Joseph V. Carcello

Client size, auditor specialization and fraudulent financial reporting

This study examines the effect that client size has on the relation between industry‐specialist auditors and fraudulent financial reporting. Most of the major accounting firms have organized their audit practices along industry lines, reflecting a belief that industry specialization leads to higher quality audits. Furthermore, regulatory bodies and extant research suggests that larger clients have greater bargaining power and are more likely to be able to convince the auditor to acquiesce to aggressive accounting. Also, it may be more difficult for an auditor to possess industry expertise for larger clients who are likely to be more complex and operate in more than one industry. Consistent with previous research, we generally find a significant negative relation between auditor industry specialization and client financial fraud. Also, as expected, the negative relation between auditor industry specialization and financial fraud is weaker for larger clients. This study provides evidence that the positive benefits of auditor industry specialization in deterring financial fraud is affected by client size.

CEO Involvement in Selecting Board Members, Audit Committee Effectiveness, and Restatements

Research finds independent audit committees and audit committee financial experts are generally effective in monitoring the financial reporting and auditing processes. However, not all audit committees that appear in form to be independent are in fact actually independent, and not all financial experts with similar backgrounds and credentials are equally effective. CEO involvement in the board selection process can affect whether an audit committee substantively functions as an independent one. We use financial statement restatements to examine whether the benefits of having an independent and expert audit committee are diminished, or even eliminated, when the CEO is involved in the selection of board members. Our results provide some evidence that the monitoring benefits of having an independent and expert audit committee are only maintained when the CEO is not formally involved in selecting board members, although our proxy for CEO involvement in the director selection process is likely subject to some measurement error. Further, we find that these results appear to be driven by the more severe restatements, including misstatements in conjunction with fraudulent financial reporting. In addition, we find that our results continue to apply in the post-SOX period, a period where we have a more exact measure of CEO involvement in the director selection process. Finally, we find that the stock market’s negative reaction to a restatement is mitigated only when the audit committee is independent and the CEO was not involved in selecting board members.

Audit Committee Financial Expertise, Competing Corporate Governance Mechanisms, and Earnings Management

A prime objective of the Sarbanes-Oxley Act and recent changes to stock exchange listing standards is to improve the quality of financial reporting. We examine the associations between audit committee financial expertise and alternate corporate governance mechanisms and earnings management. We find that both accounting and certain types of non-accounting financial expertise reduce earnings management for firms with weak alternate corporate governance mechanisms, but that independent audit committee members with financial expertise are most effective in mitigating earnings management. Importantly we find that alternate corporate governance mechanisms are an effective substitute for audit committee financial expertise in constraining earnings management. Finally, we find either no association or a positive association between financial expertise and real earnings management. Our results suggest that alternate governance approaches are equally effective in improving the quality of financial reporting, and that firms should have the flexibility to design the particular set of governance mechanisms that best fit their unique situations.

Audit Committee Independence and Disclosure: choice for financially distressed firms

This study examines the relation between audit committee independence and disclosure choice for financially distressed US firms. The tenor of both the financial statement notes and Management Discussion and Analysis (MD&A) is considered. For firms experiencing financial distress, there is a significant positive relation between the percentage of affiliated directors on the audit committee and the optimism of the going-concern discussion in both the notes and the MD&A. These results add to the growing body of literature documenting a relation between audit committee independence and financial reporting quality.

Should You Offer a Job to Your External Auditor

Companies searching for senior executive talent often lure partners from the firms that perform their annual audits. But this can be risky, warn the authors. Is it worth it? How can you manage those risks?

An analysis of multinational “audit failures”

Abstract The shift toward multinational corporations has exposed the auditor to many risks not found on domestic audits, including foreign currency issues, international political risks, international economic risks, greater information asymmetry, and greater complexity. As the client base of the large accounting firms becomes more multinational, it is important to understand whether multinational risk factors are associated with “audit failures.” We identified only eight multinational audit failures (multinational client bankruptcy shortly after an unmodified audit opinion) from the period 1988–1992. An examination of these eight failures provided very little evidence that multinational risk factors played any role in the failures.

Auditors’ Reporting Options and Client Disclosure Quality

ABSTRACT Auditors, legislators, and others have recently suggested that audit-reporting options be expanded so as to provide better information about expected future events. However, the last action by the Auditing Standards Board (ASB) related to auditor reporting was to reduce the reporting options available to the auditor. In this paper, we examine if the quality of footnote disclosures about pending litigation related loss contingencies deteriorated after SAS No. 79 removed the option available to auditors to issue a modified audit report for uncertainties. We find that there is no difference in the quality of disclosures in periods before and after SAS No. 79 became effective. Our results indicate that reducing reporting options did not have an adverse effect on the quality of financial statement disclosures.