Abstract

We examine auditor responses to the voluntary resignation of independent directors. We show that auditors respond by increasing audit fees or rescinding engagement with their clients, but not by increasing their audit effort. Mechanism tests reveal that independent directors’ voluntary resignation leads to increased regulatory sanctions and negative media coverage, these relationships are more pronounced after the New Securities Law. Auditor response strategies follow an order of priority: at an acceptable level of perceived risk, auditors increase audit fees; when perceived risk exceeds this level, auditors will discontinue the client relationship. Auditors associate greater risk with firms that have (vs. have not) experienced consecutive voluntary resignations by independent directors. Mandatory resignation has no such effect.

Introduction

The board of directors plays a crucial role in corporate governance. The proportion of independent directors on the board is an important metric of the effectiveness of board supervision, which is emphasized by regulatory authorities (Zhu et al., 2016). The independent director system was initially established to mitigate agency problems between shareholders and management (Fama and Jensen, 1983, Dai et al., 2014). Independent directors also supervise, advise and provide support in the form of resources for listed companies (Fama and Jensen, 1983, Liu et al., 2018a, Liu et al., 2018b, Zhou et al., 2021). What signals are sent by the voluntary resignation events of independent directors? Can auditors identify the risks involved? How do auditors respond? We explore this series of questions.

Typically, the resignation events of independent directors are categorized as mandatory or voluntary. Mandatory resignation occurs when independent directors are required to step down from their roles under regulatory pressure; voluntary resignation occurs when independent directors proactively relinquish their positions, judging that the benefits of those positions do not compensate for the risks incurred. According to signaling theory, the voluntary resignation of independent directors signals company risk to external parties (Gupta and Fields, 2009, Lin et al., 2012, Bar-Hava et al., 2021, Cao et al., 2023), such as poor company performance (Arthaud-Day et al., 2006), high levels of earnings management (Zhi and Tong, 2005) or elevated legal risks (Yang and Huang, 2015). This paper focuses on the responses of auditors, as stakeholders in listed companies, to the voluntary resignation of independent directors.

Conclusion

This paper presents an in-depth exploration of auditors’ responses to the voluntary resignation of independent directors. The findings reveal that the voluntary resignation of independent directors of a listed company transmits risk signals to auditors that elevate their perception of the risk associated with that company. In response, auditors seek to mitigate this risk by charging higher audit fees or terminating their engagement with the client company. Interestingly, we find no evidence that auditors also increase their audit effort following the voluntary resignation of independent directors, indicating that the higher audit fees charged are due primarily to an increased risk premium, rather than to cost compensation. Mechanism analysis indicates that companies with voluntary resignations by independent directors face an increased risk of regulatory penalties in both the current and subsequent periods, and such companies also receive more negative media coverage.

Further analysis reveals that since the implementation of the New Securities Law, the positive relationship between the voluntary resignation of independent directors and abnormal audit fees has become more pronounced. This suggests that the new law has a deterrent effect on auditors, increasing their perception of risk and leading them to raise audit fees. Moreover, we discover that auditors follow an order of priority in responding to the risk signals conveyed by the voluntary resignation of independent directors: when they perceive the level of corporate risk to be acceptable, they prefer to increase audit fees, but when the risk exceeds their tolerance level, they are likely to terminate the engagement, leading to an auditor change.

Abstract

     This study investigates if a gender effect exists on the audit fees associated with the presence of women in roles closely related to the audit process. The analysis is based on the largest European corporations studied between 2016 and 2018. The results show that firms with female chief financial officers and more female directors on the audit committee pay significantly lower audit fees than other firms. However, the results for the remaining gender variables (audit partner, chair of the audit committee, and chief executive officer) do not show any association. Additionally, we find that accounting expertise drives the association between female directors and audit fees. Therefore, neither non-expert female directors nor, more surprisingly, female directors who are labelled as financial experts, have any significant effects on audit fees. Another interesting finding is that the gender variables provide significant results when they are observed in more gender egalitarian contexts, though not in less egalitarian settings. These results have interesting implications at various levels.

