The State of the Literature on the Effect of Auditors’ Mindset on Audit Quality: Implications for Practice

This paper examines how individual auditors’ selection of specific key audit matter (KAM) subjects reveals their audit quality. Specifically, we find that auditors reporting more auditor-specific or less entity-specific KAMs offer lower audit quality. Moreover, we find that auditors who report more KAMs involving high measurement uncertainty, including the valuation and impairment of goodwill and long-lived operating assets, contingencies, and the capitalization of certain expenditures, fail to offer high audit quality. Our study leverages KAM reports to open up the black box of the audit process and examines how auditors’ focus on different KAM subjects signals varying levels of audit quality. This provides new insight into the information conveyed by KAM disclosure and responds to the call of prior research to go beyond demographic data to explain the variation in individual auditors’ audit quality.

Synopsis The research problem This study investigates whether auditors who participate in philanthropic activities (hereafter “philanthropic auditors”) have stronger incentives to deliver high-quality audits than the auditors who do not participate. Motivation Prior studies call for research that examines the difference in audit quality across individual auditors. In recent years, regulators in developed markets, such as the United States and the European Union, have also promulgated new regulations requiring audit firms or public companies to disclose the names of engagement partners. Another growing body of literature examines the effect of economic agents’ personal traits on their decisions and/or firm policies and practices. By examining the impact of individual auditors’ unobservable personal traits on audit quality, measured through their philanthropic actions, we link and contribute to both streams of the above literature. The test hypotheses We test a null hypothesis in this study: individual auditors’ philanthropic activity is not related to their audit quality. Target population Stakeholders of high-quality auditing including accounting regulators, audit firm partners, and company managers. Adopted methodology Ordinary least squares (OLS) regressions and archival data. Analyses In a sample of more than 19,000 Chinese firm-years from 2008 to 2017, we identified 9.40% of the observations were signed by at least one auditor who contributes either money or time to a charitable activity. We used two measures of audit quality: the propensity to issue modified audit opinions (MAOs) and unsigned abnormal discretionary accruals. Findings First, we find that philanthropic auditors are significantly more likely to issue MAOs than are their non-philanthropic counterparts. Second, they are more likely to issue MAOs to distressed companies but not to financially healthy companies. The higher propensity of philanthropic auditors to issue MAOs indicates higher audit quality rather than a higher level of audit conservatism. Third, financial statements audited by philanthropic auditors contain significantly lower discretionary accruals (DACC). Fourth, to mitigate the concern that endogeneity drives our findings, we implement the propensity score matching (PSM) approach and the client fixed effects model. Our finding that philanthropic auditors provide higher-quality audit services than other auditors holds. Fifth, the main results are robust to the inclusion of other individual auditor characteristics, such as gender, educational background, and political affiliation, and to several proxies for individual auditors’ wealth.

Do Individual Auditors Affect Audit Quality? Evidence from Archival Data

The objective of this paper is to investigate whether and how the social ties between individual auditors and client chief executive officers (CEOs)/chief financial officers (CFOs) affect audit quality using a large sample of publicly traded firms in China. We define social ties between individual auditors and client CEOs/CFOs as ‘working or educational alumni.’ We find that clients with social ties are significantly and positively associated with abnormal accruals and the presence of reporting small profits, and are more likely to receive clean audit opinions compared to clients without social ties. Moreover, we find that the working-tie effect on audit quality is stronger than the school-tie effect. Furthermore, we find that socially connected clients are more likely to downward restate their audited earnings in subsequent years. In addition, we find that the social-tie effect on audit quality can be mitigated by several personal characteristics of individual auditors, such as partner, female, accounting major, auditing experience, etc. Overall, our study sheds new light on the impact of social ties between individual auditors and client executives on audit quality.

ABSTRACT: We examine whether and how individual auditors affect audit outcomes using a large set of archival Chinese data. We analyze approximately 800 individual auditors and find that they exhibit significant variation in audit quality. The effects that individual auditors have on audit quality are both economically and statistically significant, and are pronounced in both large and small audit firms. We also find that the individual auditor effects on audit quality can be partially explained by auditor characteristics, such as educational background, Big N audit firm experience, rank in the audit firm, and political affiliation. Our findings highlight the importance of scrutinizing and understanding audit quality at the individual auditor level. Data Availability: Data used in this study are publicly available from the sources described herein.

