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SYNOPSIS: We examine whether critical audit matter (CAM) disclosures contain information about material misstatement risks that is priced in audit fees. We find that textual features of auditors' risk descriptions and the types of risks identified capture fee-relevant information. Further, the results are incremental to other determinants of audit fees considered in prior research and to managements' disclosures in the related notes to the financial statements. Overall, we provide evidence that auditors' perceptions of audit risks revealed in the newly expanded audit opinion capture information relevant for understanding audit pricing decisions. Data Availability: All data are publicly available from the sources identified in the paper. JEL Classifications: M41; M42; M48. [ABSTRACT FROM AUTHOR]

Prior research suggests oversight inspections lead to unintended consequences by motivating auditors to manage inspection risk. The current study provides evidence of the impact of a misalignment between inspection and mis-statement risks at the account level, where planning decisions are made. We predict auditors feel pressures to address more immediate inspection risks at the expense of adequately responding to mis-statement risks as prescribed by auditing standards. Employing an experiment with 182 experienced auditors, we manipulate accountlevel inspection risk (low or high). As hypothesized, auditors plan more hours for an account with higher inspection risk and correspondingly assign fewer audit hours to other accounts with lower inspection risk, even if mis-statement risk is high for those accounts, suggesting an unwarranted shift in audit efforts. Our findings suggest inspection risks impair auditors' effort allocation decisions and thus may undermine the audit risk model as the normative benchmark for program planning. [ABSTRACT FROM AUTHOR]

We study off-the-clock indiscretion accusations against corporate officers and directors and examine the extent, effectiveness, and context of auditors' response. In the year that indiscretion allegations are first publicized, auditors charge higher fees and are more likely to resign. Auditors respond to allegations against both top executives and board members. Further, reactions are strongest when allegations demonstrate a lack of individual integrity and, separately, when the audit office has previously audited other similarly accused clients. Importantly, the resulting increase in auditors' effort partially negates the association between indiscretions and lower financial reporting quality. However, auditors are primarily reactive, rather than proactive, and their response is stronger when the accused client is less important economically. These results suggest that company leadership's off-the-clock indiscretions are signals to auditors of poor tone at the top, but the audit response is not uniform across all clients. [ABSTRACT FROM AUTHOR]

SUMMARY: This study investigates whether audit clients' blockchain activities (including crypto-related activities) affect audit risk by examining the association between blockchain disclosures in 10-K filings and audit fees. Focusing on U.S. firms between 2013 and 2020, we empirically show that audit fees are higher for companies disclosing blockchain activities in 10-K filings. We further find that this positive association is more pronounced for companies disclosing current blockchain implementation than for companies with plans for blockchain activities. The results indicate that clients' blockchain activities influence audit risk as assessed by external auditors. As blockchain technology and its applications are emerging, our findings have implications that should be considered by auditors, regulators, and top management. [ABSTRACT FROM AUTHOR]

SUMMARY: This study draws on human capital theory to measure the quality of accounting personnel based on their education level and investigate whether the education level of the client firm's accounting personnel affects auditors' assessment of audit risk by examining audit outcomes. It shows that auditors charge higher fees and are more likely to make audit adjustments for companies whose accounting personnel have a lower level of education. The relationship between the education level of accounting personnel and audit fees (audit adjustments) is robust to an instrumental variable model, an entropy balancing approach, and a difference-in-differences analysis. Audit firms strategically assign more experienced partners to audit companies whose accounting personnel's average education levels are relatively low. Taken together, these findings suggest that the education level of clients' accounting personnel affects auditors' assessment of audit risk and audit outcomes. JEL Classifications: M40; M42; J01; J24. [ABSTRACT FROM AUTHOR]

This study investigates the contents and trends of critical audit matters (CAMs) as they relate to ESG matters (ECAMs). Our examination of the description of ESG matters in ECAMs suggests that the majority of ECAMs fall under measurement issues from environmental liabilities and loss contingencies. To address ECAMs, auditing procedures must assess managerial assumptions by making frequent use of an environmental specialist. Our descriptive analysis suggests that firms that receive ECAMs are more profitable, more likely to have a Big 4 auditor, and have higher litigation risk. Our cross-country comparison suggests a similar trend between ECAMs and their equivalent reports in Europe, as both focus mainly on environmental matters rather than social or governance matters. Overall, our analysis suggests that the issuance of ECAMs represents an important source for discerning a portion of firms' ESG standings. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M4. [ABSTRACT FROM AUTHOR]

