Business Commons^™

Internal Control Opinion Shopping And Audit Market Competition, Nathan J. Newton, Julie Persellin, Dechun Wang, Michael S. Wilkins

Michael S Wilkins

This study examines whether audit clients engage in internal control opinion shopping activities and whether audit market competition appears to facilitate those activities. Regulators have long been concerned about the impact of both audit market competition and opinion shopping on audit quality. We adopt the framework developed in Lennox (2000) to construct a proxy to measure the tendency that clients engage in internal control opinion shopping activities. Our empirical results suggest that clients are successful in shopping for clean internal control opinions. In addition, we find evidence that successful internal control opinion shopping occurs primarily in competitive audit markets. Finally, …

Evidence On Risk Changes Around Audit Qualification And Qualification Withdrawal Announcements, Neil Fargher, Michael Wilkins

Michael S Wilkins

Qualifications to an audit report may provide the basis for an auditor's claim that the user was warned about an unusual risk. If audit qualifications highlight changes in firm risk that are material, then the announcement of a qualification should be associated with an increase in the risk of the affected firm. In this paper, we test this proposition. Our initial tests do not detect a shift in systematic risk around qualification announcements; however, subsequent analysis shows that firms announcing recurring material uncertainties have higher levels of systematic risk than firms announcing initial qualifications. Furthermore, we document a significant decrease …

The Pricing Of Assurance Services In Secondary Equity Offerings, Neil L. Fargher, Brian W. Mayhew, Michael S. Wilkins

Michael S Wilkins

This paper examines the pricing of assurance services in secondary equity offerings (SEOs). Our empirical model extends initial public offering (IPO) fee specifications to include variables that are unique to, or more relevant for, secondary offerings. We document an inverse relationship between SEO fees and a client's ability to delay its secondary offering, suggesting that auditors do not charge as much for SEOs made by relatively mature firms. The relationship reverses, however, when the client is required to use more comprehensive types of filings (i.e., when assurance effort is higher). We also show that fees are higher when the SEO …

The Reputational Penalty For Aggressive Accounting: Earnings Restatements And Management Turnover, Hemang Desai, Chris E. Hogan, Michael S. Wilkins

Michael S Wilkins

In this paper we investigate the reputational penalties to managers of firms announcing earnings restatements. More specifically, we examine management turnover and the subsequent re-hiring of displaced managers at firms announcing earnings restatements during 1997 or 1998. In contrast to prior research (Beneish 1999 and Agrawal, Jaffe and Karpoff, 1999), which does not find increased turnover following GAAP violations or revelation of corporate fraud, we find that 60% of restating firms experience a turnover in at least one top manager within 24 months of the restatement compared to only 35% among age-, size- and industry-matched firms. Moreover, 85% of the …

Arachnophobia: A Case On Impairment And Accounting Ethics, Julie Persellin, Mike Shaub, Michael S. Wilkins

Michael S Wilkins

This case requires students to apply accounting and ethical decision-making within the context of a potential land impairment decision. Students are required to research the relevant professional literature and provide appropriate FASB Codification references and IAS cites as they investigate the significant uncertainties that frequently are associated with valuation and impairment analyses. Students also are required to evaluate the ethical implications of the decisions that could be made regarding the necessity of impairment. The case provides an opportunity for students to extend their research and financial accounting abilities, to consider the consequences associated with a set of potentially reasonable accounting …

Competition For Andersen's Clients, Mark Kohlbeck, Brain Mayhew, Pamela Murphy, Michael Wilkins

Michael S Wilkins

We examine competition for Andersen’s public clients during and after its failure in 2002. This setting provides a natural experiment to examine audit market dynamics at the local level. We construct a database documenting Big4 purchases of local Andersen offices. After exploring the factors associated with office purchases, we examine the impact of office purchases on public client market share gains and changes in audit fees. We find that three Big4 firms – Deloitte, Ernst & Young, and KPMG – purchased approximately 60% of Andersen’s offices while PricewaterhouseCoopers did not purchase any. The probability that a firm purchased a specific …

