Cost overruns on multi-period projects are large and frequent in natural environments. Reasons for these overruns include cost understatements in initial project proposals and escalation of commitment to projects when initial actual costs turn out to be higher than expected. Prior literature has suggested, and some firms have implemented, a device that limits escalation and thus potentially reduces cost overruns: changing decision makers (superiors) so that the manager who approves continuation of a project is not the same individual who approved the project initially. We provide theoretical explanations and experimental evidence about how changing versus continuing superiors affect the underestimates of cost in initial project proposals. We find that although changing superiors, as expected, are more likely than are continuing superiors to react skeptically to continuation proposals when first-period cost overruns have occurred, this does not reduce initial cost understatements and overruns. On the contrary, in our setting it leads to greater initial understatements and overruns. Subordinates anticipate that new superiors will be more critical of their projects; hence, they discount later-period payoffs and focus on gaining initial funding by providing understated cost estimates.

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn MailTo Tools Icon Tools Get Permissions Search Site Cite View This Citation Add to Citation Manager Citation Mark L. DeFond; Annual Report and Editorial Commentary for The Accounting Review. The Accounting Review 1 November 2016; 91 (6): 1817–1839. https://doi.org/10.2308/accr-10507 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest filter your search All ContentThe Accounting Review Search Advanced Search

We address whether SOX 404(b) internal control audits under two auditing standards regimes and SOX 404(a) management assessments are associated with improved internal control system quality, an important and largely unstudied potential benefit. In 2013, the PCAOB disclosed that 15 percent of inspected control audits were ineffective, suggesting that the current control auditing standard may not be sufficient to induce implementation of high-quality control systems. We use an indirect measure of internal control system quality—future unaudited accruals quality—to proxy for internal control quality because sustained internal control improvements should be exhibited in future quarterly financial reports unaltered by contemporaneous financial statement audits. We find that internal control audits initially provided internal control quality benefits. After the 2007 auditing standards change, internal control quality deteriorated for ICFR audited versus unaudited firms. Finally, we find limited evidence that management assessments affect internal control quality. Results indicate that recent PCAOB concerns may have merit. Data Availability: Data are publicly available from the sources identified in the text.

We find that auditors of more conservative clients charge lower fees, issue fewer going concern opinions, and resign less frequently, consistent with more conservative clients imposing less engagement risk on their auditors. Using path analysis, we find evidence that both inherent risk and auditor business risk explain these associations. Also consistent with conservatism reducing auditor business risk, we find that client conservatism is associated with fewer lawsuits against auditors and with fewer client restatements. Taken together, our results are consistent with auditors viewing client conservatism as an important determinant of engagement risk that, in turn, affects auditor-client contracting decisions. Our findings should be of interest to auditors who actively manage client risk and to standard-setters who recently dropped conservatism as a desired attribute of financial reporting quality. Data Availability: All data are publicly available from sources indicated in the text.

In this study, we examine the benefits of membership in an accounting firm association, network, or alliance (collectively referred to as “an association”). Associations provide member accounting firms with numerous benefits, including access to the expertise of professionals from other independent member firms, joint conferences and technical trainings, assistance in dealing with staffing and geographic limitations, and the ability to use the association name in marketing materials. We expect these benefits to result in higher-quality audits and higher audit fees (or audit fee premiums). Using hand-collected data on association membership, we find that association member firms conduct higher-quality audits than nonmember firms, where audit quality is proxied for by fewer Public Company Accounting Oversight Board (PCAOB) inspection deficiencies and fewer financial statement misstatements, as well as less extreme absolute discretionary accruals and lower positive discretionary accruals. We also find that audit fees are higher for clients of member firms than for clients of nonmember firms, suggesting that clients are willing to pay an audit fee premium to engage association member audit firms. Finally, we find that member firm audits are of similar quality to a size-matched sample of Big 4 audits, but member firm clients pay lower fee premiums than do Big 4 clients. Our inferences are robust to the use of company size-matched control samples, audit firm size-matched control samples, propensity score matching, two-stage least squares regression, and to analyses that consider changes in association membership. Our findings should be of interest to regulators because they suggest that association membership assists small audit firms in overcoming barriers to auditing larger audit clients. In addition, our findings should be informative to audit committees when making auditor selection decisions, and to investors and accounting researchers interested in the relation between audit firm type and audit quality.

Employee contracts often allow for managerial discretion, such that the manager decides after observing an employee's performance how that employee will be rewarded or penalized. Importantly, the effects of such evaluation outcomes can extend beyond the employee(s) directly affected, because such outcomes can be observed by other employees within the firm. The net effect of such vicarious learning as an indirect control depends on the inferences employees make after observing a peer's evaluation outcome. In this study, we use an experiment to investigate whether the inferences observer-employees make about how managers evaluate and reward employee behavior depend on whether the valence of the observed outcome is positive or negative. Using the setting of a strategic performance measurement system, we test and find support for a causal model, in which the valence of the observed outcome influences observer-employees' inferences and subsequent behavioral focus via their psychological distance from, and their construal of, the observed outcome. Our results suggest that how observer-employees respond after observing a peer employee's evaluation outcome is asymmetric. Specifically, when contemplating their own behavior, employees who observe positive outcomes focus on the performance measures within the strategic performance measurement system, whereas those who observe negative outcomes focus on the underlying strategic construct.