Post on 27-Mar-2021
Lead Auditors,
their Client Portfolios and
Performances
Amin S. Sofla
Umeå School of Business and Economics
Umeå 2016
Responsible publisher under swedish law: the Dean of the Medical Faculty
This work is protected by the Swedish Copyright Legislation (Act 1960:729)
ISBN: 978-91-7601-567-4
ISSN: 0346-8291
Electronic version available at http://umu.diva-portal.org/
Printed by: UmU-tryckservice, Umeå University, Umeå
Umeå, Sweden 2016.
i
Table of Contents
Acknowledgements iii
Abstract v
Svensk sammanfattning vi
Summary 1
1.1 Introduction 1
1.1 Background 6
1.1.1 Lead Auditors 6
1.1.2 Accounting Firms 8
1.1.3 Lead Auditors’ Client Portfolios 10
1.1.4 Audit Quality 14
1.2 Research Hypotheses and Research Questions 19
1.2.1 Lead Auditor - Performance 20
1.2.2 Situation 25
1.3 Research Design 28
1.3.1 Data 28
1.3.2 Operationalisation 29
1.3.3 Statistical Models 31
1.4 Results and Conclusions 33
References 39
Studies I, II, III and IV 62
ii
iii
Acknowledgements
I would like to take this opportunity to thank everyone who has helped me during
my PhD studies.
iv
v
Abstract
This thesis focuses on lead auditors’ differences in terms of client portfolios and
performances. First, lead auditors are surveyed and their responses on professional
scepticism linked to their performances. Second, survey and archival data are
combined to check whether self-control is related to performance. Third, lead
auditors’ client portfolios are examined with regard to industry similarity, portfolio
dispersion and client grouping. Finally, auditors’ independence is tested in the
private firm setting. Overall, the findings indicate that performance is not
homogenous across lead auditors in the same (tier) audit firm(s), and that the
characteristics of lead auditors and accounting firms are determinants that partly
explain the differences.
vi
Svensk sammanfattning
Avhandlingen fokuserar på skillnader i klientportföljer och prestation mellan
ansvariga (alternativt påskrivande) revisorer och består av fyra huvudsakliga delar
(alternativt studier). I den första delen kopplas mått på professionell skepticism, som
bygger på enkätsvar från ansvariga revisorer, till prestation. I den andra delen
kombineras enkätdata med arkivdata för att undersöka sambandet mellan
självkontroll och prestation. I den tredje delen analyseras revisorernas
klientportföljer utifrån dimensionerna branschtillhörighet, klientgruppering och
portföljspridning. I den sista delen genomförs tester av revisorns oberoende för
uppdrag i privata företag. Sammantaget indikerar resultaten att prestation varierar
mellan revisorer från samma revisionsbyrå och att egenskaper hos ansvariga
revisorer och revisionsbyråer delvis kan förklara dessa skillnader.
1
Summary
1.1 Introduction
Financial statement audits seek to reduce potential agency problems1 by
providing reasonable assurance about the accuracy of the information provided in
financial reports. High quality audits play a crucial role in the proper functioning of
the financial market (DeFond and Francis 2005, 5) and in the viability of the
auditing profession (IFAC 2009, 6). The importance of delivering high quality
audits increased as a result of the accounting scandals at the beginning of the 21st
century (DeFond and Francis, 2005). Given these, the enhancement of audit quality
has been one of the main concerns of regulatory bodies and academics. Prior
auditing studies have examined the different factors that are important in auditing
(see e.g., Defond and Zhang 2014; Knechel et al. 2012; Francis 2011). However,
there are still many under-researched or unexplored areas, one of which is the
individual auditor (Defond and Zhang 2014; Francis 2011).
Auditors bring their individual characteristics to audit process and audit task
(Nelson and Tan 2005, 48) and it is likely that those characteristics affect the quality
of audits. The effect arises because auditing is replete with unstructured tasks, where
subjective judgment plays a major role (Abdolmohammadi and Wright 1987, 5).
Individual auditors work in accounting firms.2 Accounting firms employ individual
auditors, train them and provide them with incentives. The accounting firms are
often categorised as professional service firms (PSFs). Three distinctive
characteristics that are associated with PFSs are knowledge intensity, low capital
intensity and professionalised workforces. The distinctive characteristics of
accounting firms make it difficult to determine the quality of service, which also
increases the challenges related to the retaining and directing of a skilled workforce
(Von Nordenflycht 2010, 160). Accounting firms devise various mechanisms to
control the behaviour of lead auditors (Covaleski et al. 1998, 294), although the
1
Agency relationship refers to “a contract under which one or more persons (principal(s)) engage another person (the
agent) to perform some service on their behalf which involves delegating some decision making authority to the agent”
(Jensen 1976, 308). According to agency theory: “(a) the desires and goals of the principal and agent conflict and (b) it is
difficult or expensive for the principal to verify what the agent is actually doing”(Eisenhardt 1989, 58). 2 In this thesis, the terms accounting firm and audit firms are used interchangeably.
2
effectiveness of this control is controversial.3 Accounting firms may respond to
managerial challenges by decentralising decision-making to individual auditors and
choosing to guide and nudge, rather than fully control lead auditors (Malhotra et al.
2006). The knowledge intensity basis of accounting firms, combined with the
decentralised decision-making system, will in turn intensify the role of individual
auditors. Therefore, if we want to understand why audit firms do the things they do,
or how they perform the way they do, the dispositions of their individual auditors
need to be considered.
In fact, accounting researchers are well aware of the need to investigate different
aspects of individual auditors. Behavioural audit research constitutes a major part of
the audit literature (see e.g., Trotman et al. 2011; Nelson and Tan 2005; Nelson
2009). For example, the majority of the papers published in Behavioural Research in
Accounting (BRIA), focus on individuals (Shields 2007, 9). Moreover, judgement
and decision making4 research has been an important research paradigm,
constituting 5,745 papers between 1970 and 2009 in four major journals (Trotman et
al. 2011, 278-280). Although experimental research on auditors’ attributes has a
long and enduring tradition in auditing research, very little archival research has
been conducted in the past two decades (Francis 2011, p. 134). Experimental
research usually has a higher level of precision in terms of control and measurement
than other research strategies, but does not always have a high degree of
generalisability (McGrath 1981, 183). In other words, the results from experimental
research cannot be generalised, because samples are often limited to a small number
of individuals. Moreover, experimental research is conducted in a deliberately
contrived and controlled setting which lacks existential realism (ibid., 185). This
indicates that other factors in non-laboratory settings could affect the results, which
is often the case in an auditing context. Audit scholars have been always interested
in conducting archival research on individual auditors, although one of the main
problems with this is the availability of data on individual auditors. There are two
3 Effectiveness control is controversial for at least two reasons: First, it is not feasible for audit firms to completely
standardise or control audit outcomes, because the quality of the outcome is difficult to measure. For instance, analytical
works suggest that free riding cannot be eliminated in accounting firms (Holmstrom 1982). Second, such controls could
create tension between firms and individuals due to the fact that individual auditors are skillful and have considerable
bargaining powers (Von Nordenflycht 2010).
4 Auditing is full of unstructured tasks, where subjective judgement plays a major role (Abdolmohammadi and Wright,
1987, p. 5).
3
reasons for this. First, in many countries the name of the firm appears on the audit
report, rather than the individual who has conducted the audit. Second, even when
individual auditors can be identified, information about their characteristics is
limited.
Archival research often focuses on the lead auditor5 who conducts the audit. The
prior research for instance examine whether lead auditors’ attributes, such as
busyness (e.g., Goodwin and Wu 2016), industry expertise (e.g., Hsieh and Lin
2015), experience (e.g. Ernstberger et al. 2015), network (e.g., Bianchi et al. 2016),
academic background (Ernstberger et al. 2016), gender (e.g., Ittonen et al. 2013),
time-invariante fixed effect (e.g., Aobdia et al. 2015) and risk attitude (Amir et al.
2014) are predictive of performance. While this research provides some insights into
the role of individuals in the auditing context, we still know very little about lead
auditors. As a result, recent research has called for more research on lead auditors
(e.g., Defond and Zhang 2014, 304).6 This thesis responds to these calls by
providing further evidence of lead auditors’ differences. In particular, the thesis
focuses on lead auditors’ scepticism, self-control, and client-portfolios.
This thesis consists of four studies. Study I links lead auditors’ survey responses
on professional scepticism to their compensation and reporting. The findings suggest
that the level of professional scepticism is positively associated with auditors’
income in Big 4 audit firms, while no such association is found for non-Big 4
auditors. This result indicates that professional scepticism is more likely to be
valued in the Big 4 accounting firms. Furthermore, only the non-Big 4 lead auditors’
scepticism is associated with auditor reporting. In other words, unlike that of non-
Big 4 lead auditors, the ability of Big 4 lead auditors to affect audit quality does not
necessarily reflect their sceptical trait.
