Conference on Regulation and
the Audit Industry
Audit Partner Disclosure: Potential
Implications for Investor Reaction
and Auditor Independence
Tamara A. Lambert
Benjamin L. Luippold
Chad M. Stefaniak
Outline
Tamara
Ben
• PCAOB
• Hypotheses
• Method
– Audit partner disclosure
– Proponents / opponents
• Where disclosure occurs
• Research question
• Model of audit
independence
– Three propositions
–
–
–
–
Participants
Procedures
Design
Variables
• Results
– Investment choice
• Allocation
– Mediation analysis
– Experience
• Conclusion
2
PCAOB: Audit Partner Disclosure
3
PCAOB: Audit Partner Disclosure
Proponents
Opponents
4
Where Partner Disclosure Occurs
5
Will disclosing the identity of the audit partner in
the audit report lead to improved audit quality /
investor protection?
Research Question
Model:
Audit Partner
Identity
Disclosure
Potential Audit
Partner
Independence
Impairment
• Audit partner disclosure may lead to independence
impairment
• Three propositions
7
Model: Proposition 1
Audit Partner
Identity
Disclosure
Fusing of
Partner
Reputation
with Client
• No well-calibrated measures available (Francis 2004)
• Accounting information transfer (Gleason et al. 2008)
• Representativeness heuristic (Kahneman 2011)
8
Model: Proposition 2
Audit Partner
Identity
Disclosure
Fusing of
Partner
Reputation
with Client
Audit Partner
Incentive Shift
• Ill-informed partner-related inferences may lead to
– Increased focus on individual reputation
– Client attraction / retention concerns
• Audit / earnings quality proxies used by academics
9
Model: Proposition 3
Audit Partner
Identity
Disclosure
Fusing of
Partner
Reputation
with Client
Audit Partner
Incentive Shift
Potential Audit
Partner
Independence
Impairment
• Auditors role to reduce information risk
– Conflicting investor / management incentives
• Increased prominence of individual reputation
– Implicit permission for individuals to act in their own
interests (Hunton et al. 2011)
10
Hypothesis 1
• Information transfer as a proxy for reputation fusing
• Negative information is contagious
– Firms within an industry (Gleason et al. 2008)
– Firms audited by Arthur Andersen (Huang and Li 2009)
– Firms that share a common director (Chen and Goh 2010)
• Representativeness may play a role (Kahneman 2011)
11
Audit partner identity disclosure will result in
partner-based (reputational) information transfer
between reporting entities.
Hypothesis 1
Hypothesis 2
• Would partner disclosure require other changes to
audit report? (PCAOB 2009)
– Partner signing firm’s name is evidence that audit report is
product of the firm (PCAOB 2008, 2009)
– Partner disclosure could confuse investors about what
audit opinion means
• Less knowledge = more reliance on
representativeness (Gigerenzer and Goldstein 1996)
13
Modifying the audit report with language intended
to highlight the audit firm’s responsibility for the
audit will reduce the amount of partner-based
(reputational) information transfer resulting from
audit partner identity disclosure.
Hypothesis 2
Method: Participants
380 participants
All have investing experience
15
Method: Procedure
Company
Amer.
Comp.
Comp.
World
Elec.
USA
US
Tech.
Wired
States
Big 4 Firm
Firm ABC
Firm ABC
Firm DEF
Firm DEF
Firm DEF
2.35
2.25
2.37
2.38
2.23
28
32
27
25
39
Return on
Assets
12.3
9.8
12.6
12.9
8.1
Profit
Margin
14.5
11.4
14.7
14.8
8.3
Market
Share
8.41
6.74
8.5
8.7
5.53
Current
Ratio
Days Sales
of Inventory
16
Method: Procedure
Company
Amer.
Comp.
Comp.
World
Elec.
USA
US
Tech.
Wired
States
Big 4 Firm
Firm ABC
Firm ABC
Firm DEF
Firm DEF
Firm DEF
2.35
2.25
2.37
2.38
2.23 → 1.97
28
32
27
25
39 → 65
Return on
Assets
12.3
9.8
12.6
12.9
8.1 → 4.8
Profit
Margin
14.5
11.4
14.7
14.8
8.3 → 5.0
Market
Share
8.41
6.74
8.5
8.7
5.53 → 5.22
Current
Ratio
Days Sales
of Inventory
17
Method: Procedure
Company
Amer.
Comp.
Comp.
World
Elec.
USA
US
Tech.
Wired
States
Big 4 Firm
Firm ABC
Firm ABC
Firm DEF
Firm DEF
Firm DEF
Audit
Partner
David
Lastings
David
Lastings
James
Keaton
Thomas
Edwards
Thomas
Edwards
Current
Ratio
2.35
2.25
2.37
2.38
2.23 → 1.97
28
32
27
25
39 → 65
Return on
Assets
12.3
9.8
12.6
12.9
8.1 → 4.8
Profit
Margin
14.5
11.4
14.7
14.8
8.3 → 5.0
Market
Share
8.41
6.74
8.5
8.7
5.53 → 5.22
Days Sales
of Inventory
18
Method: Procedure
Audit Opinion Note. Each audit firm stresses in its
audit reports that while the audit opinion is signed
by both the audit partner and the audit firm, the
audit opinion represents that of the entire firm.
Additionally, each firm notes that the audit involves
many firm employees and includes technical
guidance and other resources from its national
headquarters.
