Jayanthi Krishnan

The Role of Economic Trade-Offs in the Audit Opinion Decision: An Empirical Analysis

We extend existing audit opinion models by incorporating economic tradeoffs that arise in the auditors qualification (modification) decision. Prior qualification studies (e.g., Dopuch, Holthausen, and Leftwich [1987]; Bell and Tabor [1991]) do not investigate whether the opinion issued is influenced by particular trade-offs facing an auditor. On the one hand, the audit firm faces the risk of losing the client if it issues a qualification, and on the other, failing to qualify exposes the auditor to lawsuits and reputation loss. We model the auditors qualification decision as a two-stage model. We estimate a bivariate model that breaks down the probability of qualifying into two components: (1) the probability that the client deserves a qualified opinion based on the audit and (2) the probability that the auditor reports a qualified opinion, given the auditor considers that the client deserves such an opinion. We hypothesize that the second-stage decision to qualify or not is influenced by factors such as the auditors risk of litigation, the type (Big Six or not) of auditor, the extent of outsider ownership, the share of public debt in total debt, the relative importance of the client in the auditors portfolio, and the future growth rate of the client. Our results indicate that the auditors litigation risk, the extent of outsider ownership, the relative importance of the client in the auditors portfolio, and future growth are important factors in the audit opinion decision. Estimated mean and median probabilities indicate significantly higher values of reporting probabilities for qualified as compared to unqualified firms, suggesting that the second stage is an important component of the qualification decision.

The Simultaneous Relation between Auditor Switching and Audit Opinion: An Empirical Analysis

Previous studies examining the relation between the audit opinion and auditor switching assume a one-way causation, with the issuance of a qualified opinion triggering a switch. However, analytical studies dealing with auditor independence issues (e.g., Magee and Tseng, 1990; Dye, 1991; Teoh, 1992) suggest an opposite causation, in which the auditor is less likely to qualify the opinion for a client who may switch auditors. Some evidence of an opposite causation is provided by Krishnan (1994), who finds that auditors treat switchers more conservatively (relative to non-switchers) in issuing the audit opinion. The causation between switching and the audit opinion is clearly important for policy decisions regarding both opinion shopping and auditor independence. In this paper, we test the two-way causation hypothesis and find evidence in support of a two-way causation. Our simultaneity-adjusted estimates confirm previous findings of a positive effect of a qualified opinion on switching (Chow and Rice, 1982; Craswell, 1988; Citron and Taffier, 1992). However, we find in addition that auditors are more likely to issue qualified opinions to switchers. This finding does not support the analytical studies cited earlier.

THE WEALTH MOBILITY OF MEN AND WOMEN DURING THE 1960s AND 1970s

Research on poverty and inequality is dominated by cross-section studies that are useful but disguise change over time. Investigation of change requires longitudinal data, which are relatively rare and expensive. This paper researches wealth mobility in a national sample of 4,255 households monitored in the National Longitudinal Surveys of Older Men and of Mature Women from the mid-1960s to the mid-1970s. Our measure of wealth is net family assets, excluding automobiles. We present descriptive measures and estimate econometric models of mobility, including persistence in the lower and the upper end of the wealth distribution, and movement into the upper and the lower end of the wealth distribution. The results place inequality measures in perspective and shed light on mechanisms that influence household wealth mobility. The gainers were farmers and those with skilled jobs or high levels of education, while groups that fell behind included single people, blacks, and families disrupted by divorce or death of a spouse.

Client Industry Competition and Auditor Industry Concentration

This study examines the association between auditor concentration and intra-industry competition in the client industry. It has been suggested that competition within the client industry may cause some firms to seek auditors that are not associated with their competitors, due to concerns of loss of proprietary information. Prior studies (Kwon 1996; Hogan and Jeter 1999) examining the association between auditor industry concentration and client industry competition have yielded opposite results. I attempt to reconcile these conflicting findings by using an additional measure of client industry competition (i.e., the speed of adjustment of abnormal profits) and by controlling for industry size. My results indicate that auditor industry concentration is negatively associated with the degree of competition within the client industry, regardless of the measure of auditor industry concentration used. Thus, although the average level of auditor industry concentration is generally high, there is some evidence that a more competitive industry has lower auditor concentration. One implication of this result is that involuntary audit market changes (e.g., Andersens demise) that reduce the number of audit firms available, may counter some of the effect of client industry competition in limiting auditor industry concentration.

Quality upgrading and restrictive hiring practices in unionized jobs

Most previous work has suggested that unionized employers upgrade labor quality of new hires, but has been silent on the behavior of unions when they control hiring. In this paper, it is argued that unions also have the incentive to upgrade quality, but to an extent less than or equal to upgrading by employers. Empirical support for this argument is provided using data from the National Longitudinal Surveys of young men and young women, in conjunction with an industry measure of union control over hiring. Years of schooling and worker IQ measure labor quality.