Study II takes the first non-laboratory step towards understanding the role of a
central personality trait – self-control – in the auditing context. Survey and archival
data have been examined to determine whether and how the level of self-control of
individual auditors is related to audit quality, generated audit revenue and
5 Lead auditors are individual auditors who are responsible for the direction, supervision and performance of an audit
team (ISA 220.15). 6 In their review of archival auditing research, DeFond and Zhang (2014) “encourage future research to consider
additional individual auditor characteristics, such as professional skepticism, personality traits, gender, the complex audit
team interactions, and the socio-economic characteristics.” (p. 304).
4
compensation. The empirical evidence suggests that self-control is only predictive of
audit quality for Big 4 auditors, implying that lead auditors in these firms perceive
audit quality as a desired outcome. In addition, it is observed that the ‘generated
audit revenue’ of Big 4 auditors mediates the association between self-control and
compensation, meaning that the market (both intra and extra firm) rewards highly
self-controlled Big 4 auditors by assigning them more resources (audit revenue).
Study III suggests research designs that could enable future researchers to study
the audit offices’ allocation of lead auditors across clients. It is observed that the
majority of lead auditors are active in many industries. In addition, the results show
that a lead auditor’s client portfolio dispersion is negatively related to earnings
quality. Finally, in the nontrivial number of offices, the client portfolios of the lead
auditor are grouped according to client size, rather than other clients’ characteristics,
and that the extent of the sorting varies considerably across audit firms and offices.
Study IV sheds light on the issue of auditor independence in the private firm
setting. Prior research (e.g. Hope and Langli 2010) finds no evidence to suggest that
auditors compromise their independence through fee (or non-audit fee) dependence
in the private firms market. The study investigates whether auditors slant their
decisions when auditor switching takes place (or is perceived to be taking place).
The results indicate that private firms successfully engage in audit opinion shopping.
Furthermore, the evidence shows that auditor switches are predictive of a reduction
in earnings quality. These findings, in contrast to prior research, imply that auditors
compromise their independence in the private firm setting.
The thesis offers contribution to the field of auditing in multiple ways. First, it
contributes to the literature on individual auditors’ traits by linking professional
scepticism and self-control to the archival auditing and accounting data. The
combination of survey and archival data in this thesis responds to the recent calls to
bridge the gap between behavioural and archival research in accounting and auditing
(Kachelmeier 2010). Second, it takes up the suggestion of prior research (DeFond
and Zhang 2014) to investigate why audit quality varies between Big 4 and non-Big
4 audit firms by reporting that accounting firms’ strategies of valuing and
controlling traits differ among audit firms. Third, it paves the way for future
research at the individual auditor level by introducing some models that can be used
5
to study lead auditors’ client portfolios. Forth, it juxtaposes research on audit
offices in that it goes some way towards increasing our knowledge about the
allocation of human resources in audit offices. Finally, the findings are relevant to
regulators, audit quality oversight bodies and audit firms in their allocation of
quality control resources and in their recruitment and client assignment decisions.
The remainder of the chapter is organised as follows. Section 1.2 presents the
background, section 1.3 includes the research hypotheses, and section 1.4 describes
the data and methodology. Section 1.5 present the results and concludes the paper.
6
1.1 Background
1.1.1 Lead Auditors
Unlike that of archival research, the study of individual auditors has a long
tradition in behavioural auditing research (Nelson and Tan 2005). One line of this
research focuses on expertise, experience and knowledge. Research on auditing
expertise is important because it sheds light on two factors: auditors’ transition from
novice to expert and how and why some auditors perform better than others. Earlier
research on auditor expertise has focused on the differences between auditors and
students. For instance, Ashton and Kramer (1980) document the dissimilarities
between students and auditors in terms of consistency, and Messier (1983) report
differences between students and auditors. It would appear that the choice of task
and participant affects the findings of this research (Abdolmohammadi and Wright
1997). As the research on auditors’ expertise continues, the next move is to
investigate the interaction between knowledge and task. In addition, some
behavioural auditing research relies on a psychometric approach and identifies
several types of knowledge that are important in auditing. At the beginning of the
1990s, behavioural auditing research focused more on industry expertise than task-
specific knowledge and sub-specialty knowledge (Bonner and Lewis 1990). This
research provides evidence that industry specific knowledge improves the quality of
audits (e.g. Bedard and Biggs 1991). Up to 1997, research on auditor expertise was
either experimental or relied on surveys. In the mid-1990s, Tan and Libby (1997)
combined psychometric measures with filed data to demonstrate the effect of
expertise in the field.
Another area of behavioural research on individual auditors studies the effect of
individual or cognitive attributes and performances. This area of research usually
uses two kinds of proxies for performance: audit quality-related performance and
auditors’ employment-related performance. Research on audit quality-related
proxies was popular in the 1970s, declined in the 1980s and became popular again in
the 1990s (see Libby 1981; Ho and Waymond 1993). For instance, Bonner and
Lewis (1990) find that the ability to solve problems is predictive of performance and
Hyatt and Prawitt (2001) find a link between auditors’ locos of control and
accounting firms’ audit structures. However, studying the effect of individual
7
characteristics on auditors’ careers became popular after the 1970s. For instance,
Harrel et al. (1986) studies the effect of organisational and professional commitment
on job satisfaction, while Choo (1986) examines the effect of personality on job
stress (Nelson and Tan 2005). In their review of the literature, Nelson and Tan
(2005) point to four principles that should be taken into account when studying
individual auditors’ characteristics. These are that: (1) the characteristics should be
relevant to auditing, (2) there should be a strong theoretical foundation to the effect
of the given characteristics, (3) the instrument should be reliable and valid and (4)
individual characteristics should be easily captured (Nelson and Tan 2005, 50).
Behavioural research on individual auditors is not limited to the above-mentioned
streams. In fact, an impressive body of behavioural auditing research investigates
the different aspects of individual auditors and how these affect performance. For
instance, prior research finds that auditors vary in terms of assessing probabilities
(Schultz and Reckers 1981), evaluating control risk (Reimers 1992), committing
biases (Shelton 1999), giving disclosure recommendations (Schultz and Reckers
1981) and negotiation skills (Brown and Johnstone 2004). Furthermore, studies
show that auditors are susceptible to bias (Hackenbrack 1992) and that their
objectivity and self-control may decline (Bazerman et al. 1997 and 2006; Hurley
2016).
As already noted, the majority of these studies use experimental research and
very few archival studies have been conducted in this area. Archival research often
focuses on the lead auditors who conducts the audit. Lead auditors7 are individual
auditors who are responsible for the direction, supervision and performance of an
audit team (ISA 220.15). Borrowing from team leadership theory8, it is possible to
assume that lead auditors affect performance by means of two mechanisms: i) a lead
auditor’s own behaviour and ii) a lead auditor’s influence on the audit team. It is fair
to assume that both these mechanisms depend to some extent on the characteristics
of lead auditors.
7 In this thesis, the terms ‘lead auditor’, ‘signing partner’, ‘engagement partner’ and ‘auditor-in-charge’ are used
interchangeably to refer to the individual auditor who leads the audit team and signs the audit report.
8 Team leadership theory predicts the extent to which a team leader can affect the team’s performance. According to this
theory, “there are two mechanisms through which individual traits affect [… outcomes]. The first involves actual
behaviors that result as a function of the leader’s traits. […]. The second mechanism through which leader’s traits might
impact [… outcomes] is not through actual behavior but rather how followers attribute and identify with the leader’s
traits” (DeRue et al. 2011, 20).
8
Archival research uses a variety of sources to determine the roles played by
individual auditors. For example, some research provides evidence of lead auditor’s
heterogeneity using fixed effect models (e.g. Cameran et al. 2016; Aobdia et al.
2015; Gul et al. 2013). This line of research claims that there is a huge heterogeneity
among lead auditors. Moreover, some research at the individual auditor level targets
issues such as lead auditor’s compensation (Knechel et al. 2013), identity (Knechel
et al. 2015) and disciplinary sanctions (Sundgren and Svanström 2016). Concerning
experimental research, another interesting area for archival research to investigate is
the effect of lead auditors’ cognitive characteristics and expertise. However, due to
the availability of data, this line of research is severely limited. Two examples of
this research are lead auditors’ risk preferences and expertise. For instance, Amir et
al. (2014) create a proxy for auditors’ riskiness using criminal records and link it to
lead auditors’ client portfolio characteristics. Ernstberger et al. (2015) investigates
the importance of technical knowledge and managerial knowledge for the quality of
audits. Study I and Study II are examples of this line of research, in that they focus
on the traits of scepticism and self-control.
Some archival auditing research approaches the problem of data availability by
creating proxies using lead auditors’ client portfolios. For instance, Carey and
Simnett (2006) use the auditor’s client specific tenure and link it to audit quality
proxies. Other researchers link client portfolio characteristics such as industry
specialisation (e.g. Goodwin and Wu 2014) or number of assignments (e.g.
Sundgren and Svanstrom 2014; Goodwin and Wu 2016) to the audit quality proxies.
Study III and Study IV in this thesis are also examples of this line of research. Study
III introduces three proxies (industry similarity, specialisation, and grouping) in
connection with lead auditors’ client portfolios in order to increase our knowledge
about the allocation process of lead auditors to clients. Study IV uses lead auditor
client switches to test for auditor independence.
