Gopal V. Krishnan

Does the SOX Definition of an Accounting Expert Matter? the Association between Audit Committee Directors' Accounting Expertise and Accounting Conservatism

The Sarbanes-Oxley Act mandates the disclosure of whether at least one member of the audit committee is a financial expert. However, the final version of the rule adopted by the SEC defined experts to include both accounting and non-accounting experts. Did the SEC do the right thing? Are the non-accounting experts just as competent as the accounting experts in enhancing the quality of financial reporting? For a sample of S&P 500 firms we examine whether the audit committees financial expertise is associated with accounting conservatism, a fundamental characteristic of financial reporting. Our results suggest that an audit committees financial expertise is positively associated with conservatism when financial expertise is defined to include only accounting experts. Our findings are consistent with the notion that accounting expertise contributes to greater monitoring by the members of the audit committee which in turn enhances conservatism. However, this finding is conditional upon the firms overall corporate governance, i.e., in weak boards accounting financial expertise is ineffective in promoting conservative accounting. Our findings have implications for regulators, corporate boards, and the accounting profession. Our findings are also relevant to regulators in other countries who are considering adopting measures to enhance corporate governance, particularly the effectiveness of the audit committees.

Do Models of Discretionary Accruals Detect Actual Cases of Fraudulent and Restated Earnings? An Empirical Evaluation

We examine the association between the existence and the magnitude of a fraudulent event that overstated earnings, non-fraudulent restatements of financial statements, and nine competing models of discretionary accruals, accrual estimation errors (Dechow and Dichev 2002 and McNichols 2002), and the Beneish (1997 and 1999) M-score. We use the size of the downward earnings restatement following the discovery of the fraud to proxy for the degree of discretion exercised to perpetrate the fraud. We find that the accrual estimation errors exhibit the strongest association with the existence and the magnitude of fraud and non-fraud restatements. Further, our results suggest that total accruals could be a low-cost alternative to many commonly used measures of discretionary accruals in detecting smaller fraud. The accrual estimation errors have incremental explanatory power over total accruals for both smaller and larger frauds.

Further evidence on knowledge spillover and the joint determination of audit and non‐audit fees

Purpose - For more than 25 years auditing research has examined whether knowledge spillovers or synergies exist from the joint provision of audit and non-audit services as well as whether the audit client benefits from knowledge spillovers. However, empirical evidence on knowledge spillover remains mixed and elusive. This article seeks to contribute to this debate, using a large sample covering both the pre- and the post-Sarbanes-Oxley Act (SOX) era. A post-SOX focus can be potentially informative because SOX has fundamentally changed the mix of audit and non-audit services that can be offered to audit clients. Design/methodology/approach - A two-stage least squares regression model is used to control for simultaneous bias due to the joint determination of audit and non-audit fees. A panel dataset is also used. Findings - A strong and significant negative relationship is found between audit fees and non-audit fees. The results suggest that knowledge spillover flows from non-audit to the audit side, as well as from the audit side to the non-audit side. For the overall sample, a 1 percent increase in non-audit fees is associated with a 0.59 percent decrease in audit fees. Similarly, a 1 percent increase in audit fees is associated with a 0.49 percent decrease in non-audit fees. Research limitations/implications - Though a comprehensive set of determinants of audit and non-audit fees is used, it is possible that the model may not include some other unknown determinants of fees paid to auditors. Practical implications - The study contributes to the debate on whether regulators should ban all non-audit services. It is found that when the same audit firm performs both audit and non-audit services, there are synergies, i.e. insight learned from performing one function helps the other. Social implications - At the economy level, the findings suggest that cost savings, due to knowledge spillover, are partly passed on to the clients, particularly by Big 4 auditors. Originality/value - The findings on the existence of knowledge spillover in the post-SOX era are potentially informative to regulators, auditors, audit clients, and audit committee members.

How Do Auditors Perceive Recognized vs. Disclosed Lease and Pension Obligations? Evidence from Fees and Going‐Concern Opinions

We examine the auditor perception of recognized vs. disclosed obligations as they relate to two key decisions auditors make: determining audit fees and whether to issue a going‐concern opinion. We study two pairs of obligations – capital leases and operating leases and on‐balance sheet and off‐balance sheet pension obligations. We find that operating leases are positively and significantly associated with audit fees but not capital leases. We also find that on‐balance sheet and off‐balance sheet pension obligations have a similar association with audit fees. For going‐concern decisions, auditors regard off‐balance leases as real liabilities. However, pension obligations (both on‐ and off‐balance sheet) are not associated with going‐concern decisions. Overall, the findings shed light on how auditors regard recognized vs. disclosed obligations in their decisions that are communicated to capital market participants.

Venture Capital Financing and the Informativeness of EarningsManagerial Shareholding and Compensation Structure, Investment Opportunities and Non-Audit Service Purchases: An Alternative Explanation

The rise of fees paid to incumbent auditors for non-audit services (NAS) relative to audit fees has been actively debated by the accounting profession, investors, and regulators. Although accounting firms are banned by the Sarbanes-Oxley Act from providing non-auditing services to their auditees, the debate is far from over. Despite the negative publicity generated by NAS purchases, why do managers continue to purchase increasing quantities of NAS? We contribute to this debate by offering an alternative explanation on determinants of NAS purchase decisions. We find that (1) the association between NAS purchases and earnings management documented in extant literature is affected by the way top managers are compensated and by managers shareholdings, and (2) NAS purchases are positively associated with the proportion of performance-based compensation paid to the top five executives and this association is more pronounced for firms with high investment opportunities.