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HAVE YOU SEEN...? Troy Hyatt, University of
Northern Iowa “The Effect of Audit Quality on Earnings Management,” by C. L. Becker, M. L. DeFond, J. Jiambalvo, and K. R. Subramanyam, Contemporary Accounting Research (Vol. 15, No. 1, 1998): 1–24. This paper investigates the relationship between audit quality and earnings management. Treating audit quality as a dichotomous variable (with Big 6 auditors assumed to be higher quality than non-Big 6 auditors), the study captures discretionary accruals using a cross-sectional version of the Jones (1991) model. The authors anticipate that the effectiveness of auditing and its ability to constrain manager’s income-increasing activities vary with the quality of the auditor. Specifically, the authors predict that clients of non-Big 6 auditors will report discretionary accruals that increase income relatively more than the discretionary accruals reported by clients of Big 6 auditors. Results support the hypothesis. Clients of non-Big 6 auditors were associated with discretionary accounting accruals that were, on average, 1.5 to 2 percent of total assets higher than the discretionary accruals of clients of Big 6 auditors. “Auditor Changes and Discretionary Accruals,” by M. L. DeFond and K. R. Subramanyam, Journal of Accounting and Economics (Vol. 25, 1998): 35–67. Using a sample of auditor-change firms, this paper shows that a firm’s discretionary accruals are income-decreasing during the last year with the predecessor auditor and generally insignificant during the first year with the successor. The results also show that the income-decreasing discretionary accruals are concentrated among firms that are expected to have greater litigation risk. The findings are consistent with the idea that concerns about the risk of litigation provide incentives for auditors to prefer conservative accounting choices, and with managers dismissing incumbent auditors in the hope of finding a more reasonable successor. However, the authors are unable to rule out financial distress as a potential alternative explanation for the results. “The Relation Between Going-Concern Opinions and the Auditor’s Loss Function,” by T. J. Louwers, Journal of Accounting Research (Vol. 36, No. 1): 143–155. This paper examines whether auditor incentives influence auditors in the decision about whether to issue a going-concern disclosure to financially distressed clients. The author models the auditor’s going-concern decision as a function of the client’s financial condition and prospects, and of factors associated with the auditor’s loss function (i.e., incentive factors). Those factors are modeled to include prospective audit fees, auditor tenure, recent auditor litigation, client losses, and previously disclosed going-concern difficulties. Using a sample of over 800 financially stressed firms (1984–1991), the author does not find support for the contention that the decision to issue going concern disclosures are systematically influenced by the incentive factors analyzed in the study. Rather, only the client’s financial condition and the presence of indicators of financial distress were significant in explaining the going-concern decision. “Independent Auditor Litigation: Recent Events and Related Research,” by C. B. Cloyd, J. R. Frederickson, and J. W. Hill, Journal of Accounting and Public Policy (Vol. 17, No. 2, 1998): 121–142. This paper has several objectives. First, implications of three of the more significant litigation-related victories for public accountants are examined: Bily v. Arthur Young & Co., the Private Securities Litigation Reform Act (the Reform Act), and California Proposition 211. Second, various issues related to the Reform Act are examined, including the following: (1) litigation involving CPAs since the passage of the Reform Act, (2) whether litigation costs have indeed decreased for CPAs since the passage of the Reform Act, and (3) the movement to uniform standards, which is designed to reduce the shift of litigation from federal to state courts as a result of the Reform Act. Finally, the paper reviews several recent academic studies on auditor litigation and provides many suggestions for future research. The authors conclude that the litigation problems of public accountants are far from over and that there is a significant need for additional research in this area. “An Empirical Investigation of the Interface Between Internal and External Auditors,” by R. G. Brody, S. P. Golen, and P. M. J. Reckers, Accounting and Business Research (Vol. 28, No. 3, 1998): 160–171. This study investigates the effect of internal audit department quality on external auditors’ willingness to rely on the work performed by internal auditors. The study also examines the effects on external auditor judgment of external auditors’ recent experiences with material errors and irregularities and two previously untested (in auditing research) individual differences: (1) conflict management style and (2) perception of internal/external auditor communication barriers. Hypotheses