1.1.2 Accounting Firms
As already indicated, accounting firms are classic professional service firms
(PSFs) (Von Nordenflycht 2010, 165). Three distinctive characteristics associated
with PFSs are knowledge intensity, low capital intensity and professional
workforces: “Knowledge intensity is the most fundamental distinctive characteristic
9
of PSFs”, implying that the “production of a firm’s output relies on a substantial
body of complex knowledge” (p. 159). Knowledge intensity gives rises to two
managerial challenges, namely opaque quality and cat herding (retention and
direction difficulties) (p. 160). Opaque quality “refers to situations where the quality
of an expert’s output is hard for nonexperts [] to evaluate, even after the output is
produced and delivered” (p. 161). Cat herding refers to retaining and directing a
skilled work force. For instance, highly skilled professionals have a high level of
bargaining power and a strong preference for autonomy. Another aspect of PSFs is
low capital intensity, which acknowledges the fact that a firm’s production does not
involve significant amounts of non-human assets. Professional workforce is the third
characteristic that may create a need to allow more autonomy inside a PSF. In
particular, classic PFSs such as accounting firms may display a more extensive
usage of autonomy (p.167): “Special manifestation of autonomy may include greater
decentralization of decision making to employees” (p.161). In addition, information
asymmetry between professionals and their supervisors may create the need for
autonomy as an “organizational response to the decentralized nature of information
held by professionals”(Zardkoohi et al. 2011, 181).
Accounting firms have received significant attention in the auditing literature
(Almer et al. 2005). For example, researchers have investigated the large firm-small
firm dichotomy (e.g. Lawrence et al. 2011), audit firms’ industry knowledge (e.g.
Francis and Yu 2009; Reichelt and Wang 2010) and the engagement-specific
characteristics of accounting firms (e.g. Carey and Simnett 2006; Lim and Tan,
2010). When it comes to engagement-specific characteristics, regulators and
researchers suggest that long tenure audits can reduce audit quality (e.g. United
States Senate 1976, 21; Shokkley 1981, 789) due to the overfamiliarity effect (e.g.
Carey and Simnett 2006), close personal relationships (e.g. Whittington et al. 1995)
and/or fee dependence (e.g. Hoyle 1978). Alternatively, longer audit firm tenure can
improve audit quality (e.g. Myers et al. 2003) due to the learning effect (e.g.
DeAngelo 1981). On the other hand, shorter audit firm tenures can reduce audit
quality (e.g. Geiger and Raghunandan 2002) and increase audit failure (e.g. Carcello
and Nagy 2004).
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In spite of numerous studies conducted at the accounting firm level, knowledge
continues to be limited due to the (non-)availability of data (Francis 2011, 138).
First, apart from a narrow field study stream that could go further towards an
understanding of audit firms (e.g. Anderson-Gough et al. 2005; Dirsmith 1994
Dirsmith and Cavaleski 1985), most research has been unable to probe the black box
of the accounting firm’s organisation. Study III in this thesis seeks to increase our
knowledge about the black box of accounting firms by providing evidence of the
allocation of human resources in these firms. Second, the effect of individual
auditors’ characteristics on audit quality is an unexplored area. Studies I, II and III
provide more knowledge about this issue by investigating whether the effect of
auditors’ scepticism and self-control on performance is conditional on accounting
firm type (Big 4 vs. non-Big 4) or not. In addition, Study III describes the
differences in how accounting firms allocate lead auditors to clients.
1.1.3 Lead Auditors’ Client Portfolios
As discussed previously, archival auditing research at the individual auditor level
often creates research proxies (for both dependent and independent variables) using
lead auditors’ client portfolios.
A lead auditor’s client portfolio is the product of the ‘client acceptance and
continuation process’ (CACP). The CACP usually starts with ‘practice
development’, the objective of which is to cultivate potential clients (Asare et al.
1994). The ‘practice development’ process is followed by the ‘client acceptance
analysis’, in which an auditor performs a series of procedures to evaluate whether he
or she wants to submit a proposal to a client or stop the process. If an auditor makes
such a proposal to a client, and the client agrees to the offer, the auditor can start to
perform the audit (Asare et al. 1994; Johnston and Bedard 2010). The final stage in
the CACP is the continuation analysis, in which an auditor decides whether to
continue with the current client or not (Asare et al. 1994). Decisions about client
acceptance or continuation involve a number of criteria (Simunic 1980; Johnstone
and Bedard 2003). More importantly, a decision depends on the professional
judgement of the involved parties, such as the lead auditor, risk manager and office
manager (Asare et al. 1994; Ayers and Kaplan 2003; Johnstone and Bedard 2003;
Klersey and Roberts 2010). The engagement partner can be paired with a current
11
client at any stage of the CACP. A number of parties are involved in the formation
of any lead auditor-client pair, each of which have their own unique incentives and
limitations. Therefore, a given lead auditor’s client portfolio is often the result of a
number of these factors.
Both the audit firm and lead auditor have an incentive to influence the lead
auditor-client pairing decision for a variety of reasons. First, the lead auditor-client
pairing (PCP) may affect lead auditor-client compatibility. If there is a strong
compatibility between the lead auditor and client, the quality and efficiency of audit
may be enhanced (Brown and Knechel 2016). Compatibility improves audit quality
because of the potential client-specific knowledge (e.g. Beck and Wu 2006; Brown
and Knechel 2015). Compatibility may also affect efficiency, for example by a
reduction in the lead auditor’s labour costs (Hackenbrack and Knechel 1997; Brown
and Knechel 2015). In fact, the auditing standards specify that for each engagement,
the expertise and capabilities of the lead auditor should be matched with the client’s
needs. In view of this, it is hardly surprising that some previous research models the
audit-staffing problem as an optimisation model with the goal of minimising the
mismatch between lead auditor and task (e.g. Balachandran and Zoltners 1981; Chan
and Dodin 1986; Dodin and Elimam 1997).
In similar vein, PCP is related to audit risk (Simunic and Stein 1990;
Hollingsworth 2012). Ideally, any lead auditor-client pairing decision should take
the lead auditor’s client portfolio risk into account. For instance, some accounting
firms review lead auditors’ client portfolios in order to evaluate an individual
auditor’s risk management (Hollingsworth 2012). Second, the lead auditor-client
pairing may affect the lead auditor’s workload and can be related to dysfunctional
behaviour and lower audit quality (Lopez and Peters 2012). For each engagement,
both the lead auditor and the audit firm should ensure that the lead auditor has
sufficient time in which to manage the portfolio. In practice, lead auditors’ client
portfolios are reviewed at least annually (e.g. KPMG 2014).
PCP can affect lead auditors’ independence in two opposite directions. First,
client importance could be detrimental to audit quality. To clarify, let us assume that
an audit firm assigns an important and profitable client to a lead auditor whose client
portfolio consists of small and unprofitable companies. This may increase the
12
probability of the lead auditor compromising his/her independence for the
economically important client (Chi et al. 2012). Second, assigning a large client
portfolio to a given lead auditor may improve his/her independence due to the
greater potential loss if the lead auditor is caught cheating (Goodwin and Wu 2016;
DeAngelo 1981, 191-92).
The PCP can also play a key role in developing a lead auditor’s expertise and
specialisation. As partners learn from their clients (Westermann et al. 2015), a lead
auditor should be matched with a client that allows him/her to develop knowledge in
the area in which an office or a lead auditor seeks to position him/herself
(Lowendahl et al. 2001). All lead auditors in accounting firms do not have the same
level of expertise. Assigning appropriate clients to junior lead auditors helps them to
improve their expertise and confidence. In fact, the role of the client portfolio as a
tool for knowledge development is articulated in the literature (e.g. Fosstenlokken et
al. 2003; Bednarek et al. 2016). Furthermore, a diverse client portfolio that poses
greater coordination and managerial challenges (Bednark et al. 2016) offers a greater
opportunity for a lead auditor to improve his/her managerial skills
(Abdolmohammadi et al. 2004).
The PCP can also be used as a signalling tool, both for the lead auditor and the
firm. For instance, pairing a large company in a lead auditor’s client portfolio may
signal his/her expertise to the market. Besides, matching might benefit the lead
auditor if s/he wants to self-select to particular clients. Prior research (e.g. Knehcel
et al. 2013; Sundgren and Svanström 2015) shows that a lead auditor’s portfolio
characteristics (e.g. total client-portfolio size) determine the lead auditor’s
compensation. Thus, it is fair to assume that lead auditors are willing to audit larger
clients, and to do so their expertise is an important factor (e.g. Craswell et al. 1995).
Given the above, it can be expected that audit firms and lead auditors engage in a
purposeful auditor in lead auditor pairing. In addition, as lead auditors’ client
portfolios are the consequence of prior lead auditor-client pairings, it is predicted
that lead auditors’ client portfolios will differ from each other if there has been a
systematic allocation of lead auditors to the clients. In other words, we would
expect to observe heterogeneity in the clients’ portfolios. However, it is fair to
13
suggest that lead auditors’ client portfolios may differ across audit firms and audit
practice offices.