SUMMARY: In this study, we examine whether increased financial flexibility afforded by the Paycheck Protection Program (PPP) affects small accounting firms' public audit client portfolio decisions. We find some evidence suggesting that accounting firms receiving PPP loans exhibit greater public audit client selectivity. Specifically, accounting firms receiving PPP loans exhibit an increased likelihood of auditor switching and engage new clients that exhibit less financial and auditor business risk but greater potential for profitability relative to departing clients. Relative to both departing and continuing clients, new clients of firms receiving PPP loans exhibit some evidence of lower audit risk. Collectively, the results provide some evidence to suggest that the increased financial flexibility afforded through the PPP loans provided smaller accounting firms an opportunity to selectively manage their public audit client portfolio. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M42; M48. [ABSTRACT FROM AUTHOR]

In this paper, we first conduct a longitudinal study of public companies' climate change risk disclosures from 2005 to 2019. Results indicate that although the number of firms disclosing climate change risks increased over time, disclosure length and disclosure clarity did not improve consistently during the study period. It seems that firms temporarily adjusted their disclosure behaviors around 2010 to satisfy the SEC's 2010 guidance regarding climate change disclosures. From that point forward, however, companies' disclosure length and clarity declined. Climate change and disclosures in a client's environment can elevate both inherent risk and audit risk. Accordingly, the second part of the study empirically examines whether climate change risk disclosures are embedded into the auditors' risk model and associated audit prices. Results suggest that audit fees are significantly associated with climate change risk disclosure length and clarity, and lower climate change risk disclosure clarity is associated with higher audit fees. [ABSTRACT FROM AUTHOR]

We examine whether the quality of a firm's internal controls affects a board's decision to hire an insider as CEO. We find that the board is less likely to select an insider as CEO following an internal control material weakness (ICMW) disclosure. In cross-sectional analyses, we find that the adverse effect of weak internal controls on the likelihood of hiring an insider CEO is attenuated for firms that restate past misstatements and is pronounced when boards are more independent. We also find that audit fees are lower for ICMW firms when an outsider CEO is appointed, indicating that external auditors perceive lower audit risk. Taken together, our findings suggest that in the presence of a weak internal control environment, the board prefers an outsider CEO over an insider who may have been a part of the internal control issues, notwithstanding the fact that evaluating the outsider CEO can be challenging. [ABSTRACT FROM AUTHOR]

SUMMARY: Prior research finds that firms' stock liquidity is associated with more aggressive discretionary accruals and revenues, suggesting that firms face pressure to make more aggressive accounting decisions when liquidity is high. However, the literature has yet to examine whether the effects of liquidity on financial reporting quality are severe enough to impact audit risk. We address this gap and offer three main findings. First, we find a positive association between stock liquidity and the probability of restatements, suggesting that the pressures from liquidity to engage in aggressive reporting decisions are severe enough to increase audit risk. Second, we find a positive association between stock liquidity and audit fees, suggesting that auditors at least partially incorporate the audit risk from liquidity into their pricing decisions. Finally, we find that the positive association between liquidity and audit pricing is concentrated in firms with poor corporate governance mechanisms. JEL Classifications: G12; G30; M42. [ABSTRACT FROM AUTHOR]

SUMMARY: We examine whether consumer-generated tweets about purchases (interest) and sentiment are useful in assessing the risk of misstated revenue in the planning stage of the audit, as reflected in improvements to analytical procedures, for firms in consumer-facing industries. We obtain consumer-generated tweeting activities from 2012 to 2017 for 76 companies in 20 consumer-facing industries from a data provider. We find that, relative to a benchmark model, Twitter consumer interest, but not consumer sentiment, improves the prediction and error-detection ability of analytical procedures for most firms in consumer-facing industries. Our findings are robust to different model settings. In additional tests, we observe that the effect of Twitter consumer interest is more pronounced in smaller industries and that it remains useful in analytical procedures when compared to firms' advertising and employee headcount. Together, our results suggest that this new source of information improves auditors' assessments of the risk of misstated revenue. [ABSTRACT FROM AUTHOR]

Auditor knowledge is a key element in explaining the supply of audit quality, yet understanding of the drivers of this knowledge in the archival literature is limited. This study uses an archival approach to examine whether the sharing of auditors among firms in banking relationships results in information transfers that improve audit quality. I find that audit quality improves for both borrowers and lenders who share the same auditor office. Specifically, lenders who share an auditor office with their borrowers have more accurate loan-loss provisions, especially lenders with smaller commercial loan portfolios. Borrowers who share an auditor office with their lender are less likely to receive a clean audit opinion just prior to bankruptcy. Overall, these findings are consistent with shared auditors in banking relationships developing client specific knowledge that is transferable across clients and industries. JEL Classifications: G21; M41; M42. [ABSTRACT FROM AUTHOR]

