Lasse Niemi

Determinants of Auditor Choice: Evidence from a Small Client Market

This paper analyzes the auditor choices for a sample of 2,333 predominantly small and mid-sized Finnish firms. Finland requires virtually all commercial enterprises to have a financial statement audit, but allows the smallest firms to choose from four types of audit firms: first tier international firms, first tier national firms, second tier local auditors and non-certified auditors. We find that among the smallest firms, the choice to hire a certified auditor relates to the level of complexity in the organization as measured by size and extent of workforce. For firms that must use a certified auditor, we find that the choice between a first tier and second tier firm is related to size, the extent of debt financing, and complexity associated with being a member of an associated group. Finally, in the upper end of the market, the decision to hire a large international firm relates to size, the need for financing, be it equity or debt, and complexity due to a broad labour force. This pattern is interesting because it indicates that the need for a higher quality auditor is driven first by complexity, then as the firm grows, it is supplemented by the use of debt financing and ultimately by the need to raise equity as well as debt financing.

Auditor Size and Audit Pricing: Evidence from Small Audit Firms

In a competitive market, audit prices can vary if the clients believe that the quality of audits varies. Previous research links auditor independence, a key element of audit quality, to auditor size and consequently suggests a positive association between audit quality and auditor size. Moreover, by using the dichotomy approach (Big Five/non-Big Five), numerous studies in many countries have found that the largest audit firms with international reputations earn fee premiums due to their perceived higher quality. Little is known, however, about pricing differences arising from product differentiation among small audit firms. This study examines the relation between auditor size and audit prices by using the data on hourly billing rates and the auditor characteristics from 103 small Finnish audit firms. This study documents, after controlling for the auditors technical capability, the positive association between auditor size and audit pricing. The results suggest that both size and technical capability have a positive impact on auditor remuneration, implying that product differentiation also takes place among these small audit firms.

Empirical Evidence on the Implicit Determinants of Compensation in Big 4 Audit Partnerships

This study investigates the implicit financial incentives of individual Big 4 audit partners by examining the association between a partners compensation and characteristics of the audit firm, audit partner, and individual partner clientele for Big 4 firms in Sweden. Using tax and financial data for individual audit partners and clients, our empirical findings indicate that there is significant variation in the implicit determinants that are associated with compensation across the Big 4. We find that audit partners’ compensation is positively associated with the size of their clientele or the number of publicly traded clients, both of which represent revenue-generating opportunities. Similarly, compensation and developing an industry specialization are positively related. In three firms, gaining clients is clearly related to an increase in compensation, while losing a client is associated with a reduction in partner income in only one firm. We find that audit partner income is more sensitive to performance-related incentives, such as attracting new clients, as partners progress in their career. Finally, we find evidence that audit failures, proxied by reporting errors related to issuing a going concern opinion, are associated with lower compensation. These results should be of interest to the auditing profession, audit firms, and regulators when they consider the effects of implicit incentives of partner compensation on audit quality.

Do Joint Audits Improve Audit Quality? Evidence from Voluntary Joint Audits

This study examines whether the decision to voluntarily (i.e. without a statutory obligation) employ two audit firms to conduct a joint audit is related to audit quality. We use separate samples and empirical designs for public and privately held companies in Sweden, where a sufficient number of companies have a joint audit on a voluntary basis. Our empirical findings suggest that companies opting to employ joint audits have a higher degree of earnings conservatism, lower abnormal accruals, better credit ratings and lower perceived risk of becoming insolvent within the next year than other firms. These findings are robust to the use of a propensity score matching technique to control for the differences in client characteristics between firms that employ joint audits and those that use single Big 4 auditors (i.e. auditor self-selection). We also find evidence that the choice of a joint audit is associated with substantial increases in the fees paid by the client firm, suggesting a higher perceived level of quality. Collectively, our analyses support the view that voluntary joint audits are positively associated with audit quality in a relatively low litigious setting both for public and private firms.

Drivers of Voluntary Audit in Finland: To Be or Not to Be Audited?

