Marjorie K. Shelley

Understanding Audit Quality: Insights from Audit Professionals and Investors

Projects seeking to define, measure, and evaluate audit quality are on the agendas of auditing standards setters as well as audit firms. The Public Company Accounting Oversight Board (PCAOB) currently provides information regarding audit quality through the release of inspection reports, and the Board intends to establish and report audit quality indicators. To provide additional perspective on audit quality, we obtain auditors’ and investors’ views, definitions, and indicators of audit quality. We find that investors’ definitions of audit quality focus more on inputs to the audit process than do auditors’, and that investors view the number of PCAOB deficiencies as an indicator of overall firm quality. We find a consensus that auditor characteristics may be the most important determinants of audit quality, and that restatements may be the most readily available signal of low audit quality. We relate responses to a general audit quality framework, provide support for archival audit research, and identify additional disclosures that participants suggest could signal audit quality. Taken together, we provide evidence regarding the construct of audit quality in the post-SOX environment, evaluate many of the audit quality indicators proposed by the PCAOB, and suggest avenues for future research. Comprendre la qualit e de l’audit : points de vue de professionnels de l’audit et d’investisseurs

Do Director Networks Matter for Financial Reporting Quality? Evidence from Restatements

This study examines the effect of board of director connectedness on financial reporting quality, specifically the misstatement of annual financial statements. Because restatements are costly, it is important to understand whether firms with well-connected directors benefit from better access to the information exchanged through the director network. We examine multiple dimensions of connectedness and find that, after controlling for operating performance and corporate governance characteristics, firms with well-connected directors are less likely to misstate their annual financial statements, even in the presence of a board connection with another misstating firm. In particular, our results indicate that the negative effect on financial reporting quality of board interlocks to misstating firms can be offset by connections to other well-connected directors, by the speed at which directors can access information and by having directors who increase the likelihood of receiving more complete information through the boardroom network. We conduct several tests to address alternative explanations, as well as hold board composition constant to control for endogeneity, and find similar results. Our findings suggest that corporate boards with better-networked directors are less likely to adopt reporting practices that reduce financial reporting quality.

Corporate Transparency, Sustainable Tax Strategies, and Uncertain Tax Activities

We investigate whether the sustainability of firms’ tax strategies is associated with corporate transparency. We expect and find that firms with sustainable tax strategies are associated with more transparent information environments. Prior research shows that transparency is associated with better governance; we expect better governed firms to engage in more sustainable tax strategies and we find that firms with more sustainable tax strategies exhibit significantly higher return on assets, free cash flows and cash flows from operations, and higher Altman’s Z-Scores. We also find that the likelihood of engaging in uncertain tax activities is negatively related to both transparency and tax strategy sustainability. Finally, we find that firms with lower transparency record higher unrecognized tax benefits. These relationships are important because a firm’s degree of transparency significantly affects capital costs and value, and relying on the assumption that tax planning investments lead to more obscure information environments can be costly.

The Effects of Analysts’ Access to Management’s Private Information and the Precision of Publicly Available Information on Analyst Forecast Accuracy

We posit and find that the importance of analyst and forecast characteristics for analyst forecast accuracy varies with analysts’ access to management’s private information and with the precision of publicly available information. In particular, more experienced analysts and All-Star analysts do not maintain their superior forecast accuracy and analysts employed by large brokerage houses perform even worse than other analysts following the enactment of Regulation Fair Disclosure (Reg FD). In addition, we find a decrease in the importance of effort, the number of industries and firms followed, days elapsed since the last forecast, forecast horizon, and forecast boldness post-Reg FD. The decrease in the importance of most of these characteristics is greater when the precision of publicly available information is low. Our results suggest that the positive effects of experience, effort, brokerage house size, All-Star status for forecast accuracy pre-Reg FD were due to the information advantage these analysts enjoyed, rather than their ability to generate private information. In contrast, following the enactment of Reg FD, the importance of prior forecast accuracy increases and this increase is even greater when the precision of publicly available information is low. This suggests that prior forecast accuracy is related to analysts’ ability to generate private information. Because prior evidence suggests that investors consider analyst and forecast characteristics when they evaluate the relevance of analyst forecasts, our findings can help investors to better assess and use the information in analyst forecasts.