In three experiments, we find that rewarding professional skepticism can backfire and decrease skepticism on future audit tasks where red flags are present. We focus on rewards for costly skepticism: skepticism that is ex ante appropriate, but generates incremental ex post costs and does not identify a misstatement. Auditors interpret a reward for costly skepticism as a better-than-expected outcome and view subsequent tasks from a risk-averse gain frame. As a result, auditors seek to avoid the downside risk of skeptical action, which decreases auditors' sensitivity to red flags and their willingness to communicate severe red flags to their managers, compromising audit quality. However, we also find that a supervisor consistently rewarding costly skepticism decreases auditors' risk aversion and increases their skepticism. In sum, auditors believe skeptical action has downside risk. A cultural shift toward credible, consistent rewards for appropriate skepticism likely helps ensure that rewards have their intended effect. Data Availability: Contact the authors. [ABSTRACT FROM AUTHOR]

This study provides insights from accounting professionals on the impact of artificial intelligence (AI) adoption and the associated risks on the accounting profession. Survey data suggests that participants have an overall positive perception of AI and believe it will enhance their job performance by reducing repetitive tasks and the risk of human error. In addition, participants believe that the growth of AI technology will change the focus of accounting curriculums to include specialized computer skills. Significantly stronger agreement is expressed by public accountants in Big 4 firms compared to non-Big 4 firms, industry, and accounting educators. More specifically, skills in data management, data cleansing, and correcting inaccurate or incomplete data are valued more by industry and public accountants than by accounting educators. It is imperative that accounting programs rise to the challenge of equipping students to be life-long learners in accounting to grow with the changes in the profession. Data Availability: Data are available upon request. [ABSTRACT FROM AUTHOR]

SUMMARY: Tone at the top plays an important role in entities' internal control over financial reporting (ICFR) and in auditors' planning and risk assessment decisions. Using a novel measure based on employee perceptions, we find that strong tone at the top is associated with reduced audit pricing and that this relation holds even for firms that report effective ICFR. This relation is stronger when employees' tone perceptions are more consistent throughout the organization, when accounting is more complex, and when earnings manipulation risk is higher. We also find that strong tone is negatively associated with the incidence of reported material weaknesses and positively associated with positive abnormal accruals, and that the management integrity component of tone is more strongly associated with audit pricing than is the quality of management communication. Finally, we find evidence that auditors become familiar with employees' tone perceptions in the normal course of an audit. [ABSTRACT FROM AUTHOR]

This case gamifies several topics from a typical auditing curriculum by placing students in a modified escape room activity. Students act as new associates in Audit and Assurance services of CBA Associates, LLP. As part of their external audit orientation and training, students are provided with background information for a fictitious company, Tinsley Industrial Medical Equipment (TIME). Drawing on knowledge learned in traditional undergraduate auditing courses, students are tasked with solving several puzzles disguised as audit tasks. Topics and skills needed to unlock a series of locks include analysis of fraud scenarios, evaluation of the audit risk model, calculation of planning materiality and tolerable misstatement, identification of management assertions and related audit procedures, and detailed scrutiny of control process narratives and document flow diagrams. To successfully complete the case, students must effectively communicate and collaborate to solve the puzzles in the allotted time. [ABSTRACT FROM AUTHOR]

We examine auditors' consideration of audit risk information from the disclosure of alleged financial statement fraud (FSF) by investigating whether audit fees are higher for firms that allegedly committed fraud and for firms with ongoing FSF challenges and high short interest. We find a positive association between audit fees and FSF disclosures, and this association increases with the level of short interest. Auditors also consider ongoing FSF challenges reflected in the level of short interest when determining their audit fees. We find, however, that short sellers do not consider increased audit fees associated with the public disclosure of alleged FSF. Short sellers do not appear to contemplate audit fees and audit risk in analyzing the business risk of alleged FSF in determining their short positions. Our study has policy, practical, and educational implications for auditors, short sellers, and forensic accountants who investigate FSF. Data Availability: The data used in this study are available from the sources identified in the study. JEL Classifications: G32, M40, M42. [ABSTRACT FROM AUTHOR]

SUMMARY: We analyze the consequences of a firm hiring a generalist CEO in terms of the audit fees paid by the firm. We find that audit fees of clients with generalist CEOs are higher than those of clients with specialist CEOs. This relation is robust to considering managerial ability, other CEO characteristics, various fixed effects, instrumental variables, and change analyses. We further show that fee differences are larger for firms with weaker monitoring and higher corporate litigation risks. Through path analysis, we find that both client business risk and misreporting risk contribute to the fee difference. Finally, we find that auditors are more likely to issue going-concern opinions to clients with generalist CEOs. Our study should be of interest to auditing standard setters who link management operating styles to audit risk. We shed light on how management operating styles associated with the CEOs' general or specialized skills affect audit pricing. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M42. [ABSTRACT FROM AUTHOR]

