Non-professional investors’ perspective on commercialism in auditing: An experimental study

This study investigates whether an ex-auditor’s employment with an audit client impairs nonprofessional investors’ perceptions of auditor independence, and whether the strength of the US revolving door policy improves their perceptions of auditor independence. Despite nonprofessional investors owning over one-third of the US equity holdings, the literature has not examined how revolving door policy impacts their perceptions of auditor independence. Two between-subjects experiments examine these issues. The first experiment finds that investors perceive the ex-auditor’s integrity to be significant in explaining the firm’s decision to manage earnings, irrespective of the firm’s previous working relationship with the ex-auditor. The results from experiment two indicate that strengthening the revolving door policy above that of the American Institute of Certified Public Accountants’ policy does not improve perceptions of auditor independence. Academics may be interested in triangulating the independence ‘in a...

This study examines nonprofessional investors’ perceptions of auditor independence when an accounting firm audits a client who has offered a job to a member of the audit team. The study also compares whether the perceived independence of both public and non-public company accounting firms improve as the strength of the revolving door safeguards increase. Empirical research has not proven whether Section 206 of the Sarbanes-Oxley Act improves perceptions of auditor objectivity when issues of auditor employment with the client appear prior to the auditor leaving the firm. Ninety-six nonprofessional investors from a University in the United States respond to an experiment to answer the hypotheses in this study. While the revolving door phenomenon impairs perceptions of public and non-public accounting firms’ independence, public company auditors’ independence is perceived to be more impaired by this threat to independence. The results also indicate that even though perceptions of both firms’ objectivity improve as the strength of the independence safeguards increase, public company auditor are perceived as being more objective than non-public company auditors. This study has implications for accounting regulators and academics. Accounting regulators may first consider how to improve perceptions of firms that audit non-public companies in order to fully realize the benefits of increasing the strength of the standards. Regarding the academic literature, this study is the first post-Sarbanes-Oxley study to empirically establish that the pre-revolving door phenomenon impairs objectivity. This is also the first study to investigate nonprofessional investors’ perceptions of the issue, despite their prominence in the capital markets.

This study is the first to investigate (1) whether United States’ nonprofessional investors perceive an ex-auditor’s employment with an audit client as a threat to the accounting firm’s independence, and (2) whether the strength of the current United States revolving door policy improves independence. This study is motivated by the underrepresentation of nonprofessional investors in the literature, despite them owning approximately thirty-eight percent of the United States equity holdings. Two between-subjects experiments examine these issues. The first experiment finds that investors perceive the ex-auditor’s integrity as significant in explaining the firm’s decision to manage earnings, irrespective of the firm’s previous working relationship with the ex-auditor. The results from experiment two indicate that investors’ perceptions of revolving door firms’ independence do not significantly improve by strengthening the revolving door policy above the American Institute of Certified Public Accountants’ initial policy. Therefore, accounting regulators may consider reducing the stringency of the current revolving door policy to attract prospective audit employees to public accounting. Academics may also be interested in the triangulation of the independence “in appearance” findings in this study the independence “in fact” findings in prior research.

The practice of outsourcing the internal audit function to the external audit firm has raised fears by many parties such as the SEC of possible independence impairment. The fear stems from the increased economic bond that exists when additional services are provided to an audit client, as well as the long-held view that internal auditing is a management function and, as such, is incompatible with the external audit function. This paper reports the results of a two-phase study of the perceptions of financial analysts regarding external auditor independence when a CPA firm performs both external and internal auditing services. In phase 1, analysts' perceptions of auditor independence are greater when the client employs its own internal audit staff or outsources to a different CPA firm than when the external auditor also performs internal audit functions. Phase 2 results show that analysts' perceptions of auditor independence are higher when the internal audit services are provided by the staff of a different division of the CPA firm compared to a nostaff separation treatment. Perceptions do not differ between full and partial outsourcing treatments, which conflicts with the recent SEC rule limiting the extent of outsourcing arrangements.