This paper examines factors affecting the owner-managers voluntary decision to hire an auditor in small firms. Using a random sample of 412 small private companies in Finland responding to an Internet survey, we first probe the institutional boundaries of a prior UK study [Collis, J., Jarvis, R., and Skerratt, L., 2004. The demand for the audit in small companies in the UK. Accounting and business research, 34 (2), 87–100] and conclude that its main findings can be generalised to a different regulatory setting (Finland) typical of many Continental European countries. Second, we broaden the prior research by testing new hypotheses regarding the drivers of an audit among small companies. We hypothesise and find evidence that outsourcing of critical accounting functions creates information asymmetry between the owner-manager and the external accountant, which may arouse the need for monitoring the external accountant through a voluntary audit. In addition, we find, as hypothesised, that tax advisory services provided by the external accountant reduce the likelihood of a voluntary audit. Moreover, we hypothesise that receiving a qualified opinion from the auditor reduces the likelihood of hiring an auditor voluntarily, whereas firms experiencing financial distress would be more willing to have their financial statements audited. We find evidence consistent with these hypotheses.

Are Modified Audit Opinions Related to the Availability of Credit? Evidence from Finnish SMEs

We study the association between credit availability and modified audit opinions using a sample of more than 50,000 observations for small- and medium-sized companies. Studies in finance suggest that companies use trade-credit as a source of financing when institutional debt is not available (e.g. Petersen and Rajan, 1994; Danielsson and Scott, 2004). Building on these studies, we study whether modified audit opinions are associated with an increased use of trade credit relative to bank debt. We find no association between modified audit opinions and our measure of credit rationing. Our archival evidence focusing on SMEs is contrary to much of the earlier research finding that modified audit opinions provide incremental information for lenders. Our study adds to the scarce literature on the role of audit reports as a source of information in SME finance.

Responsiveness of Auditors to the Audit Risk Standards: Unique Evidence from Big 4 Audit Firms

Abstract We examine the effect of changes in audit risk standards on the conduct of financial statement audits in a European setting. We investigate this by analysing the audit hours and audit fees for clients of Big 4 audit firms in Finland in 1996 and 2010. Our results show that audit firms became more sensitive to clients’ business risk due to the introduction of the new audit risk standards, with more audit hours allocated to owner-managed companies in 2010 than in 1996, and fewer audit hours allocated to low-risk clients in 2010 than in 1996. Also, the labour mix in the audit team changed for owner-managed companies, with a greater work load carried by junior auditors in 2010 than in 1996. Regarding the price of audit, we find an increase in audit fees for clients with high business risk, while audit fees remained at roughly the same level for low-risk clients. These findings should be of interest to the auditing profession and those involved in the development of auditing regulations.

What Turns the Taxman On? The Effect of Tax Aggressiveness and Voluntary Audit on Adjustments to the Tax Returns of Private Companies

Using a large proprietary data set from the internal records of the Finnish Tax Administration for the fiscal year 2011, we examine the factors that trigger adjustments by the tax authority to the taxable income reported by around 25,000 small private companies. Using that data, we develop a new direct measure of tax aggressiveness and introduce the direct and indirect effects of external audit into the tax aggressiveness literature, whilst avoiding the classic endogeneity problem. We hypothesize and find that being tax aggressive increases the likelihood of the tax authority not accepting taxable income as reported, whereas having a voluntary audit with an unqualified audit opinion decreases it. We also find that an unqualified audit opinion moderates the positive effect of tax aggressiveness on the likelihood of the tax authority making adjustments. While these findings are statistically significant when tax aggressiveness is measured by the book-tax difference (non-taxable revenues less non-tax deductible expenses) reported in the company’s tax return, they are insignificant when measured by the conventional metric of book-tax difference based on publicly available financial statement data. The main results are insensitive to whether the full sample is used or a balanced sample based on propensity score pairing of tax-adjusted firms with their non-adjusted counterparts. The robustness tests show that our results are qualitatively unaffected by the modifications made to the variable definitions and sample composition.

Why Do Owner-Managers of Micro-Companies Opt for Voluntary Audits? The Importance of Debt Providers’ versus Entrepreneurs’ Needs

This study investigates the extent to which the pressures from outside stakeholders, specifically the providers of debt and trade credit, as opposed to owner-managers’ internal needs explain the use of voluntary audits in micro-companies. Whereas previous studies have mainly focused on how bank debt affects the demand for voluntary audit in small and medium-sized enterprises (SMEs), micro-companies have largely been overlooked in related prior literature. Using a sample of some 50,000 Finnish micro-companies over the period 2008-2010, we find that voluntary audit is expectedly more likely in micro-companies which have above average levels of trade credit or bank finance than those relying on owner’s equity. Surprisingly, the results also indicate that a very significant proportion of companies (26 percent) relying on owner’s equity only also choose voluntary audit. Interview data provide insights into the reasons hereof and confirm the benefits of audit in reducing control risk and business risk for management.