SYNOPSIS: This study investigates the impact of political connections, as measured by having directors that previously held political positions, on audit pricing. We document that auditors charge higher fees to politically connected firms than to similar non-connected firms. Our findings are robust to a battery of additional analyses and the inclusion of transaction-based measures of political connections (campaign contributions and lobbying expenditures) in the model. The effect of political connections on audit fees is mitigated by independent monitoring. Moreover, the effect is stronger in firms with complicated operational structures and higher litigation risk, but weaker for distressed firms. Although our findings suggest that auditors exert greater effort at connected clients, we show that connected clients report higher discretionary accruals, consistent with auditors' incremental effort being insufficient to offset the audit risk inherent in these engagements. Collectively, our study illuminates how auditors perceive political connections and their impact on financial reporting quality. Data Availability: All data are publicly available from sources quoted in the text. [ABSTRACT FROM AUTHOR]

SUMMARY: This case provides instructors the opportunity to have students analyze an audit population via either Excel Pivot Tables and/or cluster analysis via the R programming language and RStudio free software environment. The analysis takes place in the context of audit risk analysis and planning. The case was developed with a background description based on a real company and instructor-generated synthetic data containing seeded misstatements. Analysis via Excel Pivot Tables is fairly straightforward and allows students to easily get into the underlying audit planning questions. Use of cluster analysis via R is more difficult but provides students with an opportunity to think about cluster analysis when there is no underlying basis for discrete population splits or as a population stratification methodology. Student feedback from use of the R language approach was very positive with students indicating they had a better understanding of how to apply cluster analysis in an audit context [ABSTRACT FROM AUTHOR]

SUMMARY: Audit associates routinely interact with clients to request explanations and evidence regarding financial statement account balances. Client explanations may be vague or incomplete. We examine whether auditors' assessments of the quality of client explanations and their decision to follow-up with the client are influenced by (1) communication modes that vary in media richness, and (2) a prime that is intended to stimulate skeptical behavior. Media richness refers to the amount of data inherent in the communication mode. We predict that richer communication modes, such as video, can be more distracting than less rich communication modes, such as email. More distracted auditors will assess the quality of the client's response as higher and are less likely to follow-up with the client—potentially impairing audit quality and increasing audit risk. We predict and find that a prime that focuses auditors on the verifiability of the client's response will mitigate this behavior. [ABSTRACT FROM AUTHOR]

SUMMARY: This study examines the impact of drought on the pricing of audit services for U.S. firms over the period 2001–2015. We employ the Palmer Drought Severity Index (PDSI) to determine drought intensity conditions at the state level on a yearly basis and regress audit fees on drought intensity after controlling for other known factors of audit fees. We document that auditors charge significantly higher audit fees for client firms headquartered in areas affected by drought. The effect of drought on audit fees is more pronounced among firms with lower accruals quality and among firms with high business operation concentration in their headquarter states. Collectively, our findings suggest that climate risk in the form of drought not only affects firm risk but also audit risk, thereby highlighting that externalities from climatic conditions are relevant to firms and auditors. [ABSTRACT FROM AUTHOR]

We propose a methodology for Continuous Risk Monitoring and Assessment (CRMA). As a new component of Continuous Assurance (CA), CRMA converts static CA systems into dynamic and adaptable systems that respond to changes in audit risks from client business risks, thereby improving the relevance and robustness of CA systems to changes in client business risks and possible business failures. The present methodology proposes to develop relevant leading and lagging indicators to monitor and assess a client's business risks and recognize emerging business risks or harmful impacts of materialized business risks in near real time. To illustrate, we develop a lagging indicator of reputational damage measured from real time postings published in social media websites. We present two cases where the present lagging indicator is measured using public Twitter messages ("tweets") and used to assess the potential reputational damage to two large corporations. [ABSTRACT FROM AUTHOR]

SYNOPSIS: This study examines whether the presence of a general counsel (GC) in top management affects audit effort and audit outcomes. Hopkins, Maydew, and Venkatachalam (2015) find that firms with GCs in top management have lower financial reporting quality and tolerate more aggressive financial reporting practices, which likely influences audit risk. Given the GCs' influence on the financial reporting process, we posit that auditors of firms with GCs in top management increase the amount of effort they expend to provide reasonable assurance that financial statements are stated fairly. We find that the presence of GCs in firms' top management is positively associated with audit effort but does not directly affect the likelihood that these firms will receive unqualified audit opinions that contain explanatory language. Our findings suggest that GCs influence the external audit market by participating in the financial reporting process. JEL Classifications: M42. Data Availability: Data are available from the public sources cited in the text. [ABSTRACT FROM AUTHOR]

SUMMARY: The novelty, ambiguity, and the lack of official guidance surrounding cryptocurrency transactions impose additional audit risks that should be considered during client acceptance and retention and planning audit procedures. We develop a four-quadrant model to assist auditors in client acceptance and continuance decisions and identify cryptocurrency risks that should be considered during audit planning and audit evidence gathering. [ABSTRACT FROM AUTHOR]