were tested based on the responses provided by 107 audit seniors from one Big 6 firm to an experimental case developed by the authors (each auditor completed one of three versions). Results suggest that external auditors do respond to internal audit department quality differences and that all three individual auditor differences examined do influence auditor judgments. The authors discuss implications for audit practice as well as provide directions for future research. “The Calculated and the Avowed: Techniques of Discipline and Struggles over Identity in Big 6 Accounting Firms,” by M. A. Covaleski, M. W. Dirsmith, J. B. Heian, and S. Samuel, Administrative Science Quarterly (Vol. 43, 1998): 293–327. An ethnographic field study in Big 6 public accounting firms, where management by objectives and mentoring are used as techniques of control, examines how organizations transform professionals into disciplined and self-disciplining organizational members whose work goals, language and lifestyle come to reflect the imperatives of the organization. The study shows that the scope and effect of these techniques shaped the identities of organizational participants, but the discourse of professional autonomy fueled resistance to these pressures toward conformity. Implications of these results are discussed as they relate to conflict between professionals and organizations and to the critical study of organizations. “Changes in European and Australian Companies When They Choose a ‘Big 5’ Auditor,” by W. A. Wallace, European Management Journal (Vol. 16, December 1998): 653–659. Empirical profiling of 193 companies in six countries that choose to change auditors to a Big 5 firm permits managers who are responsible for such decisions to benchmark their financial context. In particular, the level of debt, returns and taxes observed when companies change auditors to a Big 5 firm are quantified, as are the significant changes observed in size, dividends, and the operating income-to-total capital ratio. Of particular interest are reasonably consistent declines in five-year average effective interest incurred post-change. “The Impact of Legal Liability Regimes and Differential Client Risk on Client Acceptance, Audit Pricing, and Audit Effort Decisions,” by A. A. Gramling, J. W. Schatzberg, A. D. Bailey, Jr., and H. Zhang, The Journal of Accounting, Auditing and Finance (Vol. 13, No. 4, 1998): 437–460. This study employs experimental methods to examine client acceptance, audit pricing and effort decision for clients of varying risk under two legal rules, joint and several liability, and proportionate liability. The authors predict greater availability of audit services for high-risk clients, lower audit prices, and lower audit effort under proportionate liability relative to joint and several liability. The evidence does not strongly support predicted prices due to underpricing behavior, but prices do reflect risk differences across client groups for both liability regimes. The results also exhibit some support for the predictions that auditors select low effort for the lowest-risk clients, and a low effort level under proportionate liability relative to joint and several liability for moderate-risk clients. The results also indicate that, as predicted, for the highest-risk clients, high effort is selected under proportionate liability. Finally, the results provide some evidence of a substantial reduction in contracting under joint and several liability. “An Application of the Bootstrap Method to the Simultaneous Equations Model of the Demand and Supply of Audit Services,” by D. R. Dies and R. C. Hill, Contemporary Accounting Research (Vol. 15, No. 1, 1998): 83–99. The paper extends the application of the bootstrap method in accounting research to a simultaneous equations model of the supply and demand of audit services with mixed qualitative and continuous dependent variables. A moderately sized sample of 188 quality control reviews (Copley et al. 1994) is used to demonstrate the bootstrap method and compare results to estimates of standard errors obtained from Amemiya’s (1978) asymptotic generalized least squares (GLS) procedure. They find the GLS t-statistics are inflated by as much as 55 percent and the corresponding p-values are likewise overstated when compared to the bootstrap method results. For the qualitative dependent variable for audit quality, the results indicate that the problem is more acute. “Consumer Perceptions of CPA WebTrust Assurances: Evidence of an Expectations Gap,” by R. W. Houston and G. K. Taylor, International Journal of Auditing (Vol. 3, No. 3, 1999 forthcoming). This paper examines consumers’ perceptions of the assurances provided by WebTrust and the effect of WebTrust on their willingness to make Internet purchases. The results suggest that, while WebTrust provided no additional assurances with respect to business and security practices, it resulted in higher perceived product quality. The authors also find product quality to be the most important determinant of subjects’ willingness to