Studies Make a Case for Engagement Partner Identification

By Jason Bramwell
 
Three research studies  two of which were published recently in an American Accounting Association (AAA) journal and the other presented during an academic accounting conference last month  make a case for requiring audit engagement partner identification in the audit report, an issue the Public Company Accounting Oversight Board (PCAOB) is expected to discuss by the end of the year.
 
The three studies examine whether knowing the name of the engagement partner leading an auditing effort is valuable to investors and whether being required to provide this information enhances the performance of engagement partners. The studies specifically focus on Sweden, China, and the United Kingdom, each of which requires identification of lead auditors in company financial statements.
 
The PCAOB may reexamine a proposal before the end of this year that could require disclosure of the engagement partner's name in the audit report. The PCAOB may also require disclosure in the audit report of other accounting firms and other persons not employed by the auditor who took part in the audit.
 
According to the PCAOB standard-setting agenda dated June 30, 2013, the project, "Audit Transparency: Identification of the Engagement Partner and Other Public Accounting Firms or Persons That Are Not Employed by the Auditor but Participate in the Audit," is scheduled for adoption or re-proposal sometime between now and December.
 
Does Engagement Partner Identity Matter?
The first study, Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions, which was presented during the Canadian Academic Accounting Association's 28th Annual Contemporary Accounting Research Conference on October 25, is based on an analysis of audits performed over a seven-year period by the Swedish subsidiaries of the Big Four accounting firms.
 
The authors of the study  W. Robert Knechel, Ann Vanstraelen, and Mikko Zerni  made the following three conclusions:
  1. That aggressive or conservative reporting is associated with the particular engagement partners who head the audits over and above any influence of the Big Four firms that employ them.
  2. That these individual differences in reporting style persist over time and across clients.
  3. That they contribute significantly to such economic factors as the credit ratings that client firms receive and how they are assessed by stock investors.
"A firm audited by an engagement partner who is consistently aggressive is more likely than other companies  other factors being equal  to be penalized through higher interest rates, lower credit ratings, and greater perceived likelihood of insolvency," Knechel, a professor in the Fisher School of Accounting at the University of Florida Warrington College of Business Administration and editor of Auditing: A Journal of Practice and Theory, published by the AAA, said in a written statement. "If the company is public, it is also likely to be penalized by a lower Tobin's Q  a measure that reflects investor approval of a firm and optimism about its prospects. In short, we find that the reporting differences of lead auditors have a significant effect on both the lending and equity markets."
 
The authors reviewed the accounting styles of auditors  both aggressive and conservative  in two specific ways:
  1. Through their propensity to issue going concern opinions (the warnings about firms' future viability that auditors insert in financial reports of distressed companies).
  2. By their tendency to err on the high or low side in estimating the value of accruals (noncash items, such as accounts receivable or inventory).
The authors found that some auditors failed to issue going concern opinions for firms that went bankrupt a year or less later, a tendency that the authors equated with aggressiveness. An auditor with a prior history of frequently erring in this way were three to four times more likely of doing it again in a subsequent year than an auditor without that history.
 
"Collectively, the findings of this paper emphasize the importance of analyzing audit quality at the level of the individual auditor and contribute to the limited, but growing, evidence that the characteristics of individual auditors effect audit outcomes," the authors concluded in the study. "Because the auditor's reputation is a potentially critical aspect of audit quality, the reported findings should be of interest to practitioners, regulators, academics, and users of financial statements. Specifically, our results imply that the identity of the engagement partner matters to the market." 

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