Following its purchase of Westinghouse Electric Company and subsequent macroeconomic events, Toshiba faced declining profits. In response, Toshiba engaged in earnings management through two accounting treatments. First, it delayed the recognition of losses under long-term contracts. Second, it inappropriately applied price masking to account for transfers of components between itself and contract manufacturers. Students using this case will assess how business risks and corporate culture relate to audit risk, and how accounting for price-masking transactions can lead to increased fraud risk. Students will also research aspects of auditing standards related to fraud and accounting estimates. The case is designed for auditing courses and capstone courses with an auditing component. [ABSTRACT FROM AUTHOR]

Data security breaches have been shown in the literature to negatively affect firm operations. Auditors serve as an important, external governance mechanism with respect to a firm's overall risk management protocol. Consequently, our study examines whether auditors price breach risk into their fees and if a firm's internal governance can mitigate the potential increases in audit fees. Using a sample of breached firms ranging from 2005–2014, we adapt the Houston, Peters, and Pratt (2005) model to explore how auditors view audit risk related to breach risk. We find that breaches are associated with an increase in fees, but the result is driven by external breaches. Our evidence suggests the presence of board-level risk committees and more active audit committees may help mitigate the breach risk audit fee premium. Additional evidence suggests that both past breach disclosures as well as future disclosures are associated with audit fees. [ABSTRACT FROM AUTHOR]

SUMMARY: We examine whether the readability of financial statement footnotes in the annual report is informative about audit engagement risk. Using various readability measures, we predict and find that firms with less readable footnotes have longer audit report lag, incur higher audit fees, and are more likely to receive a first time modified going concern opinion. We also show that readability of footnotes is associated with a higher likelihood of financial misstatements and future accounting-related litigation. Our results are robust to several measures of readability used in prior literature, as well as different specifications and design choices, revealing that financial statement footnote readability provides incremental information about audit engagement risk that affects auditor-client contracting. Data Availability: Data are obtained from public sources identified in the paper. [ABSTRACT FROM AUTHOR]

SYNOPSIS: Identifying ways to improve and maintain professional skepticism, particularly for the purpose of reducing the risk of material misstatement due to fraud, continues to be a top priority for the auditing profession. This study examines two strategies for improving skeptical behavior in a fraud-related task: (1) practicing inward-directed skepticism through repeated risk assessments and (2) performing timely fraud inquiries of operational-level employees. Results indicate auditors made more skeptical judgments when revisiting and reassessing fraud risk assessments. Further, when auditors performed operational-level fraud inquiries prior to substantive testing, participants exhibited significantly greater increases in skeptical judgment than those who performed inquiries subsequently or not at all. We also observed a greater tendency toward skeptical action, but only on the part of participants who were highly skeptical by nature. These findings support the effectiveness of two strategies for improving skepticism throughout an audit engagement that can improve fraud detection. [ABSTRACT FROM AUTHOR]

SUMMARY: As the scope of the audit continues to broaden (Cohen, Krishnamoorthy, and Wright 2017), research questions in management control and internal control are beginning to overlap. Even so, there is little overlap between these fields in terms of published research to date. The purpose of this paper is to take a step in bridging the gap between the management control and the internal control literatures. We survey relevant findings from the extant management control literature published between 2003 and 2016 on dysfunctional behavior and the ways in which it might be mitigated. We then use the fraud triangle as an organizing framework to consider how the management control literature might help to address audit risk factors identified in SAS 99/AU SEC 316 (AICPA 2002). The outcome of our analysis is meant to identify and classify the extant management control literature of relevance to research on internal control in a manner that researchers new to the management control literature will find accessible. We conclude with a set of future research opportunities that can help to broaden the scope of current research in internal control. [ABSTRACT FROM AUTHOR]

SUMMARY: This article summarizes "Managing Group Audit Risk in a Multicomponent Audit Setting" (Graham, Bedard, and Dutta 2018), who address a long-standing issue in audit practice that remains a concern of regulators and auditors in the current environment. Specifically, how can auditors demonstrate that sufficient evidence has been gathered to support the auditor's opinion when the entity comprises multiple components and when sufficient evidence cannot be attained by selecting all or just a few large components for examination? The model presented in the original paper conforms to the general principles of multicomponent audits in auditing standards literature. By explicitly documenting assumptions used in applying the model, the auditor articulates the elements of judgment going into scoping decisions regarding the number of components selected and the extent of procedures to be performed at those locations. Here, we show a simple example illustrating the model, while the original paper contains computation details and more complex scenarios. [ABSTRACT FROM AUTHOR]

