Monika Causholli

Audit Firm Tenure, Non‐Audit Services, and Internal Assessments of Audit Quality

We use data from internal assessments of audit quality in a Big 4 firm to investigate the impact of audit firm tenure and auditor-provided non-audit services (NAS) on audit quality. We find that first-year audits receive lower assessments of audit quality and that quality improves shortly thereafter and then declines as tenure becomes very long. Partitioning our sample between SEC registrants and private clients, we find that the decline in audit quality in the long tenure range is attributable to audits of private clients. For audits of SEC registrants, the probability of a high quality audit reaches its maximum with very long tenure. We also find that audit fees are discounted for first-year audits but auditor effort is higher than in subsequent years. We find no association, on average, between total NAS fees and audit quality in the full sample but observe that total NAS fees are positively associated with quality for SEC registrants and negatively associated with quality for privately held clients. Our findings are important for regulatory policies related to audit firm tenure and auditor-provided NAS.

Future Nonaudit Service Fees and Audit Quality

Prior to the Sarbanes�Oxley Act of 2002, audit partners experienced economic pressure to grow revenue from the sale of nonaudit services to their audit clients. To an auditor who is highly rewarded for revenue generation and growth, nonaudit services may represent a particularly strengthened economic bond with the client. Prior research shows that, in general, nonaudit service fees received in the current period do not impair audit quality. We examine a different setting. We propose that auditor independence can become impaired, and audit quality compromised, when clients that currently purchase relatively low amounts of nonaudit services, increase their purchases of nonaudit services from the auditor in the subsequent period. We test our prediction in the context of earnings management as a proxy for audit quality, measured by (a) performance-adjusted discretionary accruals and (b) classification shifting of core expenses. Our results indicate that prior to the Sarbanes-Oxley Act, rewards to the auditor in the form of future additional nonaudit service fees from current-year high fee-growth-opportunity clients adversely affects audit quality. This effect is particularly strong among companies with powerful incentives to manage earnings. Our findings indicate that regulators should consider the multiperiod nature of the client�auditor relationship when contemplating policies that restrict nonaudit services, as well as the overall environment in which audit partners operate. This might include partner compensation arrangements that put pressure on audit partners to focus on increasing revenue at the expense of audit quality.

Competitive Procurement of Auditing Services with Limited Information

We analyse the auditing procurement process when the client is initially uncertain about her/her auditing needs and when she/he cannot discern the level of assurance provided by the auditor. The clients limited information can lead to under-auditing and substantial rent for auditors, despite the presence of ex ante competition among auditors. The information asymmetry can also make it difficult for new auditors with superior auditing technologies to displace incumbent auditors. In addition, the asymmetry can limit the incentives of auditors to improve their technologies.

Lending relationships, auditor quality and debt costs

Purpose - The purpose of this paper is to examine the circumstances under which high quality audits reduce a firms cost of debt. The paper extends previous research by Pittman and Fortin by considering how auditor quality relates to the capital cycle and industry of the firm. Design/methodology/approach - The paper uses a sample of US initial public offerings (IPOs) from 1986 to 1998 to analyze a firms debt costs for the five years following the IPO. The paper uses a firms private age as a proxy for its capital cycle and existing banking relationships to capture the likely extent of debt dependence prior to IPO. The authors separately analyze technology firms from other firms. Findings - Consistent with prior literature, it is found that firms that are young at the time of an IPO pay higher interest rates and auditor quality plays a significant role in lowering the cost of debt financing. Consistent with the hypotheses made, the authors also observe that the effect of auditor quality is larger for firms in the high tech industry sector. Further, the relationship between auditor quality and age depends on industry, with the benefits of hiring a high quality auditor primarily accruing to younger tech firms and older non-tech firms. Originality/value - While the issue of auditor quality and cost of debt has been examined by previous researchers, the additional insight that the effect of auditor quality depends on both capital cycle (age) and industry of a firm, increases understanding of the circumstances under which the audit of financial statements is socially desirable and economically valuable to investors and other stakeholders.

Industry Specific and Task Specific Auditing Expertise: The Case of Goodwill Impairment

There is growing interest among academics and auditing regulators on the role of auditing on the quality of accounting estimates including goodwill impairment. Prior research shows that managers exercise discretion when recording goodwill impairment by either delaying the decision to record the impairment, and/or understating the amount of impairment leading to overstatement of earnings. This study examines how auditor industry expertise, measured as within-industry market share, and task specific expertise, measured as the extent of auditor’s prior experience with goodwill impairment, mitigates managerial discretion. We find no evidence of an association between industry expertise and goodwill impairment. We find that task specific expertise reduces managerial discretion related to the impairment. Specifically, prior experience with goodwill impairment is positively associated with both the likelihood of recording impairment loss as well as the amount of impairment. Our findings have implications for ongoing discussions about auditor characteristics affecting the quality of accounting estimates.

The Ties that Bind: Knowledge-Sharing Networks and Auditor Job Performance

The dissemination of knowledge in audit firms is a critical process that has gone relatively unexamined by researchers. Using social network analysis to quantify the knowledge-seeking networks in a Big 4 audit firm in the U.S., we examine the association between the types and patterns of knowledge-seeking ties and individual auditor performance. Our initial finding is that auditor job performance is negatively associated with the number of knowledge-seeking ties. Further, our analyses demonstrate that this negative association is being driven by explicit knowledge-seeking rather than tacit knowledge-seeking activities and is stronger for higher-ranked auditors. Thus, knowledge-seeking by auditors may come at a cost, particularly when that knowledge is codifiable and when the seeking is done by those at higher levels of the firm. We also find that tacit knowledge-seeking ties to managers can be beneficial for auditor performance, and tacit knowledge-seeking ties to senior managers and partners is sometimes detrimental (particularly when sought by lower-ranked auditors). In sum, this suggests that who is seeking knowledge and who is being sought for knowledge are both important for performance. Our findings may assist researchers to better understand how auditors leverage their social connections to learn, which in turn may affect audit efficiency and effectiveness. Further, audit firms might benefit from better understanding the consequences of knowledge-seeking from different sources and use this understanding to make decisions that maximize desirable information flows.