Introduction

     The accounting profession is usually viewed as particularly gendered (Almer et al., 2012; Carmona & Ezzamel, 2016; Haynes, 2017). This study continues a well-established line of research on the relationship between gender and audit fees. It investigates how the presence of women in roles more closely related to the audit function (engagement audit partner, member and chair of the audit committee (AC), chief executive officer (CEO), and chief financial officer (CFO)) impacts the level of audit fees. According to agency theory (Jensen & Meckling, 1976), principals (shareholders) and agents (managers) are likely to have conflicting goals. In this context, an external audit reduces incentive problems that may arise when the firm’s managers are not the owners of the residual claims generated by the firm. Both the supply- and demand-side theories of the audit function provide arguments for a significant impact of the appointment of women to these positions on audit fees. As in previous studies (e.g., Hardies et al., 2015; Lai et al., 2017), we focus on audit fees because (i) they are the direct outcomes of decisions made by the AC (Lai et al., 2017); (ii) they are expected to differ across audit partners based on their respective characteristics and reputations (Hardies et al., 2015; Zerni, 2012), and (iii) there is evidence that managers participate in these decisions (Cohen et al., 2010; Dao et al., 2012; Dickins et al., 2008; KPMG, 2004). The empirical analysis relies on the constituents of Standard and Poor’s Europe 350 (S&P 350) stock market index for the period between 2016 and 2018.

Conclusions

     The accelerated process of incorporating women into senior management positions over the last few years has made it necessary to update the evidence on the relevance of gender in audit fees. As a result of gender quota regulations enacted in a growing number of countries, companies are forced to appoint female directors to their boards (as well as their ACs) to meet gender quotas. This is contrary to the situation before these regulations were passed, where women were voluntarily appointed to these positions. Again, as some prior studies have shown, these gender quota regulations do condition the relationship between gender variables and audit fees and, consequently, updated evidence is welcome.

     This study finds that the presence of female directors on the AC is negatively associated with audit fees, with a similar result observed for female CFOs. In the case of female directors, this result is driven by individuals with accounting expertise, whereas the presence of female directors with financial expertise alone is not associated with audit fees. On the other hand, results for audit partners and CEOs are negligible. However, there are some limitations that should be considered when interpreting these findings. First, the relatively small sample size of the study reduces the soundness of the analysis examining the importance of gender equality as a conditioning factor in the association between gender and audit fees. The second limitation derives from the meagre presence of women in some of the examined positions, most notably as CEOs. However, it should be noted that the accelerated incorporation of women into senior management positions over the last few years has diminished the importance of this problem in comparison with earlier studies.

Abstract

Keywords

JEL classification

1. Introduction

2. Literature review and hypothesis development

3. Research design

4. Summary statistics and results

5. Robustness checks

6. Further research

7. Conclusion

Credit author statement

Funding

References

Abstract

We examine whether the diversity of signing auditors affects audit quality of listed firms in China. Using the Blau’s index of diversity measure based on eight characteristics of signing auditors and a series of audit quality proxies, including modified audit opinions (MAO), restatement of annual financial reports (Restate), and discretionary accruals (DA), we document a negative relationship between the diversity of signing auditors and firms’ audit quality. Additional analyses show that corporate governance, signing auditor and audit firm characteristics moderate the relationship between the diversity of signing auditors and audit quality. Our findings suggest that reducing the diversity of signing auditors is an effective way to improve audit quality.

1. Introduction

Audit quality is an important part of the information disclosure system, which directly affects the quality of accounting information that leads to stakeholders’ decisions and actions (Francis, 1984). A large body of literature investigates the factors contributing to audit quality from the perspective of audit firms and listed companies including audit firm size, audit firm or auditor rotation, and the corporate governance structure of listed companies (Behn et al., 2008; Choi et al., 2010; DeAngelo, 1981; DeFond & Zhang, 2014; Deng et al., 2012; Firth et al., 2012; Zhao et al., 2020). In addition, several recent studies suggest that personal characteristics of the signing auditors are associated with audit quality (Guan et al., 2016; He et al., 2017; Knechel et al., 2015). However, the literature focuses on various characteristics of one auditor (i.e., the engagement partner) on audit quality. In practice, a listed company’s audit is generally the responsibility of several auditors, including the engagement and the review partners. These partners are all signing auditors. It is not clear how audit quality relates to the characteristics of an audit team. We examine this research question.

Several recent accounting scandals in Chinese capital market have turned the spotlight on audit quality issues. A listed company named FUREN Pharmaceutical (Stock Code: 600781.SH) failed to pay a RMB 60 million (approximately US$ 8.57 million) dividend promised to investors on July 20th, 2019, while apparently holding a cash balance of more than RMB 1.8 billion (approximately US$ 257 million).1 Another case of accounting fraud occurred at KDX Company (002450.SZ) in 2018.2 Ironically, the auditing firm of the two companies, Ruihua Certified Public Accountants Firm, had been issuing unqualified audit opinions for more than six years, when in fact, modified audit opinions seemed more appropriate in both cases. The auditing opinions on FUREN Pharmaceutical and KDX Company turned out to be completely lacking in their assurance function. Such an abominable level of audit quality seriously misled the investors’ decisions and actions, damaged investor confidence, and thus adversely affected the order of the capital market. These events provided us with the impetus to explore the role of audit team characteristics in audit quality.