Articulation In Cash Flow Statements: A Resource For Financial Accounting Courses, Michael S. Wilkins, Martha L. Loudder

Michael S Wilkins

Recent accounting research (Bahnson, P., Miller, P., & Budge, B. (1996). Nonarticulation in cash flow statements and implications for education, research and practice. Accounting Horizons, 10, 1–15 has shown that firms implementing the indirect method for reporting cash flows under SFAS 95 rarely produce financial statements that articulate cleanly. The purposes of this paper are (1) to provide financial accounting educators with a list of companies for which articulation does exist, (2) to describe the process by which educators can update the list in the future, or modify it to suit their own preferences, and (3) to present an …

Corporate Disclosure Of The Decision To Change The Fiscal Year-End, Thomas Porter, Edward Swanson, Michael Wilkins, Lori Holder-Webb

Michael S Wilkins

This paper investigates whether registrants comply with SEC rules designed to provide timely notification and transparent disclosure of the effects of a change in fiscal year-end. For a sample of 79 firms, the Form 8-K announcement of the change was filed late 25% of the time and no announcement was available for an additional 14% of the firms. In the subsequent Form 10-K, roughly half of the firms did not report operating results for both the transition period and a comparative period from the prior year, as required by the SEC. The rate of non-compliance was higher for firms audited …

The Impact Of Audit Firm Industry Differentiation On Ipo Underpricing, Kun Wang, Michael Wilkins

Michael S Wilkins

Purpose – The purpose of this paper is to investigate the relationship between auditor industry differentiation (specialization) and the underpricing of initial public offerings (IPOs). The intention is to determine whether IPO firms – particularly those in the small firm segment of the market where information asymmetry is likely to be greatest – can benefit from significantly better IPO pricing by engaging the services of differentiated auditors. Design/methodology/approach – The paper examines a broad sample of initial public offerings made between 1991 and 2000. It also conducts univariate and multivariate tests to assess the relationship between IPO underpricing and auditor …

Timely Industry Information As An Assurance Service: Evidence On The Information Content Of The Book-To-Bill Ratio, Neil Fargher, Larry Gorman, Michael Wilkins

Michael S Wilkins

Assurance services include independent professional services that improve the quality of information. Once such service is the collection of confidential information from participating firms on behalf of an industry association and the release of summarized information to investors. An example of this type of service is the collection of industry-wide information for the Semiconductor Industry Association. The primary output from this process is the monthly release of a ratio of new orders received to chips shipped, known as the book-to-bill ratio. We evaluate the association between book-to-bill disclosures and common stock prices. Statements in the financial press suggest that the …

Refinancing Pressure And Earnings Management: Evidence From Changes In Short-Term Debt And Discretionary Accruals, L. Paige Fields, Manu Gupta, Michael S. Wilkins

Michael S Wilkins

Refinancing pressure may entice a very specific form of managerial misbehavior on the part of borrowers. Borrowers utilizing a greater amount of short term debt in one period may feel pressure to make their firms look as attractive as possible leading into the next period when refinancing may take place. In other words, potential refinancing pressure may lead managers to manipulate earnings. We examine the relation between changes in debt in current liabilities (short-term debt) and discretionary accruals as an indicator of the propensity to manage earnings. Our results show that (i) firms have higher discretionary accruals during periods of …

Initial Technical Violations Of Debt Covenants And Changes In Firm Risk, Neil Fargher, Michael Wilkins, Lori Holder-Webb

Michael S Wilkins

The purpose of this paper is to investigate whether initial technical debt covenant violations are associated with significant increases in the equity risk of violating firms. Our results indicate that first-time violations are associated with significant increases in both systematic and unsystematic risk. The increase in systematic risk is attributable primarily to rising levels of financial leverage as opposed to changes in the underlying asset beta. We also find that the change in unsystematic risk experienced by first-time debt covenant violators is a significant predictor of future exchange delisting, even after controlling for other factors typically associated with increasing financial …

