Importance of Auditing
Does Auditing Matter?
Janice Rhodora P. Carpentero
La Salle University
and
Eljoy Delos Santos
La Salle University
May 22, 2013
Does Auditing Matter?
SUMMARY: The scrutiny auditing has received post-Enron provides compelling evidence that auditing does matter, to answer the rhetorical question posed by the paper’s title. What is unclear, however, is whether auditing was sufficiently “broken” in the first place to warrant the radical reforms and changes effected by the Sarbanes-Oxley Act (SOX). Despite a relatively small number of high profile corporate failures and accounting scandals such as Enron and WorldCom, the number of demonstrated audit failures as evidenced by successful litigation or SEC sanctions approaches an annual failure rate of close to zero. In addition, our interpretation of the academic research suggests that many of the “solutions” embodied in SOX are not only unlikely to solve the profession’s alleged “problems,” they may well have serious unintended negative consequences. So the disconnect is large between the scientific evidence on audit quality and institutional changes premised on the assumption that auditing is broken. This paper attempts to stimulate research into some of the important questions implicitly raised by SOX regarding the audit profession’s potential failings. An outline of our primary observations and suggestions are presented in the paper’s Introduction.
Does Auditing Matter?
INTRODUCTION While the beginning of the 21st century has been marked by accounting scandals, a major stock market crash, and the most sweeping securities market reforms since the 1930’s, one unexpected consequence of these events is an increased awareness that auditing “matters.” In particular, regulators, market participants, and the public all seem to have a greater appreciation for the critical role auditing plays in the successful functioning of the U.S. financial markets. Along with
Janice Rhodora P. Carpentero
La Salle University
and
Eljoy Delos Santos
La Salle University
May 22, 2013
Does Auditing Matter?
SUMMARY: The scrutiny auditing has received post-Enron provides compelling evidence that auditing does matter, to answer the rhetorical question posed by the paper’s title. What is unclear, however, is whether auditing was sufficiently “broken” in the first place to warrant the radical reforms and changes effected by the Sarbanes-Oxley Act (SOX). Despite a relatively small number of high profile corporate failures and accounting scandals such as Enron and WorldCom, the number of demonstrated audit failures as evidenced by successful litigation or SEC sanctions approaches an annual failure rate of close to zero. In addition, our interpretation of the academic research suggests that many of the “solutions” embodied in SOX are not only unlikely to solve the profession’s alleged “problems,” they may well have serious unintended negative consequences. So the disconnect is large between the scientific evidence on audit quality and institutional changes premised on the assumption that auditing is broken. This paper attempts to stimulate research into some of the important questions implicitly raised by SOX regarding the audit profession’s potential failings. An outline of our primary observations and suggestions are presented in the paper’s Introduction.
Does Auditing Matter?
INTRODUCTION While the beginning of the 21st century has been marked by accounting scandals, a major stock market crash, and the most sweeping securities market reforms since the 1930’s, one unexpected consequence of these events is an increased awareness that auditing “matters.” In particular, regulators, market participants, and the public all seem to have a greater appreciation for the critical role auditing plays in the successful functioning of the U.S. financial markets. Along with