In 2017, the PCAOB began requiring audit firm tenure disclosure within the audit report for SEC registrant clients. Many commenters raised the concern that prominent disclosure of firm tenure would lead investors to inappropriately infer a negative relation between audit quality and long tenure. This is particularly troubling given that empirical evidence generally does not support this concern. In our first experiment, we predict and find that disclosing an audit firm's long tenure within the audit report increases investors' perceptions that the audit firm's independence was impaired while conducting the audit. However, we also identify an intervention that mitigates the effects of disclosing long tenure—an accompanying disclosure in the audit report of the firm's adherence to the SEC's mandatory partner rotation requirement. We find that such a disclosure moderates the effect of long tenure disclosure such that in the absence (presence) of a partner rotation disclosure, investors do (do not) perceive increased independence impairment when long firm tenure is disclosed. In a second experiment, we predict and find that long firm tenure disclosure reduces investors' preference to invest in an otherwise quantitatively optimal investment and that this relation is driven, in part, by perceptions of independence impairment. Again, this result is attenuated by partner rotation disclosure. Our results should be useful to regulators in understanding the effects of their disclosure mandate and to audit firms in understanding a practical way in which they might mitigate the implications of such effects.

Auditors fulfill a crucial societal role by increasing the credibility of financial reports, which requires that appropriate audit quality be provided and auditors are factually independent and perceived as such. So far, regulators and researchers have focused on a few measures for improving independence, namely the prohibition of non-audit services (NAS), audit firm and audit partner rotation, and joint audits. Despite these regulatory initiatives, accounting scandals still happen, and the independence of the auditors involved is questioned. Therefore, this explorative study aims to identify alternative measures that may strengthen auditor independence. Non-professional investors and auditors participated in a survey to identify promising independence-enhancing measures.Surprisingly, not only non-professional investors but also auditors support the implementation of many instruments. Non-professional investors rate measures related to oversight, controls, and sanctions as particularly useful. Likewise, auditors perceive measures for oversight and control as helpful but rank most sanctions lower than non-professional investors. They also support a stricter civil liability and rank some direct independence-improving measures as highly useful. Overall, the participants perceive a greater need for improving the independence of public interest entity (PIE) auditors.This explorative study widens the research horizon by adding alternative measures for improving independence in appearance. Thus, researchers may identify promising avenues for future research. Also, the paper is of interest to regulators and potentially helps in setting independence standards. Auditors and audit committees can identify opportunities for taking voluntary actions to ensure factual and perceived auditor independence.