Audit Firm Industry Specialization As A Differentiation Strategy: Evidence From Fees Charged To Firms Going Public, Brian W. Mayhew, Michael S. Wilkins

Michael S Wilkins

This paper examines IPO assurance fees to assess the use of industry specialization as a differentiation strategy by audit firms. Theory suggests that as an audit firm’s share of a client industry increases their costs will decrease and their service quality to that industry will increase. In this setting, the impact of industry specialization on fees is indeterminate. We extend existing theory by considering both the supply and the demand for industry specialization. We conclude that the market for audit services is generally price-competitive, suggesting that auditors will be forced to share cost savings with clients. However, when an audit …

An Investigation Of Recent Changes In Going Concern Reporting Decisions Among Big N And Non-Big N Auditors, Linda Myers, Jaime Schmidt, Michael Wilkins

Michael S Wilkins

Corporate accounting failures and regulatory proceedings that led to the enactment of the Sarbanes-Oxley Act of 2002 (SOX) increased the scrutiny of auditors. We investigate whether these events resulted in a change in auditor behavior with respect to going concern reporting. Generally speaking, we find that non-Big N auditors became more conservative while Big N auditors became more accurate. Specifically, non-Big N auditors issued more going concern opinions to both failing and non-failing clients post-2001, reducing their Type II misclassifications at the expense of increased Type I misclassifications. However, Big N auditors decreased their Type I misclassifications with no corresponding …

The Impact On Ipo Assurance Fees Of Commercial Bank Entry Into The Equity Underwriting Market, Neil Fargher, L. Fields, Michael Wilkins

Michael S Wilkins

Changes in the provisions of the United States Banking Act of 1933 have allowed the entry of commercial banks into the initial public offering (IPO) underwriting market. In this paper, we examine the effect of commercial bank equity underwriting on the fees paid to auditors. We predict that IPO assurance fees will be higher for equity offerings underwritten by commercial banks than for offerings handled by traditional underwriters because (1) commercial banks are relatively inexperienced in bringing firms public, requiring additional assistance from accounting firms in the IPO process; (2) new entrants into the underwriting market may manage lower quality …

The Importance Of Call Delays And Cash Flow Positions In Evaluating The Information Content Of Convertible Preferred Stock Calls, L. Fields, Michael Wilkins, Eric Mais

Michael S Wilkins

We examine a sample of in-the-money convertible preferred stock calls and find that they are delayed. We find that the length of the call delay does not depend on the relation between the preferred stock dividends and the pro rata common dividends to be paid on conversion. Thus, our evidence suggests that preferred stock calls may be used for signaling purposes. In support of this, we find that only delayed calls (i.e., those with potential signaling elements) are viewed negatively by equity investors. We also show that, in responding to delayed call announcements, investors appear to react to two distinct …

Technical Default, Auditors' Decisions And Future Financial Distress, Michael Wilkins

Michael S Wilkins

A study was conducted to examine auditors' responses to first-time debt covenant violations and to assess whether these responses can be employed to forecast financial distress. Data were drawn from a sample of 159 companies traded on the NYSE/AMEX or NASDAQ that had initial default dates ranging from 1978 to 1988. The findings reveal that auditors are more likely to need debt reclassification when the violations are not waived by lenders. However, the waiver decision does not seem to significantly affect the auditor's qualification decision. For companies experiencing technical default, the audit option is an important determinant of future financial …

Evidence On The Audit Risk Model: Do Auditors Increase Audit Fees In The Presence Of Internal Control Deficiencies?, Chris Hogan, Michael Wilkins

Michael S Wilkins

The article discusses the study of determining whether audit risk model is descriptive of what occurs in the auditing practice or if the relationship between fees and internal control deficiencies (ICDs) suggest that audit enterprises exert more effort in auditing firms that impart ICDs. The study examines the internal controls over financial reporting (ICOFR), generally accepted accounting principles (GAAP), audit risk model, audit fees and sections of Sarbanes-Oxley Act. The study found out that audit fees are significantly higher for firms disclosing material weakness.