This mixed‐methods study investigates whether individual auditors' career advancements to more prestigious audit firms can predict their audit quality. Using hand‐collected data on more than 2,000 audit partners from professional networking website profiles, I identify audit partners with advancements from less to more prestigious audit firms and empirically test whether these upward trajectories predict audit partner quality. I find that these audit partners provide higher‐quality audits, as evidenced by discretionary accruals and going‐concern opinions. These results are robust to audit partner changes, entropy balancing, and other sensitivity analyses. Moreover, clients of these partners report more conservative financial statements. The qualitative results from 10 semistructured audit partner interviews indicate that audit partners enter the auditing labor market at less prestigious firms due to both internal factors (e.g., late entry into the job market, location preferences) and external factors (e.g., poor market conditions/recessions or lack of Big N recruitment). In fact, their choice to make upward advancements results from both work considerations, such as limited growth opportunities, feeling unchallenged in their previous roles, and the desire to specialize, alongside nonwork considerations, such as audit firm culture and reducing commute/travel time for client work. Taken together, the evidence suggests that these significant upward career transitions represent market corrections of initial auditing labor markets and that such transitions may be of interest to investors, regulators, audit committees, and academics.

Audit firm informatization and audit quality during COVID-19

ABSTRACTOur paper examines whether audit quality is higher for industry audit specialists at the national and city‐office levels using the framework developed in Ferguson et al. [2003] and Francis et al. [2005]. We find that auditors who are both national and city‐specific industry specialists have clients with the lowest abnormal accruals, suggesting that joint national and city‐specific industry specialists have the highest audit quality. In addition, we find some evidence that abnormal accruals of firms audited by city‐industry specialists alone (without also being national specific industry specialists) are lower than those audited by nonindustry specialists. Using alternative measures of audit quality, we find that when the auditor is both a national and a city‐specific industry specialist, its clients are less likely to meet or beat analysts' earnings forecasts by one penny per share and more likely to be issued a going‐concern audit opinion. Together these results provide consistent evidence that audit quality is higher when the auditor is both a national and city‐specific industry specialist, suggesting that auditors' national positive network synergies and the individual auditors' deep industry knowledge at the office level are jointly important factors in delivering higher audit quality.

There is a recent call from academics to study audit quality at individual auditor level. This study analyses the relationship between different audit quality measures using Finnish data from individual auditors. Several measures (peer-review grade, compliance with audit standards, discretionary accruals and going concern opinions) are used to capture audit quality. Four hypotheses are developed to assume positive relationships between the audit quality measures. Furthermore, one hypothesis is drawn for the relationship between the measures and a set of auditor characteristics (audit quality input measures). These hypotheses are assessed by correlation and factor analyses using data from 172 Finnish individual auditors. Empirical findings contradict many of the hypotheses indicating strong positive relationship between the measures of peer-review grade and compliance with standards but only loose relationships between other classes of measures. They also indicate that auditor characteristics are only weakly associated with quality outcome measures.

There is a recent call from academics to study audit quality at individual auditor level. This study analyses the relationship between different audit quality measures using Finnish data from individual auditors. Several measures (peer-review grade, compliance with audit standards, discretionary accruals and going concern opinions) are used to capture audit quality. Four hypotheses are developed to assume positive relationships between the audit quality measures. Furthermore, one hypothesis is drawn for the relationship between the measures and a set of auditor characteristics (audit quality input measures). These hypotheses are assessed by correlation and factor analyses using data from 172 Finnish individual auditors. Empirical findings contradict many of the hypotheses indicating strong positive relationship between the measures of peer-review grade and compliance with standards but only loose relationships between other classes of measures. They also indicate that auditor characteristics are only weakly associated with quality outcome measures.

This paper studies the role of the financial comment letter (CL) in auditing by investigating how CLs affect auditors’ performance. We find that the CL can stimulate auditors to improve audit quality and that the result mainly derives from the individual auditor level. Considering geographic proximity, our results show that the positive influence of CLs on audit quality is more pronounced when auditors are located closer to their clients and regulators. Additional analyses indicate that individual auditors’ independence and industry specialization can strengthen the relationship between commented auditors and audit quality. Our results suggest that CLs can motivate better audit outcomes and that geographic proximity can further influence the effect of CLs on audit quality.

