This study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001–2007 as an indicator for audit failure, I find that the amount of NAS fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict. Data Availability: All data are publicly available from sources identified in the study.

Prior research provides mixed evidence about whether competition among auditors impairs or improves audit quality. An impediment to this stream of research is the inability of researchers to observe the audit engagement bidding process. We develop a method of detecting bidding by applying a machine learning algorithm to non-incumbent (i.e., competitor) auditor views of public companies’ SEC filings. We validate our method using a proprietary sample where all instances of bidding are known. We then examine the associations between bidding, audit quality, and audit pricing. Contrary to concerns that competitive pressure may cause auditors to compromise their independence, we find that incumbent auditors perform higher quality audits during bidding years. This improvement in audit quality occurs regardless of whether the bidding ultimately results in an auditor change and persists for several years when the incumbent auditor wins reappointment. We also find that bidding is associated with modest audit fee concessions.

This article investigates whether investors respond to explanatory language (EL) added to unqualified audit reports. Although prior research finds an association between auditor EL and lower financial reporting quality, surveys suggest that many investors limit their attention to the unqualified nature of the opinion. We use three‐day abnormal returns and abnormal trading volume to measure investor response to EL in unqualified audit reports issued from 2000 to 2014. We find little evidence to indicate that investors respond to auditor EL at the audit report release date. In further analyses, we find that the lack of investor response is attributable both to incomplete investor reactions (55 percent of EL occurrences) and previous incorporation of EL (40 percent of EL occurrences). Overall, the results support policymakers’ initiatives to improve the usefulness of unqualified audit reports.

We use information extracted from a major proxy advisory service to test predictions from institutional theory regarding when and why audit committee ( AC ) members experience turnover because of evidence of ineffective governance. First, we broadly categorize AC ineffectiveness concerns as either (i) financial reporting failures or (ii) characteristics of individual AC members. Institutional theory suggests that the visible nature of the first category is more likely to threaten perceptions of AC legitimacy and hence prompt turnover, which is what we find. We then enrich the analysis by interacting the AC ‐member ineffectiveness indicators with the extent of shareholder protest votes, finding that shareholder dissent elevates the turnover effects of both categories of ineffectiveness, as institutional theory would predict. Finally, we find that otherwise effective AC members face an increased likelihood of turnover if they serve on the AC when financial reporting failures are discovered, even if they were not on the AC when the events precipitating the failures occurred. Overall, our findings support the institutional theoretic premise that boards take remedial actions when necessary to restore perceived legitimacy.

We investigate whether non‐GAAP reporting affects the audit process and thereby the quality of the related financial statements. First, we provide evidence that auditors in numerous countries, including the United States and the United Kingdom, rely to varying degrees on non‐GAAP profit before tax as a benchmark for determining quantitative materiality. Then, using Premium Listed companies on the London Stock Exchange, we document that U.K. auditor reliance on non‐GAAP materiality benchmarks often results in a higher quantitative materiality amount and can lower audit quality. Although U.K. auditors appear skeptical of managers’ more aggressive non‐GAAP adjustments, auditors adopt more of management's low‐quality adjustments when auditor independence is weaker. In sum, our results suggest that non‐GAAP reporting can indirectly affect investors by reducing the rigor of the financial statement audit.

Given that tax‐related critical audit matters (tax CAMs) were prevalent among accelerated filers (18.5% of observations) during the initial year of CAM disclosures, we examine whether an auditor's disclosure of tax CAMs is associated with variation in tax‐related financial reporting quality, tax avoidance, and tax‐related earnings management. Finding an association between tax CAMs and one of these tax outcomes would indicate that the new auditor reporting standard has indirectly affected investors. Examining the first year of CAM disclosures, we do not find that tax CAMs are associated with broad proxies of tax‐related audit or financial reporting quality (e.g., restatements, internal control weaknesses, comment letters) or tax avoidance (e.g., effective tax rates or book‐to‐tax differences). We do find that tax CAMs are associated with a modest increase in tax accrual quality, an increase in the reserve for unrecognized tax benefits, and a reduction in the likelihood of tax‐related earnings management. However, we do not find these tax CAM effects persist into the second year of CAM reporting. Our evidence is consistent with tax CAM disclosures having a modest but short‐lived effect on companies' reporting of tax accounts. Our findings should inform the PCAOB as they conduct their post‐implementation review of the new audit reporting standard.

According to auditing standards, explanatory language added at the auditor's discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client's financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000–2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) “emphasis of matter” language that discusses mergers, related-party transactions, and management's use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.

We present experimental evidence suggesting that critical audit matter (CAM) disclosures in the auditor's report involving areas of high measurement uncertainty forewarn users of misstatement risk. Specifically, in our first study with MBA students, financial analysts, and attorneys, we find that CAMs (i) lower premisstatement assessments of confidence in the financial statement area disclosed as a CAM, and (ii) lower assessments of auditor responsibility for a subsequently revealed misstatement in a CAM‐related area. In our second study with student participants proxying as mock jurors, we find that the responsibility‐mitigating effect of CAM disclosure is driven by CAM disclosures involving measurement uncertainty, as opposed to CAM disclosures involving categorical determinations. Combined, our findings help reconcile mixed evidence from prior research, supporting the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM‐related material misstatements.

This study examines local characteristics associated with non-Big 4 local market leadership and the impact of non-Big 4 local market leadership on competition. We identify non-Big 4 local market leaders by collecting accounting firm rankings from business publications for 46 of the largest metropolitan statistical areas from 2005–2010. These rankings are based on the number of local office employees and provide a more holistic measure of office size than measures based on public company audit fees. We find local supply and demand factors are significantly associated with non-Big 4 local market leadership and that non-Big 4 leadership is associated with lower overall audit fees in the local market. We also find that non-Big 4 leaders earn a fee premium over other non-Big 4 auditors. Our results imply that non-Big 4 leaders increase local market competition. Data Availability: All data are publicly available from sources identified in the study.