The process of the PCP may differ across accounting firms for a variety of
reasons. First, accounting firms’ decision-making approaches may differ.
Accounting firms use two different approaches for decision-making: the mechanistic
and the organic (Dirsmith and McAllister 1982). In the mechanistic approach, the
emphasis in on the standardisation and following of procedures, whereas in the
organic approach, the focus is on flexibility and adaptation. Prior research shows
that in the client acceptance and continuation process, accounting firms usually
follow the organic approach (Gendron 2001) but that their emphases on the organic
approach differ (e.g. Huss and Jacobs 1991; Asare et al. 1994; Gendron 2001).
Second, accounting firms differ in the degree of emphasis they give to the
profitability of an engagement (Gendron 2001; Knechel et al. 2013). The extent of
focus on profitability may lead to different types of client portfolio.
The process of PCP can differ between the offices of a given accounting firm due
to the semi-autonomous nature of audit offices (Bell et al. 2002; Johnstone and
Bedard 2003; Bedard and Johnstone 2004) and the limitations of resources and
capacity in offices (e.g. Summers 1972). Traditionally, auditing research has mainly
focused on audit firms and assumed that there are no major differences between
audit offices and individuals. Audit firms implement rules and regulations and
develop compensation systems to guarantee that individuals meet the firm’s
objectives. However, audit firms policies usually flow downward to audit offices
and engagement level that possess more intimate and negotiated levels at which they
are interpreted and implemented by the lead auditors. Thus, it is difficult for audit
firms to fully control the work that is carried out in the audit offices due to the lead
auditor’s autonomy and subjective judgement. In fact, it could be said that audit
firms “have decentralized organizations and operate through a network of local
practice offices which have considerable autonomy with respect to contracting with
clients and administering audit engagements on the behalf of the firm” (Francis et al.
2013, 1628)9. Other important issues that contribute to the differences in audit
9 The semi-autonomous nature of audit offices can be likened to what is referred to as “inhabited institutions” in
organisational literature (e.g. Hallett and Ventresca 2006b; Hallett 2010). The theory of inhabited institutions posits that
actors who inhabit or operate within institutions modify the logic or rules that have been imposed by the institution.
14
offices’ PCP are the availability of resources (the available lead auditor, expertise
etc.) and the type of client. First, prior research shows that compared to larger
offices, smaller offices have a lower level of in-house expertise (Francis et al. 2013).
The limited level of in-house expertise enhances problems in the lead auditor-client
pairing. Audit office constraints in to the extent that the mathematical formulation of
the lead auditor-client pairing may require several hundred constraints
(Vairaktarakis 2003, 719). Second, the type of client may differ across offices
(Summers 1972; Schipper and Vincent 2003). For instance, offices with clients
requiring higher audit quality may choose to assign lead auditors differently than
offices that do not. Therefore, the heterogeneity of resource and clients across
offices may result in different preferences and limitations in the lead auditor-client
pairing.
To summarise, the discussion in this section assumes that there are empirical
differences in the lead auditor-client pairing across accounting firms due to the
differences in their decision-making approaches, and the emphasis given to the
engagement’s profitability. Furthermore, in a given accounting firm, the lead
auditor-client pairing may be different across audit practice offices due to the semi-
autonomous nature of audit offices and differences in the availability of resources.
1.1.4 Audit Quality
Before discussing the notion of audit quality, it is worth outlining the concept of
quality. In their literature review, Reeves and Bednar (1994) identify several
definitions for quality. These include: (1) quality as excellence, which has its roots
in the writings of the Greek philosophers, and maintains that quality is the highest
form of all (Reeves and Bednar 1994, 420), (2) quality as value, which originated in
the mid-1700s when businesses started to target a broad range of markets for their
goods. This view defines quality in terms of the value it brings to the consumer
(Reeves and Bednar 1994, 420-421). (3) quality as conforming to specifications,
which originated when businesses start to mass produce goods. This view defines
quality in terms of meeting predetermined standards (Reeves and Bednar 1994, 422-
Arguably, the auditing that is carried out by each audit firm is a ‘loosely coupled system’. Loose coupling is “defined as
individual components interrelated, in some way, but at the same time retaining independence from one another”
(Hallett, 2010). Loose coupling could therefore be used to describe the semi-autonomous nature of audit offices.
15
423), and (4) quality as “the extent to which a product or service meets and/or
exceeds a customer’s expectations. This definition of quality is used most (ibid.,
423).
For audit quality, there is “no single agreed definition” (Financial Reporting
Council 2006, 16). Audit quality can be defined in terms of the audit service’s
excellence - the highest good that the service can reach. For example, Titman and
Trueman (1986) define audit quality in terms of “the accuracy of the information [an
auditor] supplies to investors” (ibid., 160). Wallace (1980; 2004) views audit quality
as a measure of an auditor’s ability to reduce noise and bias and improve the finesse
of accounting data. Chaney (2003) defines audit quality as “the likelihood of issuing
the correct opinion on the financial statements of a given client” (ibid., 488). Unlike
the excellence version of audit quality, the value-based definition regards quality as
something that must be judged by the market, relative to its price. In line with this
point of view, Buuren (2009) defines audit quality as the high value relevance of
audited financial reports (p. 2). Audit quality is also defined as a quality of
conformance, which is how well the audit conforms to established accounting and
auditing standards. For example, Watkins et al. (2004) considers audit quality as the
“degree to which the audit conforms to applicable auditing standards” (ibid., 153).
Similarly, Francis (2011) asserts that “audit quality is achieved by the issuance of
the ‘appropriate’ audit report on the client’s compliance with generally accepted
accounting principles” (p. 127). The audit literature also defines audit quality as the
extent to which audit services meet and/or exceed stakeholders’ expectations. For
example, DeAngelo (1981) defines audit quality as “the market-assessed joint
probability” that a given auditor will both discover (refers to competence) and report
(refers to independence) an error in the client’s financial reports (p. 186). While this
definition seems comprehensive, it is problematic in the sense that the aspect of
probability in the definition is unobserved and difficult to measure (Krishnan and
Schauer 2000, 11).
There is also a binary view of audit quality. In this perspective, audit quality is
seen as a “dichotomy of either ‘audit failure’ or ‘no audit failure’” (Francis 2011,
127). An audit failure occurs when an auditor does not enforce generally accepted
accounting principles (GAAP failure), or when an auditor incorrectly issues a clean
16
audit report (audit report failure). In both cases, the client’s financial statements are
distorted and potentially misleading to users (Francis 2004, 346). In this binary
definition, audit quality “is inversely related to audit failure, the higher the audit
failure rate, the lower the quality of auditing” (ibid. , 346). Although audit research
shows that “there are relatively few demonstrable audit failures” (ibid., 127) and that
only finding a few audit failures does not necessarily mean that the actual number of
audit failures is few (ibid., 127). Audit failure cases are difficult to determine and
can only be inferred from sources such as auditor litigation, business failures and
earnings restatements, all of which take time to track. Due to the limitation of
resources and capital, it is possible that many cases of audit failure remain
unidentified. In short, the binary view of audit quality has two main limitations,
which are that all audit failure cases cannot be identified and, as the identifiable
audit failure rate is low, generalisations are not possible.
The legal view of audit quality is based on either/or thinking that is incapable of
comprehending the intricacies of audit quality. Thus, “audit quality is more likely a
continuum that can range from very low quality […] to very high quality” (ibid.,
129). Regarding audit quality as a continuum helps to increase our understating
about audit quality in the 99+ per cent of audits that are discerned as non-audit
failures (ibid., 129). Two main products of the audit process are the audit report and
clients’ financial statements. Although the audit report can be useful in some cases,
the financial statement helps us to create more powerful research designs, in that all
companies have financial statements with variation in earnings quality, while the
majority of audit reports are standard clean reports that are unable to explain the
wide variation in audit quality (ibid., 129).
Finally, audit quality can be specifically defined for each research purpose. For
example, Elitzur and Falk (1996) define audit quality as “the amount of standardized
units of audit evidence gathered by the independent auditor” (p. 250). Moreover,
Reichelt and Wang (2010) define audit quality as “clients’ earnings quality and the
propensity to issue a going-concern opinion” (p. 651). Alternatively, Beck and Wu
(2006) define audit quality “to be the precision of the auditor’s posterior beliefs
about the client’s earnings” (p. 7).
17
To summarise so far, prior research provides many definitions of audit quality,
such as “the accuracy of the information [auditor] supplies to investors” (Titman and
Trueman 1986) ; the auditor’s ability to reduce noise and bias and improve the
finesse of accounting data (Wallace 1980) ; “the likelihood of issuing the correct
opinion on the financial statements of a given client” (Chaney 2003, 488); a high
value relevance of audited financial reports (Buuren 2009, 2); “degree to which the
audit conforms to applicable auditing standards” (Watkins et al. 2004, 153); “the
issuance of the ‘appropriate’ audit report on the client’s compliance with generally
accepted accounting principles” (Francis 2011, 127); “the market-assessed joint
probability” that a given auditor will both discover (refers to competence) and report
(refers to independence) an error in the client’s financial reports (DeAngelo 1981,
186).