19
Method: Experimental Design
Firm Name
Firm and
Partner
Name
Firm Name
and
Modification
Firm Name,
Partner
Name, and
Modification
20
Method: Variables
Main Variables
• Investment choice
• Investment allocation
• Restatement likelihood
Supplemental Variables
•
•
•
•
•
•
•
•
•
•
Financial information importance
Fault (company, firm, partner)
Influence of restatement
Familiarity w/ financial
information & auditing
Attention checks
Investment experience
Experience w/ financial
information
Job title / employer
Gender
Age
21
Results: Investment Choice
Firm Name
Partner Name
Report
Modification
American Computers
10.1%
9.0%
14.1%
Computer World
3.4%
4.5%
3.9%
Electronics USA
14.3%
17.3%
18.8%
US Technologies
67.2%
58.6%
57.8%
Wired States
5.1%
10.5%
5.5%
(n=119)
(n=133)
(n=128)
22
Results: Investment in US Tech.
75%
70%
65%
60%
55%
50%
Firm Name
Partner Name
Modification
23
Results: Investment in US Tech.
𝐼𝑁𝑉𝐸𝑆𝑇_𝑈𝑆𝑇
= 𝛽0 + 𝛽1 𝑃𝐴𝑅𝑇𝑁𝐸𝑅 + 𝛽2 𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝛽3 𝑄𝑈𝐴𝐿 + 𝛽4 𝐴𝑇𝑇𝐸𝑁𝐷_𝑃𝐴𝑅𝑇𝑁𝐸𝑅
+ 𝛽5 𝐴𝑇𝑇𝐸𝑁𝐷_𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝜀𝐼
Variable
Expected Sign
Intercept
+
PARTNER
-
REPORT_MOD
+
QUAL
?
ATTEND_PARTNER
?
ATTEND_REPORT_MOD
?
Coefficient
(S.E.)
0.916
(0.519)
-0.561
(0.310)
-0.200
(0.287)
-1.020
(0.473)
0.675
(0.277)
1.051
(0.519)
24
Results: Allocation in US Tech.
𝐴𝑙𝑙𝑜𝑐_𝑈𝑆𝑇
= 𝛽0 + 𝛽1 𝑃𝐴𝑅𝑇𝑁𝐸𝑅 + 𝛽2 𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝛽3 𝑄𝑈𝐴𝐿 + 𝛽4 𝐴𝑇𝑇𝐸𝑁𝐷_𝑃𝐴𝑅𝑇𝑁𝐸𝑅
+ 𝛽5 𝐴𝑇𝑇𝐸𝑁𝐷_𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝜀𝐼
Variable
Expected Sign
Intercept
+
PARTNER
-
REPORT_MOD
+
QUAL
?
ATTEND_PARTNER
?
ATTEND_REPORT_MOD
?
Coefficient
(S.E.)
33.165
(4.367)
-5.543
(2.912)
1.683
(2.831)
-3.902
(3.714)
5.224
(2.724)
9.895
(2.389)
25
Results: Mediation Analysis
b = 0.611
(p = 0.057)
RESTATE_UST
b = -0.113
(p = 0.022)
b = -0.559
(p = 0.041)
PARTNER
INVEST_UST
b = -0.509
(p = 0.059)
26
Results: Invest. in US Tech. by Exp.
Less Experienced Investors
More Experienced Investors
80%
80%
75%
75%
70%
70%
65%
65%
60%
60%
55%
55%
50%
50%
27
Results: Invest. in US Tech. by Exp.
𝐼𝑁𝑉𝐸𝑆𝑇_𝑈𝑆𝑇
= 𝛽0 + 𝛽1 𝑃𝐴𝑅𝑇𝑁𝐸𝑅 + 𝛽2 𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝛽3 𝑄𝑈𝐴𝐿 + 𝛽4 𝐴𝑇𝑇𝐸𝑁𝐷_𝑃𝐴𝑅𝑇𝑁𝐸𝑅
+ 𝛽5 𝐴𝑇𝑇𝐸𝑁𝐷_𝑅𝐸𝑃𝑂𝑅𝑇_𝑀𝑂𝐷 + 𝜀𝐼
Less Experienced Investors
Variable
Expected Sign
Intercept
+
PARTNER
-
REPORT_MOD
+
QUAL
?
ATTEND_PART
NER
ATTEND_REP
ORT_MOD
?
?
Coefficient
(S.E.)
1.589
(0.871)
-0.890
(0.481)
0.273
(0.435)
-1.401
(0.793)
0.891
(0.404)
0.646
(0.871)
More Experienced Investors
Variable
Expected Sign
Intercept
+
PARTNER
-
REPORT_MOD
+
QUAL
?
ATTEND_PART
NER
ATTEND_REPO
RT_MOD
?
?
Coefficient
(S.E.)
0.533
(0.716)
-0.380
(0.540)
-0.930
(0.500)
-0.474
(0.635)
0.542
(0.502)
1.602
(0.431)
28
Conclusions
• Model
– Partner disclosure will fuse reputation with client
– Fusing will shift audit partner incentives
– Shift of incentives may impair independence
• Experiment
– Partner disclosure results in information transfer
– Contagion not mitigated by our report
modification
29
Conference on Regulation and
the Audit Industry
Thank you
Tamara A. Lambert
Benjamin L. Luippold
Chad M. Stefaniak