SYNOPSIS: This paper examines whether news coverage of client firms is associated with their audit fees. Using data from China listed firms during 2004–2013, we find that high coverage client firms are on average charged higher audit fees, irrespective of the media tone. This positive association is stronger for large auditors than for small auditors, and for bad news than for good news. The main results hold for both state-owned enterprises (SOEs) and non-SOEs, and for both politically connected and non-connected firms. The results are robust after controlling for the effects of information asymmetry, auditor choice, internal corporate governance, and alternative measurements of the key variables. Overall, our evidence is supportive of the view that auditors assess high coverage clients as higher risk audits requiring greater audit efforts. We conclude that the financial news media plays a disciplining role in China through its potential to trigger reputational sanctions and regulatory action. [ABSTRACT FROM AUTHOR]

SUMMARY: Previous studies document that lenders lack incentives to monitor borrowing firms or to make concessions during bankruptcy if these lenders insure against corporate default with credit default swaps (CDS). This article investigates whether external auditors increase their audit fees for those client firms that have their debt referenced by CDS. In a comprehensive sample of U.S. companies from 2001–2015, we find that CDS-referenced companies incur larger audit fees compared to companies without CDS. The economic magnitude of the audit fee increase ranges from 5.4 percent to 11 percent, depending on the econometric specification employed. Deteriorating corporate conditions or other observable characteristics do not explain the positive association between CDS trading and audit fees, or the increase in audit fees following CDS initiations. The findings suggest that auditors increase their professional skepticism and monitoring efforts of CDS-referenced clients; they might also expect higher liability losses. JEL Classifications: G10; G30; G33; G34. [ABSTRACT FROM AUTHOR]

SUMMARY: Using data from the Chinese market where related party transactions (RPTs) are particularly prevalent, we examine how the independent auditor responds to the potentially heightened risk of RPTs and the efficacy of the auditor's response. First, we find that the auditor is more likely to issue a modified audit opinion that specifically discusses RPTs (RPTMAO) to firms reporting higher related sales or related lending, but not to firms reporting higher RPTs of other categories (i.e., related purchases, related borrowing, and related assets/equity transactions). These findings suggest that the auditor alerts investors to the possibility of earnings management and/or expropriation risk from related sales or related lending through audit opinions. The positive relation between related sales and RPTMAO is driven by related sales with nonmarket-based or undisclosed pricing policy and related sales above the industry average. Second, RPTMAO has robust predictive power for future RPT-related restatements, and the predictive power is greater than that of modified opinions that do not specifically discuss RPTs, suggesting that the auditor is effective at communicating the risk associated with RPTs through opinion modifications, especially RPTMAOs. JEL Classifications: M49 Data Availability: Data used in this study are available from public sources. [ABSTRACT FROM AUTHOR]

SUMMARY: Continuous auditing increases the coverage and frequency of analysis of a firm's activities, and has been touted as a powerful fraud deterrence and detection technique, but we identify and examine a potential unintended consequence. When continuous auditing is accompanied by more timely notifications to auditees of exceptions to control rules, information is revealed about the system's capability to flag exceptions to control rules. Therefore, if a system has weak fraud-detection capability, early notification that the system did not detect a fraudulent transaction could actually increase an auditee's propensity to commit fraud. We examine whether the benefit of early notification depends on the fraud-detection capability of the organization's monitoring system (i.e., whether it is a strong or weak monitoring system). We use an experimental economics approach to address our research question. Consistent with expectations, we find that early and frequent notification of audit results is not always beneficial in deterring fraud, and that its benefit depends on whether the fraud-detection capability of the monitoring system is strong or weak. We do not find evidence of the predicted benefit of continuous notification reducing the incidence of fraud when the system is strong, but we do find an increase in participants' inclination to commit fraud when the system is weak. We discuss the implications of these findings for research and practice. [ABSTRACT FROM AUTHOR]

This study examines whether the relationship between managerial ability and audit fees is conditional on financial distress. We find that higher managerial ability increases audit fees in financially distressed firms and decreases audit fees in non-distressed firms. We also observe that financially distressed firms with higher-ability managers display lower accrual quality and a higher likelihood of restatement. Moreover, higher-ability managers in distressed firms engage more in opportunistic financial reporting to concurrently maximize equity-based compensation and cope with debt refinancing pressures, which increases audit risks and results in greater audit fees. We confirm our results using a battery of sensitivity and additional analyses. [ABSTRACT FROM AUTHOR]

Prior research on CEO narcissism has focused on outcomes related to the CEO's firm. We extend this literature by examining how an important counterparty--the firm's external auditor--responds to a client having a more narcissistic CEO. Compared to other firms, firms with narcissistic CEOs are more likely to exhibit greater inherent risk and control risk. To maintain an acceptable level of audit risk when faced with the heightened risk of CEO narcissism, auditors must do additional work. Consistent with this notion, we find that CEO narcissism has an economically and statistically significant positive effect on external audit fees, indicating that auditors work more, charge a risk premium, or both when auditing a client with a more narcissistic CEO. We also find that firms with narcissistic CEOs are more likely to have internal control weaknesses, which suggests a possible mechanism for why auditors might need to perform more work. This is the first study to provide large-sample real-world evidence on how auditors respond to CEO narcissism and demonstrates the significant effect that executive personality characteristics can have in an audit setting. [ABSTRACT FROM AUTHOR]

