The ethical edge: how Confucianism in audit firms prevents corporate fraud

Agency Problems, Auditing, and the Theory of the Firm: Some EvidenceAuthor(s): Ross L. Watts and Jerold L. ZimmermanSource: Journal of Law and Economics, Vol. 26, No. 3, (Oct., 1983), pp. 613-633Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/725039Accessed: 29/06/2008 23:14

This paper explores how managers’ and supervisors’ equity incentives impact the likelihood of committing corporate fraud in Chinese-listed firms. Previous research has shown that corporate fraud in China is a widespread phenomenon and has severe consequences for affected firms and executives. However, our understanding of the reasons that fraud is committed in a Chinese setting has been very limited thus far. This is an increasingly important topic, because corporate governance is rapidly changing in China, and it is unclear whether adopting the executive compensation practices of the West is appropriate for Chinese firms. We show that managers’ equity incentives increase their propensity to commit corporate fraud. We also find that this effect is more pronounced for state-owned firms. However, we find a negative but not significant relationship between the equity incentives of the supervisory board and the incidence of fraud.

Voluntary certification and disclosure of internal controls over Australian financial reporting, audit fees and value relevance

Purpose: The aims of this research are to investigate the reasons for adopting big data (BD) and big data analytics (BDA), determine their extent of usage, and identify potential obstacles to their adoption in a developing country, Egypt. Motivation: Prior literature criticized the audit profession for the slow adoption of BDA, and little is known about the adoption of BD and BDA in developing countries. The reluctance to incorporate BD and BDA into auditing can be attributed to their potential obstacles. In addition, prior studies focused on the Big-4 audit firms in developed countries with little known about adopting BD and BDA in local audit firms and developing countries. Design/methodology/approach:To achieve the objectives of this study, 16 audit practitioners with various positions, specializations, and experience levels were interviewed. The 16 participants belong to audit firms of different sizes: international audit firms, local audit firms, and a governmental auditing agency. Thematic analysis was employed through using the MAXQDA software package to analyze the data. Main findings: The findings revealed that the reasons for using BD and BDA go beyond improving audit efficiency and effectiveness and satisfying clients. All audit firms collect and analyze large volumes of traditional accounting data. However, the Big-4 firms manage and analyze non-financial data and new data items as complementary audit evidence. Also, it was found that the type of audit firm affects the use of these technologies, with international firms being superior to other firms. The Accountability State Authority lags behind other audit firms in adopting BD and BDA. Furthermore, it was found that some obstacles to adopting BD and BDA arise due to the specific characteristics of the Egyptian context, while others are universal. Practical implications/Managerial impact: Determining the reasons for and obstacles to adopting BD BDA is useful for audit firms and regulators to remove these obstacles and encourage using such new audit technologies. The findings might help developers of BDA software packages to enhance their packages to meet auditor requirements. Moreover, academic scholars can benefit from the findings of this study by gaining an understanding of the main differences between developed and developing countries in relation to adopting BD and BDA. Novelty/Contribution: This study was conducted in Egypt, a developing country with a an underdeveloped audit environment. Therefore, this study enriches the relevant literature by providing information about BD and BDA in an unexplored developing environment. Besides, it delves deeper into the reasons and obstacles to using BD and BDA in external financial auditing in a developing country. Also, it adds to the literature by identifying the most common BDA software packages and techniques that auditors use in a developing country. Moreover, it considers audit practitioners’ viewpoints on audit firms of various sizes.