As already noted, there is no consensus among researchers on the definition of
audit quality. In addition, due to the knowledge intensive nature of accounting firms,
the quality of audits in unobservable. The difficulty in defining quality combined
with the difficulty of measuring audit quality creates challenges for auditing
researchers aiming to investigate the quality of audits using archival data. The
majority of prior research uses the auditor’s client characteristics to create a proxy
for audit quality. For instance, researchers use the following proxies: earnings
quality (see Dechow et al. 2010 for a review), modified audit opinion (e.g. Chang et
al. 2005; Chen et al. 2010), going concern accuracy10 (e.g. Francis and Krishnan
1999; Lennox 1999; Weber and Willenborg 2003) and fraud frequencies (e.g. Farber
2005; Dechow et al. 1996). There are also some attempts to measure the quality of
audits more directly, e.g. using the actual performance evaluation (Tan and Libby
1997), disciplinary sanctions (Sundgren and Svanström 2016), PCAOB Inspections
(DeFond and Lennox 2015), or peer reviews (for a review, see Löhlein 2016).
It could be argued that audit quality proxies suffer from measurement error. For
instance, in the case of earnings quality, prior research usually uses earnings quality
proxies for financial reporting quality. Financial reports are shaped by “a joint
10 Auditors can issue a going concern opinion if he or she thinks that the entity will go bankrupt in the near future
(usually within a year). Auditors can commit two types of error when it comes to the going concern opinion: Type I and
Type II. The Type I error occurs when a going concern opinion is issued for companies that do not enter into bankruptcy
in the subsequent year. Type II errors occur when an auditor does not issue a going concern opinion and the company
goes bankrupt in the subsequent year.
18
product of client management and auditor actions” (Carver et al. 2011, 37), which
suggests that audit quality and quality of financial reporting are positively related.
Auditing research usually uses earnings quality as a proxy for audit quality. The
quality of reported earnings is a function of both the firm’s financial performance
and errors induced by the accounting systems (Dechow et al. 2010, 5). Also, the
firm’s financial performance depends on a variety of factors, such as the operating
cycle and business condition. Therefore, the proxy is noisy, because it does not
exclusively capture the error induced in the accounting system (Dechow et al. 2010,
5-6). A similar line of argument is used for other commonly used proxies. For
instance, the modified audit opinion is a function of a firm’s performance, and
administration and accounting systems.11
It has been argued that going concern is “a very direct measure of audit quality
because the audit opinion is the auditor’s responsibility and directly under his or her
influence of control” (DeFond and Zhang 2014, 287). Although such an argument
might be valid for Type II errors (not issuing prior going concern opinions for
bankrupt companies), the line of argument for a Type I error (issuing a going
concern opinion for companies that do not enter into bankruptcy in the subsequent
year) is somewhat sketchy. In other words, arguing that a higher quality auditor has
a lower level of Type I error might not hold for some auditors. Take the case of
professional scepticism. While we expect auditors with a higher level of scepticism
to be less prone to Type II errors, predictions about Type I errors can go both sided.
In spite of the arguments against audit quality proxies12, researchers continue to
use them. For instance, researchers use earning quality metrics as a proxy for audit
quality because the evidence suggests that audit quality is linked to earnings quality
proxies (e.g., Nelson et al. 2002; Caramanis and Lennox 2008). For example,
Nelson et al. (2002) show that managers attempt earning management and that
11 Auditors can issue modified audit opinions for several reasons. First, a modified audit opinion can be issued for a
performance-related issue. For example, if there is any uncertainty about the continuation of an entity, an auditor can
issue a modified audit opinion. Second, the modified audit opinion can be issued due to errors in the administration
system. For instance, in some countries auditors can issue modified audit opinions if taxes have not been paid in time. 12 Among earnings quality measures, discretionary accruals models are the most widely used proxies for measuring audit
quality. Discretionary accruals reflect managers’ judgement and are more subjective than other components of financial
statements (Francis and Krishnan 1999, 135). These accruals often contain three elements: managers’ aggressive and
opportunistic reporting attempts, managers’ signaling attempts (Healy and Palepu, 1993) and random noises (Guayet al.
1996). Some of the widely used discretionary accrual models are Jones’ model (Jones 1991), modified Jones’ model
(Dechow et al. 1995), Dechow and Dichev approach (2002) and performance adjusted method (Kothari et al. 2005).
19
auditors require them to adjust for it. In addition, Caramanis and Lennox (2008) find
that managers are more able to manage earning when auditors consume less audit
effort. Moreover, there is some evidence to suggest that earnings quality proxies
show that GAAP has not been followed (Beneish 1997; Dechow et al. 2011).
Finally, using a comprehensive sample of firms, Dechow et al. (2011) find that the
earnings quality is low at the time of misstatements.
1.2 Research Hypotheses and Research Questions
This thesis focuses on lead auditors, and links their characteristics to their
performances. In addition, the audit firm (or audit offices) differences in the
proposed associations are investigated. The discussion is divided into two sections:
(1) lead auditor-performance and (2) the situation as a moderator. The overall
framework is depicted in Figure 1, below. This framework is somewhat analogous
to the person-situation debate, which maintains that performance (behaviour) is a
personal function and that situation acts as a moderator in the proposed association
(e.g. Judge and Zapata 2015).
Situation
• Audit firm or Audit office
• Audit firm type [Study I, II, III]
Behaviour (Performance)
• Quality-related
[Study I, II, III, IV]
• Employment-related [Study I, II and III]
Person (Lead Auditor) • Cognitive Characteristics
[Study I and II]
• Portfolio Characteristics [Study III and IV]
20
For the lead auditor, two sets of variables are studied: cognitive characteristics
(scepticism in Study I and self-control in Study II) and client portfolio attributes
(portfolio dispersion and industry similarity in Study III) and switching (in Study
IV).
For performance, two dimensions are considered: quality related and employment
related. For the quality related dimension, the sceptical outcome in Study I, and
audit quality proxies in Study II, Study III and Study IV are being studied. For the
the employment related dimension the lead auditors’ compensation is chosen in
Study I, Study II and Study III, and the lead auditors’ generated audit revenue is
being studied in Study II. For the situation (job context), the differences between
Big 4 and non-Big 4 accounting firms in the proposed associations are examined in
Study I and Study II. In addition, in Study III, Big 7 accounting firms and the
differences in audit offices’ client portfolios are described.
1.2.1 Lead Auditor - Performance
This section briefly presents the arguments in each paper specifically dealing with
the person-performance link.
In the first study (Study I), the relationship between professional scepticism and
performance is investigated. Professional scepticism is essential for audit quality
(FRC 2012) and may benefit a lead auditor’s career success. In order to link
professional scepticism to the sceptical outcome, a Nelson (2009)’s framework that
links professional scepticism to audit quality is used. According to this framework,
each lead auditor approaches audits according to his or her own level of scepticism.
And, auditors with a high level of professional scepticism exhibit higher quality
sceptical judgements (Nelson 2009). Accordingly, the following hypothesis is
formulated:
H2a [Study I]: Ceteris paribus, there is a positive association between scepticism
and sceptical judgement.
Furthermore, for the link between professional scepticism and compensation, and
based on prior research, two opposing predictions are suggested. The first is that
Figure 1: Person - Situation - Behaviour
21
accounting firms positively compensate for scepticism, in that high levels of
scepticism reduce the risk of audit failure and any resulting negative reputation
effects that follow from disciplinary sanctions. The second is that accounting firms
may punish scepticism because high levels of scepticism have adverse consequences
on the ‘generated audit revenue’. Scepticism may have adverse consequences on the
‘generated audit revenue’, because sceptical attitudes can lead to the auditor-client
conflicts, and also prevent lead auditors’ meeting time budgets. These opposing
predictions are explored with the following null hypothesis:
H1a [Study I]: Ceteris paribus, there is no association between scepticism and
compensation.
In Study II, the relationship between self-control, audit quality and ‘generated
audit revenue’ is investigated. An impressive body of literature has documented the
importance of self-control for a number of behavioural outcomes, such as academic
success (e.g. Tangney et al. 2004), interpersonal relationships (e.g. Vohs et al.
2011), finding a job (e.g. Baay et. al. 2014) and career promotions (Alberts and
Martijn 2007).
The dual processing model is used to conceptualize self-control. The dual-process
models suggest that the behaviour is determined by the interaction between two
different processes: i) implicit (automatic) and ii) reflective (controlled). Implicit
processes require limited effort and little use of cognitive resources. In contrast,
reflective processes are higher level and require extensive use of the cognitive
resource (Galla and Wood 2015). Implicit (automatic) and reflective (controlled)
processes compete with each other to determine behaviour. If a conflict between
these two systems arises, self-control is needed to resolve the conflict (Gall and
Wood 2015; Hofmann et al., 2009). It is proposed that a higher level of self-control
enables lead auditors to provide higher quality judgements and decisions,13 because
the majority of judgement and decision-making (JDM) tasks require a more
reflective process. For instance, prior research finds that self-control is required for
controlling attention (e.g. Schmeichel and Baumeister 2010), handling the cognitive
load (Griffin and Ricchiute 2012), persistence in the evaluation of audit evidence
13 The importance of lead auditors’ judgement and decision making is encapsulated in Knechel et al. (2013), who report
that “virtually every so-called ‘audit failure’ can be traced to an error in judgment … made by the audit team during the
course of an engagement” (p. 407).