purchase from a web site displaying the WebTrust seal. The authors suggest that the results indicate the existence of an expectation gap between the AICPA/CICA WebTrust purposes and consumers. “Uncertainty about Litigation Losses and Auditors’ Modified Audit Reports,” by T. A. Buchman and D. Collins, Journal of Business Research (Vol. 43, 1998): 57–63. The purpose of this paper is to address the following research questions: (1) If an audit opinion is qualified, is there a greater probability of loss of the litigation? (2) If the opinion is qualified, is any resulting loss greater than if the opinion is not qualified? The authors’ sample consists of 60 firms that had received a “subject to” qualified opinion due to a litigation uncertainty and a randomly matched sample of 60 firms that had received an unqualified opinion but had disclosed a litigation uncertainty in a footnote. Results indicate that firms whose audit reports are modified because of litigation uncertainty are not more likely to lose a lawsuit than firms with an unqualified opinion and footnote disclosure of litigation; however, many losses are reported as being immaterial. Restricting the analysis to firms that reported material litigation losses shows that significantly more of them received qualified opinions than unqualified opinions. The results also indicate that the expected amount of the loss is greater for a firm receiving a modified report than for one only having a footnote disclosure. “Commitment in Auditor-Client Relationships: Antecedents and Consequences,” by K. de Ruyter and M. Wetzels, Accounting, Organizations and Society (Vol. 24, 1999): 57–75. The purpose of this study is to introduce the concept of “relationship commitment” to the accounting literature and to empirically test several theoretical propositions with regard to the auditor-client relationship. The authors develop a framework that can be used to investigate factors that motivate clients to continue their relationship with an audit firm. The authors then test several hypotheses that flow from their framework by analyzing the responses received on 213 questionnaires returned by surveyed clients of one very large public accounting firm in the Netherlands. The results indicate several significant antecedents (service quality, trust, and interdependence) and consequences (cooperation, opportunistic behavior, and continuance intentions) of commitment in the auditor-client relationship. The authors describe a number of managerial implications for auditing firms suggested by the results. In addition, the authors discuss avenues for future research. “Client Risk and Recent Changes in the Market for Audit Services,” by F. L. Jones and K. Raghunandan, Journal of Accounting and Public Policy (Vol. 17, 1998): 169–181. This study investigates whether support can be found for statements made by the public accounting profession and others that suggest that increased litigation costs have made large public accounting firms reluctant to provide audit services to clients perceived as having high litigation risk. The authors examine the proportions of certain types of risky clients audited by Big 6 and other independent audit firms to see whether the relative proportions have changed from 1987 to 1994, a period of increasing litigation. The authors examined public manufacturing companies with total assets less than $50 million. Results indicate that the (then) Big 8 firms were more likely than were other audit firms to audit clients in financial distress or in high-tech industries in 1987. However, in 1994, the authors report a significant reduction in the likelihood that Big 6 firms would audit such clients. “A Theory of Auditor Resignation,” by K. Bockus and F. Gigler, Journal of Accounting Research (Vol. 36, No. 2, 1998): 191–208. The authors present an economic rationale (i.e., a model) for auditors resigning from the engagements of “risky” clients and then use their model to examine claims that increases in expected auditor liability are giving rise to an increase in auditor resignations. Their theory explains how an incumbent auditor rationally resigns an engagement because any attempt at risk-adjusted pricing leaves the incumbent with only unprofitable clients. Further, it shows how successor auditors who know less about the client than the incumbent can profitably accept the engagement of a client whose auditor has rationally resigned. The authors’ model provides several empirical implications. First, following a resignation, the client will engage a more wealth-constrained (i.e., smaller) auditing firm. Second, since auditor resignations occur when the incumbent auditor believes it is relatively likely that the client has a hidden risk, firms whose auditors resign have a higher incidence of adverse outcomes than other firms. Third, the incidence of auditor resignations will increase with the level of auditor legal liability. Finally, a client firm’s market value will decline following an auditor resignation since resignation signals an increase in the probability of a hidden risk. |