Abstract

     This study analyzes the auditor personality impact on audit quality, using partial least squares structural equation model and fuzzy-set qualitative comparative analysis methods. This research draws on the insights of Big 5 personality theory and empirical studies in audit quality. The PLS-SEM result reveals that the traits of agreeableness, conscientiousness and openness are positively associated with professional skepticism of auditors, while conscientiousness and neuroticism negatively affect reduced audit quality practices. The fsQCA results show the existence of multiple configurations of personality traits leading to high (low) audit quality. Moreover, the causal asymmetry found reveals that personality is a combination of individual traits that interact in a differentiated and complex way with audit quality. This study complements previous research on auditor’s drivers for supplying audit quality and provides support to audit firm decisions informing about the most relevant combinations of personality traits that auditors must have to make outstanding audit quality.

Introduction

     The provision of credible accounting information is very relevant to improve resource allocation and efficient contracts and it can be achieved through auditing (DeFond and Zhang, 2014). The confidential nature of auditing, which is in force in many countries, prevents users of financial statements from accessing the quality of the work carried out by auditors (Gundry and Liyanarachchi, 2007). However, it is not possible to anticipate the situations in which auditors could compromise audit quality (Gundry and Liyanarachchi, 2007).

     Christina and Brahmana (2019) state that, even though some studies link the individual differences in auditors to audit quality, the results are still not consistent. Some studies focused on the effect of several individual auditors’ personal characteristics, but did not focus on auditor personality (Gul, Wu and Yang, 2013). The studies that focused on the effect of auditor personality on audit quality found a significant relationship between them (Gundry and Liyanarachchi, 2007; Christina and Brahmana, 2019; Balasingam, Arumugam and Sanatova, 2019).

Conclusions, contributions, limitations and future research

     Overall, the results of our study show that there is a relationship between personality and audit quality. The PLS-SEM result reveals that agreeableness, conscientiousness and openness are positively associated with professional skepticism of auditors, while conscientiousness and neuroticism negatively affect RAQP. Additionally, configurational analysis has shown that there are different combinations (asymmetric) of personality traits that lead to the same outcomes in audit quality.

      The findings provide important theoretical, practical and policy implications. First, our work shows that personality traits are a driver of audit quality. Audit quality is influenced by contextual factors (Kleinman, Lin and Palmon, 2014), as personality may be influenced by national culture (Church, 2016). Our finding agrees with the conclusions of studies conducted in other countries (e.g., Farag and Elias, 2016), showing that the relationship seems to be indifferent to the country context. Second, we used the ‘Big Five’ taxonomy to structure the dimensions of the auditor personality, a model that has been used more since the 90 s (John et al., 2008), being the grand theory that explains the functioning of the whole individual (McCrae and Costa, 2008a). However, auditing research has used other taxonomies, such as the typeA and type-B personality model. Third, fsQCA method allows exploring the complexity of the characteristics associated with the auditor’s personality, accepting that there is more than one solution to achieve a desired outcome. Moreover, the causal asymmetry finding reveals that the linear causal methods provide limited understanding of the complexity of drivers of audit quality. Personality is a combination of individual traits that interact in a differentiated and complex way with audit quality. To the best of our knowledge, this is a pioneering study in the use of quantitative and qualitative methods in the relationship analysis between personality traits and audit quality. Moreover, the combination of two different statistical methods lends greater robustness and depth to our research. Fourth, the presence of equifinality in the personality and audit quality relationship shows the absence of an optimal audit professional prototype. Individuals are a heterogeneous strategic asset in audit firms (Samagaio and Rodrigues, 2016), being their main production factor. Consequently, the coexistence of persons with different personalities in an audit firm should call for redoubled care in defining policies for hiring and promoting its professionals and in assigning them to the various engagements, particularly those individuals (partners, managers, and seniors) who make the decisions that most influence the quality of the audit report (e.g., sufficiency and adequacy of audit evidence). A decrease in audit quality negatively impacts the prestige and performance of audit firms (Climent-Serrano, Bustos-Contell, Labatut-Serer and Rey-Martí, 2018). Finally, the relationship found between personality and audit quality has implications for policymakers. The Framework for Audit Quality (IAASB, 2014) recognizes that auditors’ characteristics are one of the determinants of audit quality. Our finding suggests that regulators should consider personality in the entry process to the profession and indicators of quality assessment, broadening the range of human capital attributes normally considered (education, knowledge, and experience).

