Ulrike Stefani

Are Extensive Audits "Good News"? : Market Perceptions of Abnormal Audit Fees and Fair Value Disclosures

Although the role of auditing is to increase the reliability of financial statements, surprisingly little is known about addressees’ perceptions of the auditor-client relationship. Using a sample of more than 1,000 U.S. bank-years from 2008 to 2011, we analyze the economic consequences of the joint announcement of audit fees and the level breakdown of fair value assets. We confirm prior findings that audit fees are higher for banks with larger proportions of Level 3 fair values. Moreover, we find that the market perception regarding fair value assets depends on the extent of managerial discretion in the estimation process. Most importantly, we find evidence consistent with the notion that addressees’ interpret abnormal audit fees as an indication of additional risk. Thus, unexpected audit fees are not interpreted as a signal for a more reliable audit, but further increase the market discount on Level 3 fair values. Bank managers have to consider these negative consequences in their reporting strategy.

The Interdependence between Audit Market Structure and the Quality of Financial Reporting : The Case of Non-Audit Services

On April 16th, 2014, the European Parliament and the Council of the European Communities adopted a proposal for a regulation on the specific requirements regarding the statutory audits of public-interest entities. This regulation contains a “blacklist” of non-audit services that audit firms are prohibited from providing to public-interest entities. The blacklist is intended to increase audit quality by improving the auditor’s independence. However, restricting the auditors’ scope of services decreases the audit firms’ total profits and can therefore further increase the already high level of audit market concentration. We integrate a strategic auditor-client game into a circular market matching model to analytically investigate the effects of audit market regulation on the market structure and the quality of audited financial statements. Our results indicate that prohibiting general non-audit services that actually do not impair independence can indeed further in-crease concentration. Moreover, a ban on these services can even decrease the quality of the audited financial statements because the average probability that managers will misreport in-creases. Our model predicts the opposite effects resulting from a prohibition on audit-related non-audit services. We find that the effects of prohibiting the supply of non-audit services depend crucially on the time at which the non-audit fees are negotiated.

Non‐additivity and the Salience of Marginal Productivities: Experimental Evidence on Distributive Fairness

We investigate the relevance of different distributive fairness norms in a team production process in which the team members’ contributions to the joint output are not necessarily additive. In some of the cases of non-additivity, the individual marginal contributions to the output are not salient. We vary the salience and investigate how third parties allocate the joint output to the team members. We find that the prevalent norm is to hold others responsible only for their inputs rather than for the incremental increase in the output. The marginal productivities are taken into account only when they are made readily apparent.

Rounding Up the Net Income: Earnings Cosmetics or Material Earnings Management?

To the extent that cognitive thresholds are relevant in the investors’ decision process, managers have an incentive to report earnings that exceed the given critical value. If the net income is below this threshold, managers might simply use accounting discretion to round up the earnings number. As a consequence, the second digits of the net income in a sample of firms rounding up do not follow Benford’s Law. However, the magnitude of rounding up (i.e., the difference between the (unobservable) pre-managed and the reported earnings) is important in assessing whether rounding up reduces the decision usefulness of financial statements. Rounding up reduces the financial reporting quality only if the earnings manipulation is material but not in cases of non-material “earnings cosmetics”. To differentiate between these cases, we investigate whether deviations from the Benford distribution are more likely in subsamples of firms with lower earnings quality. We find deviations of earnings numbers from the Benford distribution for firms that maximize their earnings via discretionary accruals, for firms with a non-Big 4 audit firm, and for firms with an auditor who is not an industry specialist. We do not find divergences for the subsamples of firms with higher financial reporting quality as approximated by these metrics. In contrast, earnings smoothing and overstepping investors’ cognitive thresholds seem to be opposing goals because only firms with low degrees of earnings smoothing deviate from the Benford distribution. Taken together, we find evidence for the materiality of the manipulations used to round up the net income.

Audit Market Regulation and Earnings Characteristics: Cross-Country Evidence on the Role of the Audit Market Structure

The main objectives of recent audit market regulations are to (1) increase audit quality, (2) decrease audit market concentration, and (3) foster competition between audit firms. However, the empirical evidence on whether such regulations fulfill these goals is limited. We construct a unique database of the regulations in effect in the audit markets of 29 countries to explore the link between audit market regulation and the abovementioned objectives. The staggered implementation between 2002 and 2014 across the sample countries allows better identification of the role of audit market regulation than in single-country studies. We find that only one of the analyzed regulations, the restriction of auditor liability, is positively associated with all three goals. Mandatory auditor rotation, fee disclosures, and fee caps appear to be detrimental: The associations with two of the objectives are in the wrong direction, with no positive counterbalancing effect with regard to the third goal. Restricting non-audit services is associated with a lower degree of concentration within the group of market leaders and higher audit quality, but is negatively related to competition. The role of audit partner rotation and that of joint audits remain ambiguous. Our findings are helpful for regulators and academics and represent a necessary first step for a comprehensive cost-benefit analysis of audit market regulations.

The Interdependence between the Structure of the Audit Market and the Quality of Audited Financial Statements: The Case of Non-Audit Services

On April 16th, 2014, the European Parliament and the Council of the European Communities adopted a proposal for a regulation on the specific requirements regarding the statutory audits of public-interest entities. This regulation contains a “blacklist” of non-audit services that audit firms are prohibited from providing to public-interest entities. The blacklist is intended to increase audit quality by improving the auditor’s independence. However, restricting the auditors’ scope of services decreases the audit firms’ total profits and can therefore further increase the already high level of audit market concentration. We integrate a strategic auditor-client game into a circular market matching model to analytically investigate the effects of audit market regulation on the market structure and the quality of audited financial statements. Our results indicate that prohibiting general non-audit services that actually do not impair independence can indeed further in-crease concentration. Moreover, a ban on these services can even decrease the quality of the audited financial statements because the average probability that managers will misreport in-creases. Our model predicts the opposite effects resulting from a prohibition on audit-related non-audit services. We find that the effects of prohibiting the supply of non-audit services depend crucially on the time at which the non-audit fees are negotiated.

The Interdependence Between the Structure of the Audit Market and Financial Reporting Quality

On April 16th, 2014, the European Parliament and the Council of the European Communities adopted a proposal for a regulation on the specific requirements regarding the statutory audits of public-interest entities. This regulation contains a “blacklist” of non-audit services that audit firms are prohibited from providing to public-interest entities. The blacklist is intended to increase audit quality by improving the auditor’s independence. However, restricting the auditors’ scope of services decreases the audit firms’ total profits and can therefore further increase the already high level of audit market concentration. We integrate a strategic auditor-client game into a circular market matching model to analytically investigate the effects of audit market regulation on the market structure and the quality of audited financial statements. Our results indicate that prohibiting general non-audit services that actually do not impair independence can indeed further in-crease concentration. Moreover, a ban on these services can even decrease the quality of the audited financial statements because the average probability that managers will misreport in-creases. Our model predicts the opposite effects resulting from a prohibition on audit-related non-audit services. We find that the effects of prohibiting the supply of non-audit services depend crucially on the time at which the non-audit fees are negotiated.