References: Abbott, L. J., S. Parker, and G. F. Peters. 2004a. Audit committee characteristics and restatements. Auditing: A Journal of Practice & Theory 23 (1): 69-87. Abbott, L. J., S. Parker, G. F. Peters, and D. V. Rama. 2004b. Audit, non-audit and information technology fees: Some empirical evidence. Working paper, University of Memphis. Agrawal, A., and S. Chadha. 2005. Corporate governance and accounting scandals. Journal of Law and Economics : Forthcoming. Anderson, R. C., S. A. Mansi, and D. M. Reeb. 2004. Board characteristics, accounting report integrity, and the cost of debt. Journal of Accounting and Economics 37 (3): 315-342. Ashbaugh, H., R. LaFond, and B. W. Mayhew. 2003. Do nonaudit services compromise auditor independence? Further evidence. The Accounting Review 78 (3): 611-639. Balsam, S., J. Krishnan, and J. S. Yang. 2003. Auditor industry specialization and earnings quality. Auditing: A Journal of Practice & Theory 22 (2): 71-97. Barton, J., and P. J. Simko. 2002. The balance sheet as an earnings management constraint. The Accounting Review 77 (Supplement): 1-27. Basu, S. 1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics 24 (1): 3-37. Basu, S., L. Hwang, and C.-L. Jan. 2001. Differences in conservatism between big eight and non-big eight auditors. Working paper, Emory University. Bazerman, M. H., G. Loewenstein, and D. A. Moore. 2002. Ambiguity in accounting and auditing. Harvard Business Review 80 (11): 97-102. Beasley, M. S. 1996. An empirical analysis of the relation between the board of director composition and financial statement fraud. The Accounting Review 71 (4): 443-465. Beasley, M. S., and S. E. Salterio. 2001. The relationship between board characteristics and voluntary improvements in audit committee composition and experience. Contemporary Accounting Research 18 (4): 539-570. Becker, C. L., M. L. DeFond, J. Jiambalvo, and K. R. Subramanyam. 1998. The effect of audit quality on earnings management. Contemporary Accounting Research 15 (1): 1-24. Bédard, J., S. M. Chtourou, and L. Courteau. 2004. The effect of audit committee expertise, independence, and activity on aggressive earnings management. Auditing: A Journal of Practice & Theory 23 (2): 13-35. Beneish, M. D. 1999. Incentives and penalties related to earnings overstatements that violate GAAP. The Accounting Review 74 (4): 425-457. Bhagat, S., and B. Black. 1999. The uncertain relationship between board composition and firm performance. Business Lawyer 54 (3): 921-963. Blue Ribbon Committee. 1999. Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. New York Stock Exchange and National Association of Securities Dealers. Burgstahler, D., and I. Dichev. 1997. Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics 24 (1): 99-126. Bushman, R., and A. Smith. 2001. Financial accounting information and corporate governance. Journal of Accounting and Economics 32 (1-3): 237-333. Carcello, J. V., and T. L. Neal. 2000. Audit committee composition and auditor reporting. The Accounting Review 75 (4): 453-467. ------. 2003. Audit committee characteristics and auditor dismissals following "new" going-concern reports. The Accounting Review 78 (1): 95-117. Choi, J., and T. Wong. 2002. Auditor choice and legal environments: An international investigation. Working paper, The Hong Kong University of Science and Technology. Chung, H. S., and S. Kallapur. 2003. Client importance, nonaudit services, and abnormal accruals. The Accounting Review 78 (4): 931-955. Cotter, J., and M. Silvester. 2003. Board and monitoring committee independence. Abacus 39 (2): 211-232. Craswell, A., D. J. Stokes, and J. Laughton. 2002. Auditor independence and fee dependence. Journal of Accounting and Economics 33 (2): 253-275. Craswell, A. T., J. R. Francis, and S. L. Taylor. 1995. Auditor brand name reputations and industry specializations. Journal of Accounting and Economics 20 (3): 297-322. Dalton, D. R., C. M. Daily, A. E. Ellstrand, and J. L. Johnson. 1998. Meta-analytic reviews of board composition, leadership structure, and financial performance. Strategic Management Journal 19 (3): 269-290. Dechow, P. M., R. G. Sloan, and A. P. Sweeney. 1996. Causes and consequences of earnings manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research 13 (1): 1-36. DeFond, M. L. 1992. The association between changes in client firm agency costs and auditor switching. Auditing: A Journal of Practice & Theory 11 (1): 16-31. DeFond, M. L., R. N. Hann, and X. Hu. 2004. Does the market value financial expertise on audit committees of boards of directors? Journal of Accounting Research : Forthcoming. DeFond, M. L., K. Raghunandan, and K. R. Subramanyam. 2002. Do non-audit service fees impair auditor independence? Evidence from going concern audit opinions. Journal of Accounting Research 40 (4): 1247-1274. Fama, E. F., and M. C. Jensen. 1983. Separation of ownership and control. Journal of Law and Economics 26 (2): 301-325. Felo, A. J., S. Krishnamurthy, and S. A. Solieri. 2003. Audit committee characteristics and the perceived quality of financial reporting: An empirical analysis. Working paper, Penn State Great Valley.