Abstract

Keywords

1. Introduction

2. Goffman’s dramaturgical framework

3. The script

4. Generating a character

5. Research methods

6. Findings

7. Discussion and conclusion

acknowledgements

Appendix A. Development of a typology of impression management (IM) strategies (see Fig. 2)

References

Abstract

To examine how Big Four auditors react to public scrutiny, we explore their evidence at a public inquiry on the Irish banking crisis. We use impression management theory to make sense of this evidence. By extending Goffman to a contemporary auditing context, we mobilize less-researched aspects of his dramaturgical framework. Drawing upon the prior literature, we develop a typology for examining how Big Four auditors impression-manage on a ‘frontstage’. Using meaning-oriented content analysis, we apply our typology to Big Four auditors’ public-inquiry evidence. Our findings indicate that Big Four auditors convey the following four impressions: (1) their hands are clean (i.e., they are not to blame for audit failure); (2) their hands were tied (i.e., they were powerless to prevent audit failure); (3) their work was good; and (4) their intentions are good. We conclude the paper by linking these four impressions to the professional beancounter character, and by considering whether the Big Four’s impression management succeeded in influencing their audience. Identifying impression management by Big Four auditors provides insights into their beliefs, ambitions and concerns, and on how they regard clients, regulators and the general public.

1. Introduction

We examine how Big Four auditors respond to public scrutiny, and how they deploy impression management at a public inquiry. Impression management refers to attempts to control the perceptions of others (Leary & Kowalski, 1990). Organizations impression-manage for many reasons, for example to restore legitimacy after a crisis (Hooghiemstra, 2000), to secure acceptance of controversial changes (Arndt & Bigelow, 2000), and to manipulate perceptions of corporate achievement (Guillamon-Saorin, García Osma, & Jones, 2012). Often, corporate reports serve as the vehicles for organizational impression management (Aerts, 2005; Brennan, Guillamon-Saorin, & Pierce, 2009; Cooper & Slack, 2015; Ogden & Clarke, 2005). Using evidence from a public inquiry, we study how Big Four auditors impression-manage in response to public scrutiny.

Our motivation to study Big Four impression-management stems from recognition of the “wider social and political consequences of impression management [which] include unwarranted support of organizations and their activities by non-financial stakeholders or by society at large” (Brennan & Merkl-Davies, 2013, p. 110). We are especially interested in the impression management activities of Big Four auditors, whose societal impact is not trivial (Flint, 1971). As a state-approved oligopoly, the Big Four operate a closed-product market (Addison & Mueller, 2015), and thus wield considerable economic power among the business elite. Cooper and Robson (2006) highlight their centrality in matters of professionalization and regulation. The Big Four “dominate the global market for the audit of listed companies” (Humphrey, Loft, & Woods, 2009, p. 813). They are larger than many of their listed clients (Malsch & Gendron, 2011). They have also diversified beyond their “core product” of auditing (Detzen & Loehlein, 2018, p. 2043) to activities such as consultancy, mergers and acquisitions, information technology and securitization (Arnold, 2009; Gow & Kells, 2018; Suddaby, Gendron, & Lam, 2009). They fund academic research projects (Gendron, 2000) and advise governments (Cooper & Robson, 2006). They have a global workforce (Detzen & Loehlein, 2018), and their revenues (Rapoport, 2018) and partner salaries (Kinder, 2019) continue to rise.

Over the past 15 years, efforts to stem the wave of financial scandals in large companies have resulted in substantial changes in the regulatory landscape and the way in which financial statement audits are conducted (Humphrey, Kausar, Loft, & Woods, 2011; Knechel, 2013). In many jurisdictions, the development of auditing regulation has moved from a national level to an international level. In addition, there has been a shift in the regulation of auditors from self-regulation by the accountancy profession to substantial oversight by government authorized bodies, coordinated through international networks (Humphrey & Loft, 2013). A fundamental change in audit regulation between 1996 and 2010 was the introduction of risk-based ISAs that required greater documentation of the client’s business risks (Curtis & Turley, 2005; van Buuren, Koch, van Nieuw Amerongen, & Wright, 2014). At the same time, auditing standards became more detailed and prescriptive, and greater emphasis was placed on assessing clients’ risk in terms of operations, internal controls and management fraud. However, the question of whether audits have become more risk-oriented depends on how willing the auditor is to follow the new risk-based standards and how strongly they are enforced. The purpose of this study is to investigate the extent that the new risk standards are reflected in the auditing process. The study is set in Finland which joined the European Union (EU) in 1995. At that time, guidance for auditors and quality checks in Finland were based on voluntary peer review and recommendations provided by professional associations of auditors. However, in 2005, the European Group of Auditors’ Oversight Bodies (EGAOB) was set up by the European Commission to co-ordinate a new public oversight system of statutory auditors and audit firms in EU Member States, which is enforced through a network of national oversight bodies. This was followed in 2006 by the Directive on the Statutory Audits of Annual Accounts and Consolidated Accounts (2006/43/EC).1 This meant that future guidance for auditors would come from International Standards on Auditing (ISA) issued by the International Auditing and Assurance Standards Board (IAASB), the independent standard-setting body of the International Federation of Accountants (IFAC). In addition, the quality checks previously provided by the Finnish accountancy profession were replaced by systematic inspections by a national oversight body, the Auditing Board of the Central Chamber of Commerce (AB3C).