Internal Control Opinion Shopping And Audit Market Competition, Nathan J. Newton, Julie Persellin, Dechun Wang, Michael S. Wilkins

Michael S Wilkins

This study examines whether audit clients engage in internal control opinion shopping activities and whether audit market competition appears to facilitate those activities. Regulators have long been concerned about the impact of both audit market competition and opinion shopping on audit quality. We adopt the framework developed in Lennox (2000) to construct a proxy to measure the tendency that clients engage in internal control opinion shopping activities. Our empirical results suggest that clients are successful in shopping for clean internal control opinions. In addition, we find evidence that successful internal control opinion shopping occurs primarily in competitive audit markets. Finally, …

Auditor Perceptions Of Audit Workloads, Audit Quality, And The Auditing Profession, Julie Persellin, Jaime Schmidt, Michael Wilkins

Michael S Wilkins

In this study, we use a survey instrument to obtain perspectives from over 700 auditors about present-day audit workloads, the relationship between audit workloads and audit quality, and auditing as a career. Our findings indicate that auditors are working, on average, five hours per week above the threshold at which they believe audit quality begins to deteriorate and often 20 hours above this threshold at the peak of busy season. We find that auditors perceive workload fatigue as having the largest negative impact on morale, and understaffing and staff turnover as being two of the biggest impediments to delivering a …

Internal Control Disclosures, Monitoring, And The Cost Of Debt, Dan Dhaliwal, Chris Hogan, Robert Trezevant, Michael Wilkins

Michael S Wilkins

We test the relationship between the change in a firm's cost of debt and the disclosure of a material weakness in an initial Section 404 report. We find that, on average, a firm's credit spread on its publicly traded debt marginally increases if it discloses a material weakness. We also examine the impact of monitoring by credit rating agencies and/or banks on this result and find that the result is more pronounced for firms that are not monitored. Additional analysis indicates that the effect of bank monitoring appears to be the primary driver of these monitoring results. This finding is …

Bringing Darkness To Light: The Influence Of Auditor Quality And Audit Committee Expertise On The Timeliness Of Financial Statement Restatement Disclosures, Jaime Schmidt, Michael Wilkins

Michael S Wilkins

This study investigates whether auditor quality and audit committee expertise are associated with improved financial reporting timeliness as measured by the duration of a financial statement restatement’s ‘‘dark period.’’ The restatement dark period represents the length of time between a company’s discovery that it will need to restate financial data and the subsequent disclosure of the restatement’s effect on earnings. For a sample of dark restatements disclosed between 2004 and 2009, we find that companies that engage Big 4 auditors have shorter dark periods than companies that do not engage Big 4 auditors. We also find that companies with more …

The Interaction Among Multiple Governance Mechanisms At Young, Newly Public Firms, Tammy K. Berry, L. Paige Fields, Michael S. Wilkins

Michael S Wilkins

We focus on the relations among inside ownership, board composition, unaffiliated block ownership, and compensation structure for a sample of firms following their IPOs. Specifically, we follow firms for up to eleven years after their IPOs and examine the full sample and subsamples of firms that survive, are acquired, or that file for bankruptcy during the sample period. We find that as CEO ownership declines, board independence, board seats held by venture capitalists, and unaffiliated block ownership increase. Our findings suggest that as inside ownership decreases alternative governance mechanisms evolve to help mitigate the resulting increase in agency costs. Interestingly, …

An Investigation Of The Pricing Of Audit Services For Financial Institutions, L. Fields, Donald Fraser, Michael Wilkins

