Donghui Wu

Is the Effect of Industry Expertise on Audit Pricing an Office-Level or a Partner-Level Phenomenon?

Several studies report an audit fee premium for auditor industry expertise measured at the office level. We extend this line of research by examining whether there is a fee premium for auditor industry expertise measured at the partner level. Using Australian data, we show that the coefficient for partner-level industry expertise is highly significant and economically important. This is consistent with industry knowledge or expertise residing in the human capital of individual engagement partners. Inconsistent with prior research, we show that there is no auditor industry expertise fee premium at the audit office level when partner-level expertise is controlled for. Consistent with prior research, we find little evidence of a fee premium at the national level. The results suggest that the auditor industry expertise fee premium is mainly a partner-level phenomenon, casting doubt on the belief that industry knowledge or expertise is distributed across engagement partners within an audit office.

What is the Relationship Between Audit Partner Busyness and Audit Quality

Contemporaneous studies generally find a negative relationship between audit partner busyness (APB), measured as the number of clients in an audit partners portfolio, and audit quality. Their argument is that a busy partner does not devote sufficient time to properly audit his average client. Contrary to these studies, we argue that when busyness is optimally chosen by the partner, in equilibrium, there is no causal relationship between APB and audit quality. Using Australian data for the 1999–2010 period, we show that APB is not reliably linked to audit quality, consistent with this equilibrium theory. We argue that causality can be ascribed to the APB-audit quality relationship when accounting scandals exogenously shocked the Australian audit market during the 2002–04 period and APB likely deviated from optimum levels. Supporting this disequilibrium view, we find that higher APB reduces a partners propensity to issue first-time going-concern opinions during this period. Our evidence highlights the importance of the equilibrium condition in testing empirical associations between audit outcomes and endogenous auditor attributes, and shows that the detrimental effect of APB on audit quality is not as pervasive as contemporaneous studies suggest.

Network Analysis of Audit Partner Rotation

Although mandatory audit partner rotation has become prevalent worldwide, prior empirical research seldom considers how the successor partners are identified and the economic consequences of different rotation strategies. We examine the importance of internal networks to the selection of successor partners and the underlying incentives in the selection process in China, which affords an opportune testing ground for analyzing our research questions. We find that candidate partners who are familiar with the incumbents—evident in prior teamwork experience—are more likely to be selected as successors. Consistent with expectations, this phenomenon is more pronounced when the engagement information is more complex, alternative channels to transfer client information to the successor are not available, and the engagement is more attractive. These results are consistent with auditors’ incentive to facilitate information transfer and maintain client satisfaction after the transition. Reinforcing this interpretation, we find that post-rotation audit quality improves and clients are less likely to switch audit firms after the rotation when the successor partner is familiar with the incumbent. Enriching our understanding of the production of audit services in audit firms, our analysis contributes to the public policy discourse on partner rotation.

When Auditors Say 'No', Does the Market Listen?

Previous research on whether the market responds to auditors’ opinions has provided mixed results. We revisit this issue in China, where the stock market is dominated by individual investors who are less sophisticated in assimilating value-relevant information such as modified audit opinions (MAOs). In addition, China permits audit modifications triggered by violations of the generally accepted accounting principles (GAAP) or disclosure rules (GAAP/DISC MAOs), which are subtler than going concern opinions (GCOs) in their value implications and thus are more likely to be mispriced. The Chinese stock market thus gives us the best chance of detecting MAO mispricing. We find that MAOs predict firms’ future financial performance, and that the market reaction during the short window around MAO disclosure is also consistent with such predictive power of MAOs. Importantly, MAO disclosure is not followed by negative long-term stock returns, suggesting that stock price adjustments to MAOs are speedy and unbiased. These findings hold for both GCOs and GAAP/DISC MAOs. Together, our findings support the informativeness of audit opinions and cast doubt on the argument that investors inefficiently use this important information in pricing securities due to information processing bias.

The Political Dynamics of Corporate Tax Avoidance: The Chinese Experience

One institutional feature behind China’s spectacular economic growth is its political selection system, which it uses to promote officials who are capable of growing local economies. Against this backdrop, we examine how political turnovers cyclically influence firms’ tax avoidance behavior. Consistent with the prediction that newly appointed local leaders tend to collect more taxes to expand fiscal expenditures and boost local economies, we find that state-owned enterprises (SOEs) decrease their tax avoidance behavior after new leaders take office. However, this finding does not hold for non-SOEs. Our analyses also reveal that the political turnover effect on SOEs’ tax positions is stronger when the incoming leaders have more political clout to command favors from SOEs, managers’ incentives to divert resources are stronger, or politician-manager networks are more likely to work. Furthermore, SOEs that undertake less aggressive tax positions following turnovers receive more government subsidies in the future. Overall, our findings suggest that political incentives shape the tax planning activities of local SOEs in a “two-way favor exchange” manner.