SYNOPSIS: In this paper I investigate whether nonprofessional investors' beliefs mirror the Securities and Exchange Commission's (SEC) concerns that earnings quality and auditor independence have declined over time. I also examine whether lower perceptions of earnings quality are associated with more or less reliance on a firm's audited financial statements and fundamental analysis of those statements when making investment decisions. My results suggest that the SEC's concerns are valid: Perceived earnings quality for all publicly traded firms has declined overtime, as has perceived auditor independence and the perceived reliability of audited financial information. In contrast, the perceived relevance of audited financial information has increased. In addition, results reveal that lower perceptions of earnings quality are associated with greater reliance on a firm's audited financial statements and fundamental analysis of those statements when making investment decisions. This result suggests either (1) lowe r perceptions of earnings quality lead investors to examine more thoroughly a firm's audited financial statements, or (2) more thorough analysis of a firm's financial statements leads investors to lower their assessments of the firm's earnings quality. Keywords: investor beliefs; earnings quality; auditor independence; reliability; relevance. Data Availability: data and complete survey are available upon request. INTRODUCTION In this paper I investigate whether investors' beliefs mirror the Securities and Exchange Commission's (SEC) concerns that earnings quality and auditor independence have declined over time. (1) I also examine whether lower perceptions of earnings quality are associated with more or less reliance on a finn's audited financial statements and fundamental analysis of those statements when making investment decisions. Within the SEC, Commissioners Isaac Hunt, Jr. and Laura Unger have recently, and repeatedly, expressed their concerns about earnings quality and earnings management (Hunt 2001a, 2001b; Unger 2001a). Their concerns mirror those of former chairman of the SEC, Arthur Levitt, who expressed concern over earnings management and its effect on resource allocation in his 1998 speech, The Numbers Game. In his speech, Levitt notes that management abuses of big bath restructuring charges, premature revenue recognition, cookie jar reserves, and write-offs of purchased in-process R&D threaten the credibility of financial reporting. Levitt reiterates these concerns in his book, Take on the Street (Levitt 2002). To conduct my investigation I surveyed 414 individual investors who are members of the National Association of Investors Corporation (NAIC). Survey-based research complements archival-based research and experimental studies. Archival-based research provides statistical power and cross-sectional variation, but is less suited for examining individual behavior and beliefs. Experimental studies are excellent for determining how changes in variables affect individual behaviors and beliefs, but are less well suited for gathering large amounts of descriptive data on multiple behaviors and beliefs. Surveys offer a balance between archival-based and experimental studies by gathering data on a multitude of beliefs and practices for moderately large samples of individuals. Results from survey research can be used for building and testing theories, for attempting to explain what underlies market-level decision outputs (e.g., prices, returns, or trading frequencies), and for identifying trends in beliefs and practices. As with all types of research, the survey approach has potential drawbacks. Surveys measure beliefs and not necessarily actions, and surveys might be subject to various response biases. I test for potential biases by comparing statistics from my sample to statistics for the national population of NAIC investors, prior archival-based studies, and a market-level performance metric. …

Abstract:This paper reports the findings of a laboratory experiment designed to assess the moderating role of field dependence cognitive style in the effects of management consultancy services and qualified audit reports on subjects' perceptions of auditor independence. Using an ANOVA repeated‐measures experimental design, 22 accountants were administered a questionnaire which contained four scenarios, each representing one of four possible combinations of levels of the two exogenous variables. To measure levels of confidence in the auditors' independence in each of the scenarios, subjects were requested to respond to a seven‐point scale. In addition, subjects were classified as field dependent or field independent on the basis of the Group Embedded Figures Test. Results showed that field dependence cognitive style interacted to moderate the effects of management consultancy services and qualified audit reports on subjects' perceptions of auditor independence. The findings suggest that cognitive style is an important moderating variable that affects subjects' perceptions of auditor independence.

This study examines the impact of joint provision of audit and non-audit services on investors' perceptions of auditor independence in Egypt as one of emerging markets. The findings of the study reveal that investors' perceptions of auditor independence, reliability of financial statements and investment decision are lower when auditor provides both audit and non-audit services compared to the situation in which auditor provides audit service only. The findings also reveal that investors' perceptions of auditor independence, reliability of financial statements and investment decision are lower when non-audit services are provided by the same staff performing financial statements audit.

Using 20 bankers as subjects, this exploratory study examined the effects of audit committees on bankers’ perceptions of auditor independence. Results reject the null hypothesis which suggest that bankers place more reliance on financial statements in considering loan applications given information on the presence of audit committees than given information on their absence. Those bankers given information on the presence of audit committees recommended a lower interest rate premium than those given information on the absence of audit committees. These findings suggest that bankers given information on the presence of audit committees perceived a lower loan risk as a result of a higher confidence in the auditor to maintain independence than those given information on the absence of audit committees. It can then be concluded that audit committees had a significant effect on bankers’ perceptions of auditor independence.

In recent years, audit profession was confronted with different regulations, revised rules on non-audit services (NAS) and on auditor independence. In depth, professional accountancy bodies amended their independence rules according to Sarbanes-Oxley Act of 2002. For instance, the Securities Exchange Commission (SEC) and the American Institute of Certified Public Accountants (AICPA) in the USA, Capital Market Board (SPK) in Turkey made amendments to their independence rules on non-audit services and on auditor independence in light of the Sarbanes-Oxley Act of 2002. The purpose of this paper is to examine whether non-audit services jeopardize institutional investors’ perception of auditor independence in Turkey. Therefore, questionnaire was administered to 34 institutional investors in Istanbul, Turkey. It was generally found that institutional investors’ perception of auditor independence is not impaired at the time of joint provision of NAS and audit services to an audit client.