Michael S Wilkins

In this paper we investigate audit pricing for financial institutions. We modify the standard audit fee model for industrial companies by incorporating measures of risk and complexity that are either unique to or more relevant for banks, and that are used by bank regulatory agencies. For a sample of 277 financial institutions in fiscal 2000, we find that audit fees are higher for banks having more transactions accounts, fewer securities as a percentage of total assets, lower levels of efficiency, and higher degrees of credit risk. Higher fees also obtain for savings institutions, for banks that are more involved in …

The Information Content Of Withdrawn Audit Qualifications: New Evidence On The Value Of "Subject-To" Opinions, L. Paige Fields, Michael S. Wilkins

Michael S Wilkins

Statement on Auditing Standards No. 58 (AICPA 1988) effectively eliminated the "subject-to" audit opinion which auditors used to highlight financial statement uncertainties. Elimination of the "subject-to" report implied the Auditing Standards Board's belief that the opinion conveyed no material information to users. Several market-based studies of the value of "subject-to" opinions have yielded mixed results. A major limitation in most of these studies was a lack of precision in identifying the exact date upon which information, if any, was revealed to the market.

This study extends the previous work by examining the common share price reactions to public announcements of …

An Empirical Investigation Of Stock Dividends-In-Kind, L. Fields, Michael Wilkins

Michael S Wilkins

We investigate share price reactions to announcements of dividends payable in the common stock of corporations different from the issuing firm. We find that firms that declare these dividends (typically investment companies) experience positive abnormal returns upon announcement. We also find that such dividends are more likely to be declared when the shares to be distributed have peaked in value. Consistent with this finding, we document negative announcement-period abnormal returns for firms having their shares distributed. Additional tests reveal that prices respond more negatively when the information signal is strongest, when outside ownership is more dispersed, and when management is …

Does A Lack Of Choice Lead To Lower Quality?: Evidence From Auditor Competition And Client Restatements, Nathan Newton, Dechun Wang, Michael Wilkins

Michael S Wilkins

We examine the relationship between auditor competition and the likelihood of financial restatements that occur as a result of failures in the application of GAAP. Policy makers and audit market participants have expressed concern that the current level of auditor competition is low, resulting in a negative impact on audit quality. However, we find that restatements are more likely to occur in metropolitan statistical areas (MSAs) that have higher auditor competition. The association between audit market competition and restatements is statistically and economically significant. Our finding that audit quality is higher when auditor competition is lower suggests that at least …

Tests Of A Deferred Tax Explanation Of The Negative Association Between The Lifo Reserve And Firm Value, Dan Dhaliwal, Robert Trezevant, Michael S. Wilkins

Michael S Wilkins

Guenther and Trombley (1994) and Jennings, Simko, and Thompson (1996) document a negative association between a firm's last-in, first-out (LIFO) reserve and the market value of its equity. In this paper, we test a deferred tax explanation of this negative association. Specifically, we argue that investors, conditional on adjusting inventory to as-if first-in, first-out (FIFO), estimate a firm's future LIFO liquidation tax burden as its LIFO reserve multiplied by the appropriate corporate tax rate and include this tax-adjusted LIFO reserve in the valuation of a LIFO firm's net assets. On the basis of this argument, the tax-adjusted LIFO reserve is …

The Incremental Information Content Of Sas No. 59 Going-Concern Opinions, Lori Holder-Webb, Michael Wilkins

Michael S Wilkins

The purpose of this paper is to evaluate whether the expanded requirements of SAS No. 59 (A/CPA [1988]), which requires auditors to actively evaluate and report on a client's going-concern status for the coming year, have allowed investors to make more accurate ex ante assessments of firms that eventually file for bankruptcy. We extend Chen and Church [1996] (hereafter CC), who conclude that SAS No. 34 (AICPA [1981]) "subject to" going-concern opinions have information value because they reduce the surprise associated with bankruptcy announcements. We hypothesize that if SAS No. 59 has achieved what was intended, going-concern opinions issued under …