The Auditors Report

Have You Seen...?

Pennie Bagley, Texas Tech University
Albert Nagy, John Carroll University
Gary Peters, University of Arkansas

“Big Five Audits and Accounting Fraud,” by C. Lennox and J. A. Pittman, Contemporary Accounting Research (Volume 27, Issue 1):  209-247.
This study examines whether the negative relation between the presence of a Big Five auditor and fraud likelihood changed in the years leading up to the Sarbanes-Oxley Act of 2002 (SOX) and whether the a negative relation is explained by Big Five auditors supplying higher quality audits, or by the endogenous effects of screening by auditors and selection by their clients. The authors examine accounting frauds committed by companies between 1981 and 2001. The authors provide evidence that Big Five firms were consistently associated with a lower incidence of accounting fraud and that the finding is robust to controlling for the endogenous effects of screening by audit firms and selection by their clients. The authors also find that the appearance of Big Five audit quality diminution after 1995 actually reflects an increasing propensity for large companies to commit accounting fraud.

“Litigation Reform, Accounting Discretion, and the Cost of Equity,” J. Boone, I. Khurana, and K. Raman, Journal of Contemporary Accounting and Economics (Volume 5 Issue 2): 80-94.
This study examines whether the increase in accounting discretion associated with litigation reform is viewed by investors as opportunistic (i.e., as distorting reported earnings) or as improving the ability of reported earnings to reflect economic value.   The authors use the context of the 1995 Public Securities Litigation Reform Act to conduct their investigation. They find evidence consistent with the increase in accounting discretion being viewed as opportunistic by investors.  The authors assert that the exogenous nature of the 1995 Act suggests that the observed increase (and pricing) of accounting discretion is related to litigation reform rather than some omitted firm-specific operating characteristic. 

Determining Whether There are any Effects of Incentive Compensation and Stock Ownership on Internal Audit Procedures,” by A. Schneider, International Journal of Auditing (Volume 14 Issue 1): 101 - 110
This study examines whether internal auditor incentive compensation and stock ownership affect internal auditors' decisions to extend audit procedures when warranted. The study is motivated by the concern that internal auditors may be reluctant to extend audit procedures in a setting that could have a negative impact on the internal auditor's compensation and/or stock value. Using a randomized response technique to elicit responses from internal auditors, the author finds that while internal auditors may be reluctant to extend audit procedures in some situations, neither incentive compensation nor stock ownership affected the audit planning decisions.

“Audit Value and Charitable Organizations,” by K. Kitching, Journal of Accounting and Public Policy (Volume 28, Issue 6): 510-524.
The author investigates the propensity of donors to favor charities that use high quality auditors. Consistent with a signaling perspective, the author finds that charities benefit simply from engaging a higher quality auditor. From an information perspective, donors are more sensitive to changes in reported accounting information verified by a high quality auditor. The author also finds positive associations between the propensity of donations and auditor quality, but that the association dissipates with the size of the charity.

The influence of litigation risk and internal audit source on reliance decisions, by B. Arel, Advances in Accounting (Forthcoming).
This study examines the association between the external auditor’s reliance decisions and the external auditor’s perceived litigation risk and the source of internal audit services. In an experimental study using 89 practicing Big 4 auditors, this study finds that auditors who perceive low litigation risk from placing reliance on the work of internal auditors will rely more on outsourced internal auditors than in-house internal auditors. The results also show that auditors' reliance decisions are sensitive to the level of account risk consistent with the risk-based approach to the integrated audit encouraged by the PCAOB.

"Time pressure, task complexity, and audit effectiveness," by A. R. Bowrin and J. King II, Managerial Auditing Journal (Volume 25 Issue 2): 160 – 181
This study examines the relationships among time pressure, audit task complexity and audit effectiveness. Using a field experiment, the author documents a negative, interactional relationship among time pressure, complexity, and effectiveness. The authors interprets their findings as a caution against the urge to reduce the time allowed for performing compliance tests, and provide training to improve the detection rate for all type of compliance deviations. The authors also observes that it may not be appropriate for audit planners to assume a uniform time pressure effect across the various tasks involved in an audit.

“The effect of benchmarked performance measures and strategic analysis on auditors’ risk assessments and mental models,” by W. R. Knechel, S. E. Salterio, N. Kochetova-Kozloskic, Accounting, Organizations and Society (Volume 35 Issue 3): 316-333.
The study examines the effect of benchmarking of performance measures and strategic analysis, on the risk judgments of auditors carrying out the initial planning of an audit. The authors conduct an experiment with a Balanced Scorecard for organizing and evaluating analytical evidence about the performance of business units within a large client.  They find that external benchmarking can cause an auditor to focus on performance measures that are unique to a business unit and disregard performance measures that are common to multiple business units but not benchmarked. However, they also find that a strategic analysis facilitates a more balanced and accurate assessment of the risks across the business units being evaluated due to auditors developing a more complete mental model of a client.

“How Costly Is The Sarbanes Oxley Act? Evidence on the Effects of the Act on Corporate Profitability,” by A. S. Ahmed, M. L. McAnally, S. Rasmussen, and C. D. Weaver, Journal of Corporate Finance (Volume 16 Issue 3): 352-369.
This study investigates the net realized costs of SOX by examining its impact on operating profitability. The authors document a decline in cash flows by 1.3% of total assets after SOX. They also note that these costs are higher for smaller firms, for more complex firms, and for firms with lower-growth opportunities. The authors also observe that the net SOX-related costs are not limited to one-time expenses associated with internal-control design and implementation. In aggregate, for the 1428 firms in their sample, the costs amount to about $19 billion per year and that profitability is lower for up to four years post-SOX.