In this activity, you are introduced to the auditor selection process and how indicators of an auditor’s audit quality may influence that process. You will gain an understanding of factors that can affect audit quality and apply that knowledge in a decision-making task – selecting an auditor for Bradco. The CAQ, PCAOB, IAASB, and other entities classify indicators according to how they impact audit quality. By completing the activity, you will learn to delineate how certain inputs (e.g., auditor training) may influence how an audit is conducted and certain outputs (e.g., PCAOB inspection findings) may measure or indicate whether an audit was conducted with an appropriate level of quality. The activity also demonstrates how indicators of audit quality may be used by audit committee members and company management to evaluate and select an auditor.

Introduction

Bradco, Inc. is a publicly-traded builder of custom, single-family homes in Illinois. Home builders like Bradco design and build homes to customers’ specifications.1 Every part of the construction process from pouring the concrete foundation, to cutting and attaching shingles on the roof, is performed at the building site.2 In the current year, Bradco reported revenues of $100 million and had a market value of $125 million. Two years ago, Bradco’s revenues were $35 million and its market value was $40 million. Most of this growth is the result of Bradco’s merger with one of its competitors, consistent with its strategy of increasing market share through acquisitions. To a lesser extent, growth in revenues stems from an increase in demand for homes to replace those that were destroyed or damaged during tornados that hit the Midwest about 27 months ago. Bradco plans to continue its strategy of acquiring other competitor home builders to accelerate its growth. Companies in the residential construction industry face unique accounting issues, such as cost capitalization, accounting for predevelopment costs, estimating projects’ costs-to-complete, and accruals for explicit and implied warranties. Downturns in the economy tend to negatively impact homebuilders ahead of companies in other industries.3 Bradco is not immune to these types of cyclical operating trends. While natural disasters, like the recent tornados, may increase demand for Bradco’s services, they also make it difficult to find building materials at reasonable prices. These issues, and Bradco’s strategy of acquiring competitor businesses, complicate its operations and may have an impact on the quality of its financial statements. The Securities Exchange Act of 1934 requires financial statements of publicly-traded companies (also known as issuers), like Bradco, be audited annually by an independent auditor registered with the Public Company Accounting Oversight Board (PCAOB). Bradco’s long-time auditor, a small public accounting firm with an audit staff of ten CPAs, recently ceased business due to the owner’s retirement. As a result, a new auditor must be hired to conduct Bradco’s annual audit. As required by the Sarbanes-Oxley Act of 2002 (SOX), engaging an external auditor is the responsibility of Bradco’s audit committee, but input from management is not prohibited. Beyond being registered with the PCAOB, the audit committee has established several criteria for engaging the new auditor.

Purpose – The purpose of this paper is to investigate, in an Egyptian context, the external auditor type (Big 4 vs local) implications on reporting quality proxied by discretionary accruals (DA) and also examine whether auditor type impacts the market’s pricing of DA, where pricing is considered a proxy for the perceived DA quality. Design/methodology/approach – The sample period is 2012–2015, that is meant to be post the Egyptian revolution financial crisis; all Egyptian stock exchange (EGX) listed firms (except banks and financial institutions) are considered. DA are estimated using modified Dichev and Dechow’s (2002) model (McNicholas, 2002). Ordinary least squares regression tests are used to investigate the external auditor type implications on DA level and the related EGX investors’ pricing. Findings – The findings generally show the external auditor’s minimal role in mitigating DA. Moreover, the findings reflect the EGX investors’ negligence and/or lack of confidence in regards to DA and external auditor type factors in stock pricing. Practical implications – The paper findings highlight to regulators the need for effective monitoring of audit firms earnings management mitigation performance to help reinforce investor confidence in financial reporting quality. Originality/value – This paper is the first that investigates the external auditor monitoring mechanism implications on investors’ perceptions of earnings quality in Egypt. The paper findings would provide important contributions, particularly post the Egyptian revolution crisis, where the EGX market is trying to restore the investors’ confidence.