22
(Hurley 2015), dealing with stress (e.g. Galla and Wood 2015) and resisting
persuasion (Burkley 2008). Accordingly, the following hypothesis is formulated:
H1 [Study II]: Ceteris paribus, there is a positive association between self-
control and audit quality.
Further, it is suggested that self-control plays an important role in determining the
generated audit revenue. This effect arises because lead auditors with a high (vs.
low) level of self-control are more easily able to manage increased workloads, are
more successful in finding new clients and have better quality interpersonal
relationships. In addition, building on economics theory, by assuming the optimal
assignment of cooperating resources to higher quality workers, it is inferred that the
market (extra and intra firm markets) assigns more resources to lead auditors with
greater(vs. lesser) self-control. The above discussion leads to the following
hypothesis:
H2 [Study II]: Ceteris paribus, there is a positive association between self-
control and the ‘generated audit revenue’.
Accounting firms use compensation schemes to motivate performance (Shaw et
al. 2002), and to signal the kind of activities that are expected from employees (Kerr
1975; Hinings et al. 1991). These compensation schemes usually reward auditors
according to the revenue they generate (Zeff 2003 a,b). Rewarding a lead auditor
based on the ‘generated audit revenue’ may enhance performance and (or) mitigate
the under-supply effort problem (e.g. making less effort to seek new clients and (or)
collect fees) (Huddart and Liang 2005, 154). Therefore, the following hypothesis is
formulated:
H3 [Study II]: Ceteris paribus, there is a positive association between ‘generated
audit revenue’ and compensation.
Assuming that both H2 and H3 hold, self-control should then have an indirect
effect on compensation through the ‘generated audit revenue’. This leads to the
following hypothesis:
H4a [Study II]: Holding all other things except ‘generated audit revenue’ equal,
there is a positive association between self-control and compensation.
23
For a link between self-control and compensation (by holding all other things
equal), the degree to which ‘generated audit revenue’ mediates14 the association
between self-control and compensation cannot be ex ante predicted. Therefore, the
mediator effect of ‘generated audit revenue’ is tested with the following null
hypothesis:
H4b [Study II]: Ceteris paribus, there is no association between self-control and
compensation.
In Study III, the allocation of lead auditors to clients is investigated. Here, it is
argued that both audit firms and lead auditors have incentives to influence the lead
auditor-client pairing decision for a variety of reasons. First, the lead auditor-client
pairing may affect lead auditor-client compatibility and could play a key role in
developing a lead auditor’s expertise. Second, the lead auditor-client pairing could
also be used as a signalling tool for both the lead auditor and the firm. In the study
three new concepts are introduced and methods for studying them suggested. First,
industry portfolio similarity (IPS) is defined as the similarity of the distributions of
all the lead auditors in an audit office across industries.15 Here the randomisation
technique from ecology research is applied, i.e. the null model analysis that provides
a statistical test to investigate whether an observed pattern is likely to happen in the
absence of a particular mechanism (Gotelli and Graves 1996). In other words, as a
lead auditor’s client portfolio is the consequence of prior lead auditor-client pairings,
it is predicted that lead auditors’ industry portfolios may differ from each other.
Second, borrowing from research on CEO specialisation, specialist vs. generalist
lead auditors are identified. Here, specialist vs. generalist is defined as the extent of
the distribution of a lead auditor’s portfolio characteristics. Using principle
component analysis, an index is created that shows the disparity of the lead auditor’s
client portfolio. Third, borrowing from research on the economics of education,
grouping (sorting, tracking16) is defined as the assignment of clients to the lead
auditor’s client portfolio based on the clients’ characteristics. Client grouping is
14 For a detailed discussion of the mediator, see Baron and Kenny (1986).
15 The main focus of this paper is on the lead auditor’s client portfolio at the audit practice office level. As a result, the
definitions in this paper are matched with this unit of analysis. The units for the definitions can be changed depending on
the researcher’s intention. For instance, a researcher who want to study the similarity of industry portfolios for the audit
offices in a specific geographic area can define the IPS as follows: The extent of similarity of the distribution of all the
audit offices in a geographical area with regard to its industries.
16 Grouping (sorting, tracking) is defined as assigning clients to client portfolios based on clients’ characteristics. For the
purpose of this paper the terms ‘grouping’, ‘sorting’ and ‘tracking’ are used interchangeably.
24
investigated by employing multinomial logit tests, which are performed separately
for each office. Finally, it is examined whether industry portfolio similarity,
specialist vs. generalist index and client grouping are related to earnings quality.
Study IV looks at the effect of lead auditor switches on audit opinions. The
available empirical evidence suggests many reasons for auditor switching, such as
overcoming the divergence of beliefs (Dye 1991; Antle and Nalebuff 1991) and (or)
punishing the incumbent auditor (e.g. Carcello and Neal 2003; Ettredge et al. 2007).
Alternately, auditors can initiate auditor switches to free up resources or to reduce
exposure to litigation and reputation risks (Taub 2004; Hogan and Martin 2009).
Although auditor changes are motivated for a number of reasons, academics (e.g.
DeFond and Subramanyam 1998) and regulators (SEC 1988) have raised concerns
that auditor changes are motivated by client opportunism. In other words, clients
might initiate auditor switching to reach the desired outcome (e.g. Lennox 2000).
Given this, over the past few years, auditor switching17 activities have been of
research interest (Carver et al. 2011). However, despite this interest, very little
archival research has been conducted on the effects of individual auditor switching
on audit quality. More importantly, very little (if any) research has studied audit
opinion shopping in private firms.
Prior research shows that as unclean audit opinions adversely affect clients (e.g.
Chang et al. 2005, clients may switch to avoid unfavourable audit opinions
(opportunistic switching). It is argued that clients in the private firm are more able to
engage in opportunistic switching and that auditors have incentives to accept this
behaviour. First, private firms have lower costs associated with switching, because
switching decisions in private firms are not restricted by corporate governance
mechanisms. Second, auditors face low levels of litigation and reputation loss risk in
private firms’ audits, because the audit outcomes of private firms are less likely to
be detected and scrutinised (Van Tendeloo and Vanstraelen 2008). Therefore, it is
suggested that auditor switching could be motivated by a client’s opportunism in the
private firm setting, which in turn could adversely affect audit quality. This
17 Firm-auditor switching refers to a change of accounting firm. Individual auditor switching refers to the change of
engagement partner.
25
prediction is tested using a methodology developed by Lennox (2000) to test audit
opinion shopping.18
1.2.2 Situation
As already noted, the situation can act as a moderator in the link between person
and behaviour. In fact, one of the main concerns in research at the individual level is
the extent to which firm-level factors moderate the behaviour and decisions of
individuals (Felin et al. 2015). Put simply, a lead auditor’s ability to affect
performance may reflect not only his or her distinctive characteristics, but also the
accounting firm’s internal structures and social milieu (Kosmala amd Herrbach
2006).
There are significant differences between audit firms with regard to resources,
culture (Jenkins et al. 2008), international networks (Lenz and James 2007) and the
type of audit clients they attract (Knechel et al. 2008). Due to these differences,
accounting firms have received significant attention in the auditing literature (Almer
et al. 2005, 1). For example, researchers have investigated the large firm-small firm
dichotomy (e.g. Lawrence et al. 2011), audit firms’ industry knowledge (e.g.
Francis and Yu 2009) and the engagement-specific characteristics of accounting
firms (e.g. Carey and Simnett 2006). Despite numerous studies at the accounting
firm level, our knowledge about the determinants of performance is still very limited
due to the availability of data (Francis 2011, 138). To date, apart from a narrow field
study stream that could go further in understanding audit firms (e.g. Dirsmith and
Cavaleski 1985; Dirsmith 1994; Anderson-Gough et al. 2005), many researchers
have been unable to probe the black box of accounting firms.
In Study I, professional scepticism is linked to compensation and the sceptical
outcome. It is further argued that the accounting firm type (Big 4 vs. non-Big 4)
could act as a moderator in the proposed associations. There is evidence to suggest
that Big 4 auditors produce higher quality audits than non-Big 4 auditors (e.g. Kim
et al. 2003; DeFond et al. 2015). In general, auditors at Big 4 audit firms are
expected to be concerned about reputation and audit quality. Big 4 auditors that do
18 According to the Securities and Exchange Commission (1988), audit opinion shopping refers to “the search for an
auditor willing to support a proposed accounting treatment designed to help a company achieve its reporting objectives,
even though that treatment might frustrate reliable reporting”.
