such low-balling can lead to reduced audit quality. I find that there is significant initial year audit fee discount in pre-SOX period and but the fee discount does not hold in post-SOX periods. The third part of my dissertation examines the association between auditor switches and auditor conservatism. I find that a large portion of Big 4 clients switch to non-Big 4 auditors and there is no significant evidence indicating that successor auditors are more conservative in the post-SOX period.

Earnings quality : some evidence on the role of auditor tenure and auditors' industry expertise

Prior studies suggest that auditors with short tenure are associated with lower earnings quality because of the lack of client-specific knowledge and/or low balling. In this study, we examine whether industry specialization of auditors and low balling affect the association between auditor tenure and earnings quality. We find that the association between shorter auditor tenure and lower earnings quality is weaker for firms audited by industry specialists compared to non-specialists. In addition, we do not find results consistent with the low balling explanation.

Auditor obligations in an evolving legal landscape

Purpose – The purpose of this paper is to look at auditor obligations to their clients and potentially to third parties such as investors, with a focus on the quality of financial disclosure in an evolving legal framework. Design/methodology/approach – The article outlines and compares established and emerging trends relative to information disclosure and contractual performance in parallel contexts where information asymmetry exists. In particular, this article considers the disclosure regime that has evolved in the insurance industry to address the substantial imbalance in the level of knowledge possessed by the insured in comparison to the prospective insurer. Abductive reasoning is used to identify causal constructs that explain the data pattern from which the theorised potential for judicial revision of the interpretation of “true and fair” in line with “good faith” in legal regulation is derived. Findings – The authors conclude that there is little doubt that a duty of good faith in relation to auditor-company contractual dealings and potentially a broader good faith duty to third parties such as investors in companies may be on the horizon. Originality/value – In the context of stated objectives by organisations such as the International Federation of Accountants to reconcile ethical and technical skills in the wake of the global financial crisis, there is an increased need to rebuild public and investor confidence in the underpinning integrity of financial reporting. This paper offers a perspective on one way to achieve this by recognising the similarities in the information asymmetry relationships in the insurance industry and how the notion of “good faith” in that relationship could be useful in the audit situation.