Does auditing multiple clients affiliated with the same business group reduce audit quality? Evidence from an emerging market

Purpose This paper aims to investigate whether and how air pollution affects auditor behavior and audit quality. Specifically, the authors draw from studies of behavioral economics and psychology to develop a new prediction that air pollution-induced negative mood causes pessimistic bias in auditors’ risk assessments of client firms, which motivates them to put more effort into achieving higher audit quality. Design/methodology/approach This study uses a sample of Chinese public firms for the period 2013 to 2018 and an ordinary least squares model to examine the effects of air pollution on audit quality. Findings The results suggest that auditors exposed to higher levels of air pollution are more likely to put more effort into their audits, resulting in higher audit quality. Furthermore, the impacts of air pollution on audit quality are more pronounced when an auditor has a higher level of education, a major in accounting or a related subject and a position as a partner. A series of identification tests and sensitivity tests further support the main findings. Practical implications This study provides deeper insight into how air pollution affects auditors’ decision-making through its effect on mood. Social implications The findings have broad potential implications for auditing and other high-skill professions. Because air pollution-induced negative mood is a common occurrence and numerous psychological experiments have demonstrated the potentially adaptive and beneficial role of negative mood in decision-making for professions like auditing that need a more conservative, alert and detail-oriented cognitive style, negative mood may to some extent facilitate decision-making. Professionals may benefit from paying closer attention to the adaptive benefits of different moods. Originality/value Few studies empirically discuss the effects of auditors’ psychology on audit outcomes. This study responds to this research gap with analyzes of how air pollution-induced negative mood can affect auditors’ professional judgment and audit outcomes. Further, this study adds to the growing literature that examines how air pollution affects various aspects of the economy and enriches the literature on behavioral economics, providing empirical evidence from a large sample of the effects of an environmental stressor on individual auditors’ professional judgment.

Synopsis The research problem Adding to the literature in auditing, this study examines whether there is an association between the religious beliefs of audit partners and audit quality in Taiwan. Motivation Previous studies have found that firms headquartered in areas with strong religious social norms are associated with higher audit quality. However, prior studies measured religiosity in terms of whether the audit practice offices were in more religious metropolitan statistical areas. No work had examined whether the religious beliefs of the individual auditors affect auditor decision making. In addition, prior studies using US data were mainly confined to one group who are, in the main, Christians. We examined this issue in Taiwan where the auditors come from three main religious groups: Christian, Buddhist, and Taoist. This setting provides another cultural environment for understanding the links between religiosity and financial reporting issues. The test hypotheses H1: Audit engagement partners with a religious belief are associated with higher audit quality. H2: The positive association between auditors’ religion and audit quality is more pronounced for auditors with industry specialization than auditors without specialization. Target population Various stakeholders include investors, auditors, financial analysts, and users of financial reports. Adopted methodology Ordinary least squares (OLS) regression and logistics regression. Analyses We conducted the study in Taiwan where audit partners are required to sign audit reports. We obtained data on the religious beliefs of auditors by distributing a questionnaire to individual auditors in the Big 4 in Taiwan. We used four measures of audit quality: (a) discretionary accruals, (b) accrual estimation errors, (c) the probability of a client meeting an earnings benchmark, and (d) the propensity to issue modified audit opinions. We tested whether there is a positive association between auditors’ religious beliefs and audit quality. Findings Our study finds that firms with an audit partner who professes a religion are associated with higher audit quality. However, unlike evidence from the United States, we do not find that auditors in an area with strong religious social norms exhibit better audit quality than auditors in less religious areas when the audit partner’s religious belief is controlled in the analysis. The results suggest that auditor quality is more affected by auditor’s personal characteristics than the social norms. We also find that the positive association between auditors with industry specialization and audit quality is stronger when the auditor has religious beliefs. The results suggest that ethics and competence are complements to each other.

Do auditors’ early-life socioeconomic opportunities improve audit quality? Evidence from China