26
not meet the quality standards put the reputation of the whole international network
at risk. Therefore, Big 4 firms have strong incentives to meet or exceed the
minimum level of audit quality. However, the incentives for (some) non-Big 4 audit
firms are lower than those for Big 4 audit firms for several reasons. First, they do
not have the same level of reputation to protect and they are not as sensitive to audit
failure (DeAngelo 1981). Second, they charge lower audit fees (Sundgren and
Svanström 2013) and may want to avoid undertaking extensive audit procedures
(that threaten short-term profitability). Therefore, it is suggested that Big 4 have
more incentives (due to client pressure, litigation risk and brand name reputation
loss) than their non-Big 4 counterparts to compensate for professional scepticism.
This leads to the following hypothesis:
H1b [Study II]: The association between scepticism and compensation is weaker
for non-Big 4 auditors.
Further, it is suggested that the pervasive internal review and quality control
processes in a Big 4 firm are likely to have a homogenising effect on auditors’
reporting. Accordingly, the following hypothesis is formulated:
H2b [Study I]: The association between scepticism and sceptical outcome is
greater for non-Big 4 auditors than Big 4 auditors.
In Study II, a link is suggested between self-control, generated quality and
generated revenue. For the link between self-control and audit quality, it is
suggested that accounting firm type (Big 4 vs. non-Big 4) could act as a moderator.
Two competing predictions are therefore proposed for the role of accounting firm
type on the suggested association. The first line of argument suggests that the degree
of association is higher for Big 4, because Big 4 lead auditors are more likely to
perceive audit quality as a reference point than non-Big 4 lead auditors. The second
argument is that Big 4 may design tighter control mechanisms, which in turn
weaken the effect of self-control in these firms, compared to that in non-Big 4.
These opposing predictions are explored in the following research question:
RQ1 [Study II]: Does the association between self-control and audit quality differ
across accounting firm types (Big 4 vs. non-Big 4)?
Furthermore, in Study II for the second hypothesis (H2), it is proposed that
accounting firms generally assign more audit work to highly self-controlled lead
27
auditors. It is also proposed that the assignment of more audit work to highly (vs.
low) self-controlled auditors is more likely to be observed in Big 4 accounting firms,
because they are more concerned about quality. This is explored in the following
research question:
RQ2 [Study III]: Does the association between self-control and ‘generated audit
revenue’ differ across accounting firm types (Big 4 vs. non-Big 4)?
Study III investigates the allocation of lead auditors to clients. It is also argued
that there are accounting firm heterogeneities in the allocation of lead auditors due
to the differences in decision-making approaches and the emphasis given to the
profitability of an engagement. Accounting firms’ decision-making approaches are
often different and consist of mechanistic and organic approaches (Dirsmith and
McAllister 1982). In the mechanistic view, the emphasis in on the standardisation of
procedures and strictly following them, whereas in the organic view the focus is on
flexibility and adaptation. Prior research shows that in the client acceptance and
continuation process, accounting firms usually follow the organic approach
(Gendron 2001). Accounting firms can also differ in the degree of emphasis given to
an engagement’s profitability (Gendron 2001; Knechel et al. 2013). Here, the focus
on profitability may lead to different types of client portfolio (Hay et al. 2007). The
above discussion suggests that there are audit firms heterogeneities in the lead
auditor-client pairing. This leads to the following proposition: There are accounting
firms heterogeneities in the lead auditor-client pairing.
Furthermore, in a given accounting firm, the allocation of lead auditors to clients
may differ across audit offices due to their semi-autonomous nature and differences
in the availability of resources. Traditionally, auditing research has mainly focused
on audit firms and assumed that there are no major differences between audit offices
and individuals. Audit firms implement rules and regulations and develop
compensation systems to guarantee that individuals meet the firm’s objectives.
However, audit firms’ policies usually flow downwards to audit offices and have
engagement levels that are more intimate and negotiated. Thus, it can be difficult for
audit firms to fully control the work that is carried out in the audit offices and in
each engagement due to the lead auditor’s autonomy and subjective judgement.
Another important issue that contributes to differences in the partner-client pairing is
28
the availability of resources (the available lead auditor, expertise etc.) and the type
of client. First, prior research shows that compared to larger offices, smaller offices
have a lower level of in-house expertise (Francis et al. 2013). The limited level of
in-house expertise can lead to problems in the lead auditor-client pairing. Second,
the type of client could differ across offices (Summers 1972; Schipper and Vincent
2003). Therefore, audit office differences in terms of resources and clients could
result in different patterns in the lead auditor-client pairing. This leads to the
following proposition: In a given accounting firm, there are audit office
heterogeneities in the lead auditor-client pairing.
1.3 Research Design
1.3.1 Data
For the purpose of the thesis, data from Sweden and (or) Finland19 is used
because this has several comparative advantages. First, due to the public disclosure
of the name of the auditor signing a report, lead auditors can be tracked. Second, the
results from the chosen setting can be generalised to the environments in which
individual auditors face litigation, because in Sweden and Finland lead auditors are
regularly investigated and could receive disciplinary sanctions from the Supervisory
Board of Public Accountants (SBPA). For instance, during the period 2006-2011,
320 disciplinary sanctions were issued, thus implying that 8 % of all the certified
lead auditors received a sanction. Third, the chosen setting facilitates the observation
of compensation and other demographic information pertaining to lead auditors and
the characteristics of their corresponding audit offices. Fourth, private companies are
subject to the public statutory audit requirement which dominates the Swedish and
Finnish audit markets. This facilitates the observation of a large sample of listed and
private firms. Including both listed and private firms improves the robustness of the
tests, because the inclusion of private firms permits a higher quality proxy for the
variable ‘generated audit revenue’.20
19 For a more detailed discussion about the institutional characteristics of Finland and Sweden, see the corresponding
section in Study I and II.
20 The inclusion of private firms enables a better proxy for generated audit revenue for the following reasons. First, it
allows us to observe most of the audit clients for each lead auditor. The majority of prior research at the lead auditor
29
In this thesis, archival data from a number of sources is used. For Sweden these
include UC, a Swedish business and credit information agency owned by the major
Swedish banks, the Supervisory Board of Public Accountants, Ratsit, an agency that
collects data from the Swedish tax authorities and Retriever Business, the leading
database for Swedish business information. The data sources from Finland include
the VOITTO database maintained by Suomen Asiakastieto Oy, the MADEUS
database maintained by Bureau van Dijk, the Finnish Auditor Register maintained
by the Auditing Board of the Central Chamber of Commerce in Finland, VIRRE
Information Service and Finnish Tax Administration.
1.3.2 Operationalisation
In this thesis, at the theoretical level for the dependent variable (behaviour), two
distinctive (but not necessarily diagonal) concepts are used: quality generation and
revenue generation. At the operational level, for quality generation, the proxies that
are extensively used in the auditing literature are applied, namely, the propensity to
issue unclean audit opinions [Study I, II and IV] and earnings quality proxies [all
four studies]. In addition, for the revenue generation measure [Study II], total client
size is used due to its high correlation with the audit fee that auditors earn. Finally,
for the purpose of the paper on audit opinion shopping [Study IV], the effect of the
lead auditor on switching is captured.
In order to operationalise the main explanatory variables in Study I and Study II,
proxies are used that match each paper’s objectives. For the professional scepticism
paper [Study I], Hurtt’s scale (Hurrt 2010) is used. Accounting researchers have
attempted to measure professional scepticism using different ranges of scales
(Nelson 2009, 10). While many of these researchers, such as Shaub and Lawrence
(1996), have used scales that were previously designed to measure other states and
traits, such as trust, independence and suspicion, some scholars have attempted to
design an appropriate scale for their experimental setting (Hurtt 2010, 150). More
recently, Hurtt (2010) has developed a scale to measure individual’s professional
scepticism by using six characteristics of sceptics: questioning mind, suspension of
level only includes public clients’ information. However, a lead auditor’s compensation and audit quality depend on both
public and private clients. Second, following prior research (e.g. Knechel et al. 2013), total clientele size is used as a
proxy for the generated audit fee. As private firms are less likely to pay the audit fee premium (e.g. Chaney et al. 2004),
the quality of the proxies will increase.
30
judgement, search for knowledge, interpersonal understanding, autonomy and self-
esteem. For the purpose of Study I, professional scepticism is proxied by the Hurtt
scale for the following reasons. First, prior studies provide evidence that the Hurtt
scale may predict sceptical behaviour (Fullerton and Durtschi 2004; Nelson 2009,
11; Popova 2013). Second, the Hurtt scale is relatively stable over time (Nelson
2009, 11), which enables the construction of a panel dataset for the analyses. Third,
it is recognised, cited and used by researchers (e.g. Fullerton and Durtschi 2004;
Hurtt et al. 2012; Quadackers et al. 2014). Fourth, it captures six different aspects of
auditor professional scepticism, which enables us to study the effects that each
dimension has on lead auditors’ reporting and compensation. Fifth, the scale is
relatively short, which results in higher response rate. Finally, to my knowledge, the
Hurtt scale is the only available for professional scepticism in the auditing context.