Introduction

Over the last two decades, the corporate failings (including Enron, Tyco and WorldCom) have interrogated the public trust in the auditing profession and resulted in increased regulatory scrutiny. For instance, the Sarbanes–Oxley Act (SOX) inaction in 2002, to call for reinforced auditor independence and the formation of Public Company Accounting Oversight Board (PCAOB) to monitor the external audit services quality (Lamoreaux, 2016). The audit market dramatic changes have increased the audit requirements demands (e.g. internal controls systems effectiveness assessment) that resulted in shifting from Big 4 audit firms to local audit firms mainly due to enlarged audit fees (Blokdijk et al., 2006; Rama and Read, 2006; Lawrence et al., 2011; Cassell et al., 2013; Comprix and Huang, 2015). Especially after 2002, local auditors are progressively exposed to higher business risk due to their acceptance of bigger size clients approaching from predecessor Big 4 auditors (Hogan and Martin, 2009). However, clients could be hesitant to engage local audit firms because of the apparent variances in name recognition or reputation, practical competences and industry know-how. Market participants’ prospects or assurance requests (e.g. shareholders, creditors, etc.) could be of major significance in their unwillingness to consider local audit firms (Cullinan et al., 2012). Commonly, literature studies have documented the relative high quality of Big 4 audit firms’ services (e.g. Boone et al., 2009; Samaha and Hegazy, 2010; Rutledge et al., 2014; Comprix and Huang, 2015). However, PCAOB suggested no audit quality differences between Big 4 and local audit firms. The US market research supported the PCAOB’s argument, for example, Lawrence et al. (2011) found that controlling for client’s size diminished the differences in audit quality between Big 4 and local audit firms. Jenkins and Velury (2011) found non-significant difference in conservatism between clients of Big 4 and local auditors in either the pre- or post-SOX periods. Moreover, Boone et al. (2010) did not evidence a significant difference in the performance-adjusted abnormal accruals between the clients of Big 4 and local audit firms. Also, Cassell et al. (2013) showed that the financial reporting credibility of local firms audited clients was indistinguishable from Big 4-audited counterparts. Consistently, Geiger and Rama (2006) documented no discretionary accruals (DA) significant differences between clients of Big 4 and local audit firms. Investigating the stakeholders’ perceptions, Gray and Ratzinger (2010) reported that vs Big 4 firms, stakeholders generally agreed that local firms provided comparable audit quality. Moreover, post the SOX, Kao et al. (2013) investigated whether local auditors have enhanced their ability to resist client pressure over accrual reporting. Regressing abnormal accruals on proxies for economic bonding, they found that changes in the association, defined as (post–pre), were significantly negative, implying local audit firms’ independence improvement. Also, Lai (2013) found that Ex-Andersen clients of non-Big 4 auditors had a higher likelihood of going-concern opinions and lower levels of DA.

INTRODUCTION

PRIOR LITERATURE AND HYPOTHESIS DEVELOPMENT

RESEARCH METHODOLOGY

EMPIRICAL RESULTS

ADDITIONAL ANALYSIS

CONCLUSION

REFERENCES

Abstract

Purpose: the purpose of this paper is to investigate how companies’ reputation affects their selection of auditors.

Introduction

This study investigates how companies’ reputation affects their selection of auditors. Analytical research has demonstrated that reputation plays an important role in determining behavior and the impact of reputation on a player’s actions is referred as the reputation effect or the reputation mechanism (Weigelt and Camerer 1988). Researchers have shown that the reputation mechanism can effectively reduce agency problems and induce behavior that is in the interest of the principal, even without a formal contract (Wilson 1985; Weigelt and Camerer 1988).1 Consistent with this argument, empirical studies provide evidence that reputation concerns affect corporate behavior, motivating management to take actions that provide long-term benefits rather than focusing on actions that only favor short-term interests. Studies have found that high-reputation companies tend to maintain higher earnings quality and enjoy a lower cost of debt and a lower cost of equity capital (Anginer et al. 2011; Cao et al. 2012, 2014). Recent research also documents a positive association between company reputation and firm value (Filbeck and Preece 2003; Anderson and Smith 2006). Despite the increasing interest in company reputation and the growing body of reputation-related research, there has been limited research on the effect of reputation on companies’ financial reporting activities. Cao et al. (2012) document that higherreputation companies tend to maintain higher financial reporting quality. They also examine the channels through which company reputation affects financial reporting quality and find that higher-reputation companies pay higher audit fees. The evidence is consistent with the argument that higher-reputation companies have greater incentives to protect their financial reporting quality and are therefore willing to pay for more audit effort. In light of the prior research, we investigate another channel through which company reputation may affect financial reporting quality, that is, the selection of external auditors. Company reputation may influence auditor choice in two competing ways. On the one hand, reputation concerns motivate high-reputation companies to maintain and signal their high financial reporting quality. As a result, they may demand great levels of audit quality to protect their good reputations. On the other hand, the reputation effect can help reduce agency problems between owners and management and therefore reduce the demand for high-quality auditors to serve as an external monitoring function. Overall, existing theories provide alternative predictions about the effect of company reputation on the demand for high-quality auditors.