This study examines whether auditors regard market pressure on client management as contributing to audit risk. The literature suggests that when management jobs are threatened by negative market reaction to poor mergers and acquisitions investment, managers are more likely to misstate financial statements in the postinvestment period due to pressure on their job security (Bens, Goodman, and Neamtiu 2012). We find that firms under such investment-related pressure experience larger increases in audit fees and audit lags in the postinvestment period. Our findings suggest that auditors perceive market pressure on client management as a risk factor, as recommended by Statement on Auditing Standards (SAS) No. 99. [ABSTRACT FROM AUTHOR]

This paper considers the potential impact of internal audit incentive-based compensation (IBC) linked to company performance on the external auditor's assessment of internal audit objectivity. We posit that external auditors will view IBC as a potential threat to internal audit objectivity, thus reducing the extent of reliance on the work of internal auditors and increasing the assessment of control risk. The increase in risk and external auditor effort should result in higher audit fees. We hypothesize that the form of incentive-based compensation, namely stockbased versus cash bonuses, moderates the association between IBC and external audit fee. Finally, we consider whether underlying financial reporting risk mitigates the external auditor's potential sensitivity to IBC. We find a positive association between external audit fees and internal audit compensation based upon company performance. The association is acute to IBC paid in stock or stock options as opposed to cash bonuses. We also find evidence consistent with the IBC associations being mitigated by the company's financial reporting risks. [ABSTRACT FROM AUTHOR]

This study investigates the efficacy of using a technology based on an elaboration of the traditional fraud risk model to assess the risk of fraud and subsequently plan the audit. The fraud risk model used is based on Srivastava, Mock, and Turner (2007, 2009) and explicitly assesses the presence of fraud triangle factors and the need for forensic tests to aid in the assessment of fraud detection risk and audit planning. Previous studies that examine fraud risk decomposition simply advise subjects to assess fraud risks separately without an analytical model. We examine the effectiveness of the approach using an experiment involving 76 experienced auditors where specific fraud risks are present or absent. As expected, the results indicate that the model significantly enhances auditors' sensitivity to differences in the level of fraud risks. That is, the auditors using the fraud risk model appropriately assessed low fraud risk as low and high fraud risk as high, whereas the auditors using the traditional Audit Risk Model approach assessed fraud risk at essentially the same level under either risk condition. The experiment also investigates effects on audit program planning decisions. Contrary to expectations but consistent with prior research, the risk decomposition technology tested did not result in auditors providing more effective fraud detection procedures. In all, the results suggest that although the tested risk decomposition technology can enhance risk assessments and recognition of the need for additional forensic tests, auditors continue to have difficulties in responding to fraud risks, perhaps because they lack the requisite fraud experience and training. [ABSTRACT FROM AUTHOR]

We report the results of an experiment that examines how the salience of post-audit reviews (PARs; i.e., U.S. Public Company Accounting Oversight Board [PCAOB] inspections and public accounting firms' internal quality reviews [IQRs]) affects auditors' perceptions of inspection risk (i.e., the risk that an auditor or audit firm will suffer harm as a result of a PAR), as well as audit effort and fees. Using large-firm, high-level auditors as participants, we find that PAR salience (i.e., anticipation of a PAR) yields higher perceived overall engagement risk assessments, even after controlling for traditional audit risk factors, consistent with auditors viewing inspection risk as incremental to these risk factors. Further, we find that auditors respond to PAR salience by increasing both audit effort and fees-- with higher perceived engagement risk and greater audit effort for PCAOB inspections than IQRs. Finally, we observe that increases in audit fees are fully explained by effort. [ABSTRACT FROM AUTHOR]

We examine the relationship between aggressive income-increasing real earnings management (REM) and current and future audit fees. Managers pursue REM activities to influence reported earnings and, as a consequence, alter cash flows and sacrifice firm value. We posit that the implications of REM are considered in auditors' assessments of engagement risk related to the client's economic condition and result in higher audit fees. We find that, with the exception of abnormal reductions in SG&A, aggressive income-increasing REM is positively associated with both current and future audit fees. Additional analyses provide evidence consistent with increased effort combined with increased risk contributing to the current pricing effect, with increased business risk primarily driving the future pricing effect. We, therefore, provide evidence that aggressive income-increasing REM activities have a significant influence on auditor pricing behavior, consistent with the audit framework associating engagement risk with audit fees. [ABSTRACT FROM AUTHOR]

