Joseph V. Carcello, Zoe-Vonna Palmrose, Auditor Litigation and Modified Reporting on Bankrupt Clients, Journal of Accounting Research, Vol. 32, Studies on Accounting, Financial Disclosures, and the Law (1994), pp. 1-30

This paper investigates the effects on audit quality and audit fees of requiring the engagement partner to sign the audit report in the United Kingdom (U.K.). The effect of requiring the engagement partner to sign the audit report is timely since the Public Company Accounting Oversight Board (PCAOB) is considering mandating a similar requirement in the United States (U.S.). In the first year after the introduction of the signature requirement, we find a significant decline in abnormal accruals and the propensity to meet an earnings threshold, and we find a significant increase in the incidence of qualified audit reports and in earnings informativeness. In addition, audit fees are significantly higher in the post-signature period than in the pre-signature period. Moreover, we compare U.K. firms with a matched sample of U.S. firms and firms in other European countries in periods both before and after the U.K. adopted a signature requirement. Our results are generally consistent with the argument of improved audit quality in U.K. firms after the signature requirement is adopted. Data Availability: Data are available from public sources identified in the text.

The PCAOB recently considered implementing mandatory audit firm rotation in hopes of better aligning auditors' interests with investors' interests, suggesting that the PCAOB views long auditor tenure as problematic. However, the accounting profession argues that long tenure actually improves audit quality. This study provides insight into investors' views by evaluating the market's reaction to events related to the potential adoption of rotation that occurred between 2011 and 2013. The results provide some evidence that the market reacts negatively (positively) to events that increased (decreased) the likelihood of rotation, although these results are sensitive to the market index used to calculate abnormal returns. More importantly, particularly given the lack of a U.S.-specific control group, cross-sectional tests provide strong evidence that the market reaction is more negative (positive) on dates that increased (decreased) the likelihood of rotation given longer auditor tenure. Moreover, we also find that the market reaction is more negative (positive) on dates that increased (decreased) the likelihood of rotation given a Big 4 auditor. Data Availability: Data are available from public sources identified in the text.

One important role of audit committees is to protect external auditors from dismissal following the issuance of an unfavorable report. We examine auditor dismissals following new going-concern reports that Big 6 firms issued between 1988 and 1999. Our findings suggest that audit committees with greater independence, greater governance expertise, and lower stockholdings are more effective in shielding auditors from dismissal after the issuance of new going-concern reports. In addition, we find that the relation between audit committee independence and auditor protection from dismissal has grown stronger over time. Finally, independent audit committee members experience a significant increase in turnover rate after auditor dismissals. These findings, coupled with those from Carcello and Neal (2000), suggest that when affiliated directors dominate the audit committee, management often can (1) pressure its auditor to issue an unmodified report despite going-concern issues, and (2) dismiss its auditor if the auditor refuses to issue an unmodified report.

This study examines the relation between the composition of financially distressed firms' audit committees and the likelihood of receiving going-concern reports. For firms experiencing financial distress during 1994, we find that the greater the percentage of affiliated directors on the audit committee, the lower the probability the auditor will issue a going-concern report. These results support regulators' concern about financial-reporting quality and the recent calls for more independent audit committees.

This study examines whether client satisfaction can help explain cross‐sectional variation in Big 6 audit fees paid by Fortune 1000 clients. After controlling for other factors related to audit fees (including audit quality attributes), client satisfaction with the audit team is positively associated with fees. It appears that a dimension of client satisfaction unrelated to audit quality attributes is the factor associated with an audit fee premium. This dimension of satisfaction may reflect other aspects of service quality not documented in the literature, or it may simply enable an auditor to earn economic rents through enhanced bargaining power. Client satisfaction with the audit firm does not appear to be priced in this segment of the audit market. The results are consistent with the view that a Big 6 audit is a service that is differentiable in the eyes of client management, and the results highlight the importance of the audit team composition in allowing a Big 6 audit firm to differentiate the audit product. Also, if auditors are earning local rents due to enhanced satisfaction levels, then a perfect competition model may not be appropriate for the audit services market.

We study going-concern (GC) reporting in Belgium to examine the effects associated with a shift toward rules-based audit standards. Beginning in 2000, a major revision in Belgian GC audit standards took effect. Among its changes, auditors must ascertain whether their clients are in compliance with two "financial-juridical criteria'' for board of directors' GC disclosures. In a study of a sample of private Belgian companies, we report two major findings. First, there is a decrease in auditor Type II errors, particularly by non-Big 6/5 auditors for their clients that fail both criteria. Second, there is an increase in Type I errors, again particularly for companies that fail both criteria. We also conduct an ex post analysis of the decrease in Type II errors and the increase in Type I errors. Our findings suggest the standard engenders both favorable and un-favorable effects, the net of which depends on the priorities assigned to the affected parties (creditors, auditors, companies, and employees).

This paper examines the relations between three board characteristics (independence, diligence, and expertise) and Big 6 audit fees for Fortune 1000 companies. To protect its reputation capital, avoid legal liability, and promote shareholder interests, a more independent, diligent, and expert board may demand differentially higher audit quality (greater assurance, which requires more audit work) than the Big 6 audit firms normally provide. The audit fee increases as the auditor's additional costs are passed on to the client, such that we expect positive relations between audit fees and the board characteristics examined. We find significant positive relations between audit fees and board independence, diligence, and expertise. The results persist when similar measures of audit committee “quality” are included in the model. The results add to the growing body of literature documenting relations between corporate governance mechanisms and various facets of the financial reporting and audit processes, as well as to our understanding of the determinants of audit fees.

Inadequate testing of fair value accounting estimates, including goodwill, is often cited as an audit deficiency in PCAOB inspection reports, and, in some cases, these deficiencies have led to enforcement actions against the auditor. As a result of these issues, the PCAOB recently proposed a new auditing standard for fair value accounting. While these regulatory actions suggest that auditors are challenged by the fair value regime of accounting for goodwill, they also highlight an area where the auditor could be influenced by their financial ties to a client. In this study, we test whether nonaudit fees are associated with goodwill impairment decision outcomes. Our results indicate that the nonaudit fees a client pays are inversely related to the likelihood of impairment in settings where goodwill is likely to be impaired. Additional examinations suggest that the negative relation between nonaudit fees and auditor independence is driven by clients who are most incentivized to exert their influence over the auditor.