A large theoretical and empirical literature examines the role of the accounting information quality (Bushman et al., 2001; Bushman and Smith, 2001; Bagaeva, 2008; Chan et al., 2009; Chan and Lee, 2009; Zhiying et al., 2012; Ran et al., 2015). One line of research (Biddle and Hilary, 2006; McNichols and Stubben, 2008; Biddle et al., 2009; Chen et al., 2011) suggests that higher quality information enables managers to identify better investment opportunities. Several studies also propose that auditor specialization can be used to reduce the information asymmetry problems (Almutairi et al., 2009; DeBoskey et al., 2012; DeBoskey and Jiang, 2012; Yaghoobnezhada et al., 2014): A specialist’s knowledge of the industry can be developed through vast auditing experience, specialized staff training, and large investments in information technology. This industry-specific knowledge allows specialist auditors to provide higher quality audit service by reducing the information asymmetry through their greater ability to detect significant anomalies. Theoretical models (Balsam et al., 2003; Lai, 2011) predict that, despite the limited evidence, a highly acquired audit quality is extremely useful for improving investment efficiencies, especially with respect to overinvestment. Based on these premises, the main purpose of this paper is to combine these two mechanisms and analyze the effect of the accounting information quality (AIQ) and the auditor specialization on investment efficiency.

Recent changes in regulation and audit processes that require new and varying forms of auditor judgment (International Auditing and Assurance Standards Board [IAASB], 2009) underscore the importance of identifying and understanding the unobservable elements that influence audit quality, such as interpersonal affect (Trotman, 2011). Emotion may interact with other variables to influence auditors’ judgments and decisions. This study investigates emotional intelligence (EI), the ability to perceive and manage one’s own and others’ emotions, as a key factor in dealing with pressures in an audit context. Specifically, we extend prior research by investigating the moderating effect of EI on auditor judgments of a hypothetical case wherein an auditor is subject to internal and external pressures. Mayer and Salovey (1997, p. 10) define EI as “the ability to perceive and express emotion, assimilate emotion in thought, understand and reason with emotion, and regulate emotion in the self and others.” Auditors’ judgments may be negatively influenced by interpersonal affect (emotional responses arising from interactions between auditors and clients). Prior research indicates that EI is a predictor of job performance and plays a large role in relieving job stress (Nikolaou & Tsaousis, 2002). Akers and Porter (2003, p. 65) state that “EI skills are critical for the success of the accounting profession.” Therefore, it is critical for auditors to recognize and manage their affective reactions when dealing with clients (Bhattacharjee, Moreno, & Riley, 2012). Moreover, Cianci and Bierstaker (2009) acknowledge the need for auditors to manage their emotions and suggest that future research explores ways in which auditors can be trained to manage their emotions. Job‐related pressures play a significant role in the accounting profession. Prior research indicates that both time budget pressure (e.g., Coram, Ng, & Woodliff, 2003; 2004; McNair, 1991) and client pressure (e.g., Hackenbrack & Nelson, 1996; Moreno & Bhattacharjee, 2003) negatively influence audit judgment. There is a need to improve our understanding of how to mitigate the ill effects of these pressures, such as dysfunctional auditor behaviors and decreased audit quality (Hartmann & Maas, 2010). Therefore, one purpose of this study is to address a gap in the literature by investigating the effect of EI on auditor judgment under various pressures. In particular, we focus on how EI influences the relationship between auditor judgment and two prevalent forms of job pressures: time budget pressure (internal pressure) and client pressure (external pressure). Owing to widespread concern in recent years regarding suspicious accounting practices and dysfunctional audit behaviors in China, Liu and Zhang (2008) argued that time pressure in an auditing context is an increasingly important environmental factor that warrants additional research. Chinese auditors may be especially sensitive to pressures from individuals viewed as superiors due to the high degree of power distance in China (Hofstede, 1993; Zhuang, Thomas, & Miller, 2005).1 Therefore, we conducted an experiment using 173 staff and senior auditors working at auditing firms in China to investigate our research questions.2 This participant group facilitated an investigation of factors which influence dysfunctional auditor behaviors and EI as a potential moderator that can mitigate such behaviors to improve audit quality.