To reduce redundancies and increase efficiency in the evaluation of internal controls (PCAOB 2007, 402-403), professional standards encourage coordination between external auditors and their clients' internal audit function (IAF). Recent surveys of internal auditors find that a component of this coordination is external auditors' involvement in developing the IAF's audit plans. Nevertheless, it is not known how such involvement affects external auditors' reliance on the internal control test work of the IAF, either before or after a negative audit discovery. Based on an experiment with 107 experienced auditors, we find that external auditors involved in the development of the IAF's audit plan perceive the IAF as more objective and that both objectivity and involvement contribute to these auditors' placing more reliance on the IAF as compared to external auditors with no involvement. This initial reliance results in the involved auditors' proposing reductions to the audit budget and re-performing less of the IAF's work. Consistent with an anchoring bias, we find that involvement leads to external auditors' continuing to place greater reliance on the IAF's work, even after they become aware of a negative audit discovery that should not have occurred had the client's controls been effective. [ABSTRACT FROM AUTHOR]

This paper reports five studies examining audit team members' willingness to raise audit issues. The first study is a survey of interacting audit teams that provides evidence that team members are more willing to speak up when they view their leader as team-oriented (i.e., emphasizing team success as opposed to the leader's own personal advancement). Experiments 1-3 provide converging evidence that audit seniors are more willing to speak up to a team-oriented leader and about issues that are aligned with that leader's concerns. Experiment 4 provides evidence that the effect of team-oriented leadership on willingness to speak up is mediated by team members' commitment to the team leader and, to a lesser extent, by their identification with their team, but not by concerns about the immediate or eventual repercussions of speaking up. Together, these studies provide evidence that auditors' willingness to raise audit issues is affected by what the auditor has to say and how they think their message will be received, potentially affecting audit effectiveness and audit efficiency. [ABSTRACT FROM AUTHOR]

This paper examines the impact of the development of Business Risk Auditing (BRA) on international audit standard setting and the implications regarding the potential for innovation in auditing practice. BRA was an audit methodology development promoted by the large international audit firms in the late 1990s as a significant innovation but, ultimately, it did not have the degree of impact on practice initially promised. Our analysis demonstrates that professional and regulatory priorities at the time interacted in ways that led to the most innovative elements of BRA not being advanced for inclusion in formal standards. Intriguingly this outcome was clear well before the critical attention given to auditing following Enron, which was the explanation offered for the fate of BRA in previous studies. We conclude that the capacity for innovative ideas to have a substantive influence on audit practice is highly dependent on interactions between a shifting mix of professional and regulatory interests and preferences. The BRA case illustrates how lasting innovation requires a willingness and commitment both to develop the scope of the audit and to accept variations in aspects of its execution. This will not happen if standardization per se is seen as an essential validation of successful innovation. [ABSTRACT FROM AUTHOR]

The PCAOB and the IAASB recently proposed several significant changes to the audit reporting model, including requiring auditors to disclose critical audit matters (CAMs) in their audit reports. While investors appear to support such additional disclosures, some audit practitioners, academics, and attorneys contend that requiring auditors to disclose CAMs will make it easier for plaintiffs' attorneys to successfully sue auditors when audits fail to detect material misstatements. A recent study, "Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability" (Brasel, Doxey, Grenier, and Reffett 2016), reports results of an experiment that inform this issue. Contrary to the above concerns, results of the study indicate that disclosing CAMs, either related or unrelated to an undetected material misstatement, likely will not increase, and could decrease (depending on the type of misstatement), the probability of jurors holding auditors liable when audits fail to detect material misstatements. Further, results indicate that explicitly stating in the audit report that there were no CAMs, an option allowed within the PCAOB's proposal, would increase negligence verdicts against audit firms. The following article summarizes the study's motivation, method, results, and implications for both audit reporting and risk disclosure in general. [ABSTRACT FROM AUTHOR]

Using a field-based questionnaire, we examine how auditors simultaneously use client-level misstatement risk (inherent risk and control risk) with account subjectivity when utilizing internal audit. We contend that auditor use of internal audit will reflect a balance of the costs and benefits of using internal audit. Prior audit research has primarily focused on lower and higher risk conditions, with relatively few studies examining the implications of moderate risk on internal audit use. Data on actual audits from an instrument administered to external auditors reveal significant differences in reliance decisions across lower, moderate, and higher misstatement risk levels. Results reveal that increases in account subjectivity have no effect on auditors' internal audit reliance when risk of material misstatement is at lower levels. However, auditors increase their internal audit reliance when account subjectivity increases across moderate misstatement risk. Finally, our results suggest that auditors decrease their internal audit reliance when account subjectivity increases across higher misstatement risk. By examining these risk variables in combination, we provide insight into the complexities associated with external auditors' internal audit usage. This research could be of interest to practitioners and academics by providing insight into how multiple risk factors may be combined when utilizing internal audit. [ABSTRACT FROM AUTHOR]