Auditor independence: The effect of auditors’ quality control efforts and corporate governance

PurposeThis paper aims to investigate the relation between audit firms’ switch to limited liability partnership (LLP) from limited liability company (LLC) and client firms’ earnings comparability. If LLP auditors, who have a higher liability exposure than LLC auditors, are more consistent in implementing generally accepted accounting principles and executing firm-wide audit methodologies, client firms’ earnings comparability will increase.Design/methodology/approachUsing data from China, the authors examine whether client firm-pairs of LLP auditors have higher earnings comparability than client firm-pairs of LLC auditors. The authors also perform cross-sectional tests to shed light on the mechanisms through which auditors’ litigation exposure affects client firms’ comparability.FindingsThe authors find that firm-pairs in which both firms are audited by LLP auditors exhibit higher earnings comparability than other firm-pairs. This result is stronger when client firms are audited by the same auditor, when client firms are audited by the top 10 auditors and when the auditors are less dependent on the client firms. The authors also document that firm-pairs in which both firms are audited by LLP auditors have lower average analyst earnings forecast error and forecast dispersion.Originality/valueTo the best of the author’s knowledge, this study is the first to examine the relation between auditor’s litigation exposure and client firms’ earnings comparability. It also extends the literature on audit firm organizational form and audit quality.

Strategic responses of the clients of multinational audit firms to corporate governance audit regulation

The purpose of this study is to examine the influences of external auditor firm type, auditor tenure, and external auditor changes on the quality of Saudi Arabian financial reports. In particular, this study examines the quality of financial reports of companies listed on the Saudi Stock Exchange using a widely accepted evaluation model modified by JonesThis study aims to determine whether Big Four and non-Big Four audit firms, auditor tenures of three or more years, and external auditor changes have any impact on the quality of financial reports of Saudi-listed companies. This study uses 175 firm-year observations of 35 companies listed on the Tadawul Saudi Stock Exchange between 2017 and 2021. Using discretionary accruals (DACC) as modified by Jones to measure the quality of financial reports, the findings illustrate that there is a significant negative relationship between Big Four audit firms and DACC. However, the study also shows a significant positive correlation between auditor tenure and DACC. The research revealed that there is no significant relationship between auditor change and DACC. These results have practical implications for policy development. According to the outcomes of this research, there are numerous ramifications for both companies and the government in Saudi Arabia in terms of enhancing the relationship between companies and audit firms and determining the most suitable auditor tenure to improve the quality of financial reports.

This study aims to examine whether corporate tax avoidance behavior changes after the 2018 amendment of Act on External Audit of Stock Companies. The amendment comprises the introduction of periodic auditor changes, broadening the criteria for auditor designation, shortening of auditor appointment period, and changing the appointing authority of the auditor from the management to the audit committee. This suggests that it comes to be more difficult for companies to opportunistically appoint auditors under the current auditing law. Accordingly, if auditor independence has improved after the regulatory change, we predict that auditors are more likely to curtail aggressive tax reporting of client firms to mitigate audit risk. Our sample consists of firms that changed auditors between 2016 and 2021, including firms subject to the External Audit Act (mandatory audit firms) as well as those that voluntarily received external audits (voluntary audit firms). Using a difference－in－differences methodology, we find that mandatory audit firms that change auditors (i.e. treatment group) show a decrease in tax avoidance after the introduction of the New External Audit Act. In contrast, voluntary audit firms that change auditors (i.e. control group) do not exhibit any change in their tax avoidance. When we divide mandatory audit firms into those with designated auditors and those with freely selected auditors, both groups show a noticeable decrease in tax avoidance. Additionally, we find that the decrease in tax avoidance among mandatory audit firms after the regulatory change is primarily attributed to those audited by non－Big 4 auditors. This study suggests that the strengthened audit environment after the introduction of the New External Audit Act contributes to enhancing firms’ tax reporting behavior as well as their financial reporting behavior. In particular, we present evidence that improved auditor independence is observed in both firms with designated auditors and those with freely selected auditors, and the improvement is more prevalent among auditors with lower bargaining power against client firms.

Accounting fraud, auditing, and the role of government sanctions in China

Do sanctioned audit firms strive to restore their damaged reputation under imperfect institutional settings?

Do Ownership Structure and Governance Mechanisms have an Effect on Corporate Fraud in China's Listed Firms?