In recent years, the audit profession was confronted with different regulations, revised rules on Non-Audit Services (NAS) and on Auditor Independence. In-depth, Professional Accountancy Bodies amended their independence rules according to the Sarbanes-Oxley Act of 2002. For instance, the Securities Exchange Commission (SEC) and the American Institute of Certified Public Accountants (AICPA) in the USA, Capital Market Board (SPK) in Turkey made amendments to their independence rules on Non- Audit Services and on auditor independence in light of the Sarbanes-Oxley Act of 2002. The purpose of this paper is to examine whether “non- audit Services (NAS)” jeopardize institutional “investors’ perception of auditor independence in Turkey”. Therefore, the questionnaire was administered to 34 institutional investors in Istanbul, Turkey. It was generally found that institutional investors’ perception of auditor independence is not impaired at the time of the joint provision of NAS and audit Services to an audit Client.

The accounting profession is currently attempting to redefine its role and is expanding the types of services provided. With this expansion, however, comes a concern regarding the potential lack of independence between the auditor and the client requesting these services. This exploratory study examines whether the outsourcing of the internal audit function to the company's external auditor affects financial statement users' perceptions of auditor independence oand financial statement reliability, as well as loan decisions. The overall objective of this study is to assess reactions to various internal-audit outsourcing arrangements, and in doing so, to evaluate the accounting profession's current position regarding the acceptability of performing this type of “extended audit service” to audit clients. Results indicate significant differences across the various outsourcing groups involving the company's external auditor and the nonoutsourced group. Specifically, auditor performance of management functions had a significantly negative impact on users' perceptions of auditor independence and financial statement reliability, and resulted in the lowest percentage of loan approvals. However, the separation of audit-firm staff performing the outsourced internal audit from those performing the financial statement audit had a significantly positive impact on financial statement users' perceptions and loan approvals. The findings of this study support the AICPA's current position on internal audit outsourcing and also suggest that a requirement be established that provides a distinct separation of staff between a CPA firm's internal and external audit teams.

This study tests the proposition that tolerance for ambiguity, a personality variable, is a significant moderating variable on the effects of management advisory services (MAS), competition and size of audit firm on bankers' perceptions of auditor independence. Using 41 New Zealand bank officers as subjects and a multifactor ANOVA design, this study found that tolerance for ambiguity moderated the effects of MAS and audit firm size on third party perceptions of auditor independence.

PurposeThe growing international legal agenda and the fast development of corporate governance rules are now prompting firms to put emphasis on anti-corruption procedures. On the other hand, wide-ranging concerns have been raised by regulators and policymakers regarding the effectiveness of audit committees in promoting ethical behavior and safeguarding auditor independence from the adverse consequences of purchasing non-audit services. The purpose of this paper is to examine the relationship between the adoption of anti-corruption measures and perceived auditor independence in the context of audit committees.Design/methodology/approachAfter conducting the Breusch–Pagan Lagrange Multiplier test and the Hausman test, the random-effect model is used as the most appropriate estimator. Several endogeneity tests are also used to account for the endogenous nature of the corporate governance variables in the models.FindingsUsing a sample of UK FTSE 350 firms, this paper provides evidence that anti-corruption efforts are associated with lower purchases of non-audit services and lower economic bonding between auditors and their clients. Furthermore, the findings of this paper reveal that the adoption of anti-corruption efforts substitutes the role of audit committees in enhancing perceived auditor independence and that audit committees do not play a significant incremental role.Originality/valueTo the best of the author’s knowledge, this is the first study of its kind to focus on bolstering perceived auditor independence while enhancing the control and ethical environment from the clients’ side instead of the auditors’ side.