Research on audit quality in the business sector has emerged because the auditor’s profession has been the focus of society in recent years, from Enron (2001), Worldcom (2002), to Adelphia (2002) cases in America. Similarly in Indonesia, Telkom’s case (2003) makes the credibility of auditors increasingly questionable. Public confidence in government accountants is declining due to media scrutiny that questioned the quality of the audit, as some government agencies that received Unqualified Opinion (WTP) opinion were still found to be corrupt in the agency. Research on audit quality is done Carcello et al. (1992) that provides information about audit quality attributes by including those who prepare financial statements and users of financial statements as part of the audit quality attribute, while Behn et al. (1997) conducted a similar study to see whether quality attributes have a direct effect on client satisfaction, Behn et al (1997) found only 6 attributes of 12 attributes studied by Carcello et al. (1992) which has a positive effect on client satisfaction. Widagdo et al. (2002) conducted research on quality audit attributes by the public accounting firm that has an effect on client satisfaction. The results show that there are 7 attributes of audit quality that influence. Another study conducted by Lowensohn et al. (2007) states that auditor industry specialization affects audit quality, Schelker (2009) states that auditor competence through auditor expertise has an effect on audit quality, while Brown and Raghunandan (1995) mention that audit quality in public sector is lower than audit quality In the private sector, low quality of public sector audit due to low litigation risk. To improve the quality of audits in the public sector, the auditor must have the courage to reveal the actual facts. The actual disclosure of facts especially related to finance greatly facilitates the achievement of audit quality, such as Copley (1998) quality audit studies have a positive effect on the disclosure of financial statements in the public sector. An efficient auditor must possess certain general qualities besides statutory qualification, so that he can carry out his work efficiently and smoothly. The qualities of an auditor as classified below. Professional Qualification i.e., Statutory Qualification. Professional Qualities i.e., Personal Qualification. Personal Qualities i.e., General Qualities. The auditor quality is measured by ethics, commitment, independent, competence, and experience. A study conducted by the SEC (Securities and Exchange Commission) states that one of the causes of failure of auditors to detect fraud is the low skeptical level of auditor professionals, of 45 fraud cases studied 24 (60%) of which occurred because the auditor did not apply the skeptical level professionals mamadai (Beasley et al, 2001). From some of the descriptions above shows how important professional and whistleblower skeptics to reveal a cheating. Kee and Knox’s (1970) stated that professional skepticism is influenced by several factors and one of them is ethical bias. While Carpenter et al (2002) states that auditors lacking professional skepticism will lead to decreased audit quality. Chang and Leung (2006) argue that the skepticism and public confidence in the accounting profession is strongly influenced by the professionalism and ethical behavior of the accounting profession itself. Organizational commitment is a condition in which employees are very interested in the goals, values and objectives of the organization. Organizational commitment shows a power of a person in identifying his involvement in an organizational part (Mowday et al 1979).

In the aftermath of corporate scandals and the global fnancial crisis, the role of external auditors and of the internal audit function (IAF) has been critically scrutinized, and consequently, became even more in the focus of attention of external and internal stakeholders such as investors, regulators or corporate boards. Companies are under constant pressure to improve the reliability and accountability of their fnancial information, in order to comply with regulations and to compete efectively for capital in the global business environment. Since there is a certain degree of overlap between the tasks of internal and external auditors, e.g. regarding an evaluation of the efectiveness of internal controls,1 there are many opportunities for coordination and cooperation between the two functions that may yield synergistic outcomes for both sides, such as higher quality audits and economic benefts. On the one hand, external auditors may utilize the experience of the internal auditors to reduce work duplication and, in efect, the cost of the external audit (Stein et  al. 1994; Felix et  al. 2001; Al-Twaijry et  al. 2004; Lin et al. 2011; Pizzini et al. 2015). In addition, internal auditors could help external auditors to understand the company’s internal control system and the level of compliance with it.2 Due to its unique position within a company as a supporting and assuring instrument of the board and the audit committee, the IAF will potentially collaborate with the external auditors, because such collaboration potentially increases the efectiveness as well as the efciency of the external audit and the realisation of such a potential is valuable for a company. On the other hand, internal auditors may beneft from the expertise of external auditors in areas where the internal audit department needs support (Haron et al. 2004; Schneider 2009). In certain situations, an assistance from the external auditors is preferable in comparison to outsourcing or co-sourcing arrangements, because of their particular knowledge and expertise and because additional cost might be avoided. Coordination and cooperation between internal and external auditors might enable the internal auditor to beneft from the external auditors’ exposure to a wider variety of fnancial issues and knowledge about similar businesses or organizations (Fowzia 2010; Endaya 2014). Moreover, it avoids that internal auditors duplicate external auditors’ work, which results in wasted internal audit time. The elimination of redundant work will possibly leave time and resources for better audit coverage (Morrill and Morrill 2003). In addition, the IAF could use the fndings of external auditors to assess risks and to determine areas that need their future attention (Saidin 2010). Mutual communication between internal and external auditors potentially provides the IAF further insights into audit techniques and methods.3 However, it is important to note that a useful cooperation between internal and external auditors does not only require similar audit objectives but also similar audit scopes.