This paper critically examined the relationship between corporate governance and fraud prevention in Nigeria. It focused on the relationship between internal audit, audit committee, external audit, board of director's governance mechanisms and fraud prevention. Data were obtained from the administration of questionnaires on academics in management sciences' faculty, chartered accountants, internal auditors, external auditors and stock brokers. The questionnaire instrument employed was subjected to reliability test using the Cronbach's alpha. Descriptive statistics were used to show the dispersion of the distribution. The data elicited were analysed with the help of multiple regression estimation technique .The findings show that internal audit, audit committee, external audit and board of directors have significant negative relationship with fraud prevention. This infers that they are capable of reducing the incidences of fraud in an organization. The study recommends that more emphasis should be shown to encourage entrenchment of an effective internal audit function; effective audit committee; an independent and effective external audit; and an ethically sound and effective board of directors in an organization.

The aim of auditing is to protect active and potential investors from accounting fraud. Nevertheless, as many auditing scandals have demonstrated, auditing has a dark side. Correct auditing is a public good provided by private auditing firms, but these firms are paid by the enterprise being audited. Therefore, audit firms may be dubbed as agents of two principals, the audited firm and the public. Reputation theory conjectures that auditors are disincentivized from performing shallow and fraudulent auditing because of reputational concerns and associated reputational costs. However, empirical evidence does not support this claim. While it may be irrational for a large audit firm (such as Arthur Andersen LLP) to sacrifice its reputational capital for a single client by doing superficial audits (such as WorldCom), it may be quite rational for the auditing firm’s engagement partners to do so. The result might be a conspiracy against the public and investors. Because of an inelastic supply of experienced auditors and a highly concentrated market of big auditing firms, reputational losses due to auditing scandals for the audit firms’ local partners and staff seem to be rather small. With a game theoretic model, we argue here that neither higher transparency nor higher fines for auditing failures may prevent such conspiracies. Therefore, legal regulations and court rulings can only change the expected fines for audit fraud, but they cannot solve the general problems arising from the symbiotic relationship between auditors and their client firms. As auditing firms may use the so-called expectation gap to protect themselves against legal claims of wrongdoing, avenues more suitable to deterring conspiracies by auditors and their client firms might include whistleblowing, short-selling investors and investigative journalism.

This paper has been inspired by the paper issued by Evans, and the title of which is “Auditing and Audit Firms in Germany before 1931” in 2003 on Accounting Historians Journal [1]. Although some academics in the field of international accounting refer to accounting events during 1930s in some specific nations in the world as the main subject in their research, it seems to be rare to make allusion to events surrounding external statutory audit by professionals (ESAP, hereafter) in the world during 1930s, the decade characterized as the inter-war period, collectively. Under such a situation Evans Lisa tried to shed light on the comparatively slow development of the statutory audit in Germany, examine the different attitudes to the legal and organizational forms of audit firms, and to analyze the development of German auditing and audit firms prior to their statutory regulation in 1931. Evans’ work, however, has the other aspect of developing the critique of agency theory assumptions in historical contexts. In this aspect, this paper shall rely on the agency theory as the framework of searching the reasons of Japan’s specialty in relation to introducing the external statutory audit by professionals during the decade when EVANS referred to, especially focusing on the monitoring and bonding mechanism of ZAIBATSU. In literature, many papers on agency theories focus on monitoring and the way of incentives by principals. In this respect, the development of German ESAP justifies EVANS’ approach. On the contrary, in reaching the profound reasons that underlie the behaviors of related parties in relation to introducing ESAP, it’s important to pay attention to the conducts of managements that are agents, especially their bonding manner. According to Jensen and Mecling, there is no difference that actually makes the monitoring expenditures and also it will pay the owner-manager to engage in bonding activities and to write contracts which allow monitoring as long as the marginal benefits of each are greater than their marginal cost. If so, generally we can say that the balance of monitoring and bonding might be beneficial to both principals and agents. And also we can expect the situation in which too strong monitoring by the principals might lesson the bonding efforts by the agents. In this paper, I would like to deepen the understanding of the roles and places of managements of ZAIBATSU during 1930s in addition to the situation of Japanese modern big companies, especially those of which occupied the status of followers of ZAIBATSU.