Hyeesoo (Sally) Chung, Jong-Yu Paula Hao and Jinyoung Wynn
This paper aims to examine the effect of executive compensation incentives, specifically CEO inside debt holdings, on the choice of industry specialist auditor.
Abstract
Purpose
This paper aims to examine the effect of executive compensation incentives, specifically CEO inside debt holdings, on the choice of industry specialist auditor.
Design/methodology/approach
High inside debt holdings are expected to constrain excessive managerial risk-taking and align the interests of managers and outside debtholders. The authors hypothesize that reduced debtholders’ expropriation concerns will decrease the demand for high audit quality, measured by industry specialization. The authors investigate a sample of US firms from 2006 to 2018 using OLS regression and use CEO relative leverage to proxy for CEO inside debt holdings. The authors conduct an additional two-stage least squares regression analysis to address potential endogeneity issues.
Findings
The paper finds that firms with higher levels of CEO inside debt tend not to appoint an auditor with industry specialization. This result is consistent with the notion that inside debt mitigates agency conflicts between managers and debtholders, reducing the demand for high-quality audits as a monitoring mechanism. The paper also finds that among firms which are excessively leveraged, those with higher levels of CEO inside debt tend to appoint an industry specialist auditor.
Originality/value
The findings contribute to the literature on agency cost and auditor choice by demonstrating that CEO inside debt has both substitutive and complementary effects on demand for industry specialist auditors.
Details
Keywords
Hyeesoo (Sally) Chung, Sudha Krishnan, John Lauck and Jinyoung Wynn
This paper aims to investigate whether the stock market reacts to presentation options available to auditors under AS 2 (providing separate financial statement audit and internal…
Abstract
Purpose
This paper aims to investigate whether the stock market reacts to presentation options available to auditors under AS 2 (providing separate financial statement audit and internal control over financial reporting [ICOFR] audit reports, or presenting a combined report with both audit opinions).
Design/methodology/approach
Drawing on psychology theory, the authors hypothesize that presenting material weaknesses in ICOFR with an unqualified financial statement audit in a combined report effectively dilutes the weight placed on the material weaknesses perceived by investors. The authors further hypothesize the presentation format effect to vary by type of material weaknesses since some material weaknesses are considered more serious than others. The authors examine ICOFR and audit reporting and cumulative abnormal return data from 2007 to 2017 using two-stage least squares regression analysis.
Findings
The results show that a combined report of ineffective ICOFR and unqualified financial statement audit reduces the negative impact of material weakness disclosures on stock price reactions, but only when the weaknesses involve more serious entity-wide controls, as opposed to controls over specific accounts.
Practical implications
The findings help inform preparers, auditors, regulators and investors about the potentially unintended consequences of reporting format choice.
Originality/value
The findings contribute to the literature on internal control disclosures by demonstrating that market reactions to these disclosures depend not only on the types of material weaknesses disclosed but also on their presentation format.
Details
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Yiwen Li, You-il Park and Jinyoung Wynn
The purpose of this paper is to investigate investor reactions to financial restatements conditional on disclosures of internal control weaknesses under Section 404 of the…
Abstract
Purpose
The purpose of this paper is to investigate investor reactions to financial restatements conditional on disclosures of internal control weaknesses under Section 404 of the Sarbanes-Oxley Act.
Design/methodology/approach
The research uses cumulative abnormal stock returns (CARs) as a proxy for investor reactions. Restatements and internal control reports are available on audit analytics. Multivariate regression analyses were used for testing.
Findings
Using a sample of restating firms whose original misstatements are linked to underlying internal control weaknesses, the research finds that cumulative abnormal returns for firms disclosing internal control weaknesses in a timely manner is negative in a three-day window around the restatement announcements. The finding indicates that restatements with early disclosure of internal control weaknesses provide more persuasive evidence of the ineffectiveness of a firm’s internal control over financial reporting, rather than early disclosure lowering the information asymmetry between a firm and investors.
Research limitations/implications
This study employs CARs to examine the market reaction to restatements conditional on disclosure of internal control weaknesses.
Practical implications
Further study on reactions by creditors who have access to private information on firms could extend the implications of the finding.
Originality/value
The study contributes to the existing research by documenting that early disclosure of material weaknesses in internal control affects investors’ reactions to financial restatements.
Details
Keywords
Hyeesoo H. Chung and Jinyoung P. Wynn
This study aims to examine the association between corporate governance and audit fees using directors' and officers' (D&O) insurance premiums as a proxy for overall governance…
Abstract
Purpose
This study aims to examine the association between corporate governance and audit fees using directors' and officers' (D&O) insurance premiums as a proxy for overall governance quality. The use of an overall governance measure that captures both structural and non-structural governance features may shed light on the association between governance and audit fees, which is known to be inconclusive in the literature.
Design/methodology/approach
The authors employ D&O insurance premiums as a proxy for governance quality that reflects both the structural features and non-structural features of governance. D&O insurance premiums are hand-collected from a proxy circular of Canadian firms. Multivariate regression analyses are used for testing.
Findings
The authors find a positive association between D&O premiums and audit fees, suggesting that auditors charge higher fees to firms with heightened corporate governance risk. Even after controlling for structural governance variables in the regression model, the authors find a significantly positive association between D&O premiums and audit fees.
Research limitations/implications
The findings suggest that mandatory disclosures of D&O insurance policies can be useful for market participants. This study uses a relatively small sample of Canadian firms. A larger sample could strengthen the implications of the findings.
Originality/value
The findings suggest that structural features of governance may be insufficient to provide a full understanding of the impact of corporate governance on audit pricing and add to the understanding of the determinants of audit fees.