The Hurtt (2010) scale has been used extensively in prior research. In the tests for
internal consistency in a Swedish setting, Cronbach’s Alpha coefficient for the 30
item scale is 88.7 %, which is above the acceptable level. A factor analysis is then
performed to test the loading of factors. The first factor, which accounts for the most
variance, has an eigen- value of 7.46, which clearly satisfies Kaiser’s (1960) rule
(eigenvalue>1). A dimensionality test was also carried out to check whether the
scale is multidimensional and how each item is weighted for each factor. The results
are similar to those obtained by Hurtt (2010).
For the measure of self-control [Study II], the brief version of the self-control
scale (BSCS) developed by Tangney et al. (2004) is applied. In the past, researchers
have attempted to measure self-control using various scales (de Ridder et al. 2012).
BSCS is used for the following reasons. First, this scale is one of the most
recognised scales for self-control and is validated and extensively used in the
literature (de Ridder et al. 2012). For instance, de Ridder et al. (2012) report that
BSCS has been used in more than 50 studies published in high-ranking journals in a
variety of disciplines, such as social psychology, marketing and management.
Second, a meta-analysis of 102 studies (479 associations, 32,648 participants) shows
that compared to the other two recognised scales, BSCS is more able to explain
outcomes (de Ridder et al. 2012, 89). Finally, the scale is relatively short, which
could increase the response rate.
31
The internal consistency of BSCS in Study II is checked by the Cronbach alpha
test. The Cronbach’s alpha statistic equals 0.808 when calculated for the 13 item
BSCS using 493 response observations. Given that above 0.8 Cronbach’s alpha
indicates good test reliability, it can be concluded that the survey data is not biased
by internal inconsistency. The survey yielded a total of 493 responses, representing
a response rate of 37.6%. The response rate compares favourably with other online
surveys on accounting and finance research (e.g. 10% in Graham et al. 2005; 11% in
Graham et al. 2013). A number of additional analyses have been also performed and
are covered in the study.
1.3.3 Statistical Models
A number of statistical models are used in the thesis. In Study I, scepticism is
linked to sceptical outcome and compensation. In order to test the association
between a lead auditor’s self-control and compensation (H1a), the conventional
approach used in labour economics (Krueger and Lindahl 2000) and prior
accounting research is followed (Knechel et al. 2013, Sundgren and Svanström
2014), by using log-linear Mincer’s (1974) wage equation. This is described in the
following model: Compensation = f (Scepticism + Controls). In this model,
professional scepticism is the main independent variable and compensation is the
dependent variable. Both OLS and the random effect regression are estimated to test
the model. In H2a, a positive association is predicted between level of professional
scepticism and sceptical reporting. This prediction is tested using a basic research
design which links audit outcomes to the auditor characteristics described in the
following model: Sceptical Outcome = f (Scepticism + Controls). Unclean audit
opinions are used as the main dependent variables, and to estimate the model a
logistic regression is used. Finally, in H1b and H2b, Big 4 is introduced as a
moderator in the proposed associations. To analyse the moderation effect of Big 4,
the interaction term of Big 4 and scepticism is included in the models.
Study II investigates whether self-control is related to audit quality and generated
audit revenue. To test the association between a lead auditor’s self-control and audit
quality (H1), the basic research design is used which links audit quality proxies to
the auditor characteristics described in the following model: Audit Quality = f (Self-
Control + Controls). OLS is used for the model in which earnings quality is used as
32
a proxy for audit quality. Logistic regression is also used for the model in which the
modified audit opinion is the dependent variable. As for H2, a positive association is
predicted between a lead auditor’s self-control and ‘generated audit revenue’ by
holding all other things equal. To test H2, the following model is estimated using
OLS: Generated Audit Revenue = f (Self-Control + Controls). H3 predicts a positive
association between a lead auditor’s ‘generated audit revenue’ and compensation,
whereas H4b predicts no association between a lead auditor’s self-control and
compensation by holding all other things equal. The following model tests H3 and
H4b: Compensation = f (Self-Control + Controls). Finally, as H4a predicts a
positive association between a lead auditor’s self-control and compensation, all the
control variables except ‘generated audit revenue’ are included in the model.
Study III investigates the distribution of lead auditors across industries and
clients. To study the distribution of lead auditors across industries, the null model
analysis is used. This is a statistical tool that is describes and tests the randomness of
the observed patterns (Gotelli and Graves 1996). The null model analysis has been
applied in economic-based research (e.g. Bottazzi and Pirino 2010), but has mostly
been used in ecology21 (e.g. Gotelli 2000; Rodriguez-Girones and Santamaria 2006).
In economics, prior research uses null model analysis to investigate issues such as
the diversification of firms or their industry relatedness (Bottazzi and Pirino 2010).
Next, it is investigated whether client grouping takes place inside audit offices. This
follows Dieterle et al. (2015) by estimating a series of multinomial logit models of
client assignment to portfolio separately for each office-year combination. The
probability of a client being assigned to a particular engagement partner is estimated
using the following model: Lead Auditor Indicator = f (Client Characteristics).
Finally, the industry similarity, client grouping and specialisation are linked to
earnings quality using pooled regression of earnings quality proxies.
In Study IV, the auditor’s independence in the private firm setting is examined.
This is done using two models to investigate whether auditor switching is related to
the audit quality proxies. The first chosen method seeks to determine whether
private firms successfully engage in audit opinion shopping. This is done by first of
all examining the effect of auditor switching on the auditor’s reporting for the
21 In ecology, the main application of the null model analysis is to study the distribution of species and their interactions
in a geographical area.
33
companies that received unclean audit opinions in previous years using the
following model: Unclean Audit Opinion= f (Auditor Switches + Controls). Logistic
regression is used to test this model. Five switching variables are used to capture the
different definitions of switching. These are: switching lead auditor, switching the
audit firm, switching only the lead auditor and keeping the audit firm, and switching
only the audit firm and keeping the lead auditor. Another type of switch is
identified, namely downgrade activity, here defined as auditor switching from a Big
4 to a non-Big 4 audit firm. Second, following Lennox (2000), audit opinion
shopping for switching and non-switching companies is investigated by predicting
the unobserved audit opinions that clients would have made if they had they made
the opposite switch decision. In addition to the audit opinion shopping test, I also
investigate whether switching is related to the reduced earnings quality by using the
following model: Earnings Quality Proxies= f (Auditor Switches + Controls).
1.4 Results and Conclusions
This section presents the results in brief, acknowledges the limitations of the
findings and makes some suggestions for future research.
[Study I]: First, professional scepticism is positively associated with
compensation for lead auditors, but only for the sample of Big 4 audit firms. In the
study, two opposing predictions are provided regarding the effect of scepticism on
compensation. On the one hand, it is predicted that if audit firms are concerned with
audit quality and minimising (costly) audit failure, professional scepticism will be
rewarded, because auditors with a high level of professional scepticism may provide
greater audit quality (e.g. Hurtt et al. 2013 and 2012; Quadackers et al. 2014; Rose
2007; Popova 2013). On the other hand, if audit firms minimise client conflicts and
audit costs, professional scepticism is not compensated for, because auditors with a
high level of scepticism might overrun the time budget and their scepticism style
could adversely affect the auditor-client relationship. The positive association
between scepticism and compensation in Study I is in line with the first prediction
for Big 4 firms, and favours the second prediction for non-Big 4 firms. In other
words, the results imply a higher degree of sceptical value congruence between the
lead auditor and the organisation in Big 4 accounting firms.
34
Second, a positive association is predicted between professional scepticism and
the propensity to issue an audit opinion for the sample of non-Big 4 audit firms. In
the study, for the association between scepticism and audit outcome, it is predicted
that scepticism is related to audit quality. The effect arises because auditors with a
greater degree of professional scepticism are more alert to potential audit problems,
i.e. auditors who exhibit greater sceptical judgement are more likely to detect fraud
or accounting errors. In addition, we predict that the effect of scepticism on audit
outcome is less pronounced for Big 4 accounting firms, since these firms often have
pervasive internal reviews and quality control processes, which in turn homogenise
the effect of individuals’ traits. As seen in the results, the effect of scepticism on
audit outcome in Big 4 firm is not observed. This finding could be due to the fact
that large audit firms have more sophisticated quality controls and disciplining
systems than non-Big 4 firms.
[Study II] First, self-control is predictive of Big 4 lead auditors’ audit quality as
proxied by the abnormal accruals and propensities to issue a modified audit report.
For the effect of self-control on audit quality, and based on studies of the
relationship between self-control and performance, it is predicted that individual
differences in the trait of self-control should predict the ability to override impulses
and shift to the reflective process in many audit tasks. Two competing predictions
are suggested regarding the role of accounting firm type on the proposed
association. The first line of argument suggests that the degree of association is
higher for Big 4 firms, because Big 4 lead auditors are more likely to perceive audit
quality as a reference point than non-Big 4 lead auditors. The second argument is
that Big 4 firms may have tighter control mechanisms, which in turn weaken the
effect of self-control in these firms to a greater extent than in non-Big 4 firms. The
results suggest that the various mechanisms established by Big 4 audit firms to
homogenise the behaviour of lead auditors cannot supersede lead auditors’
idiosyncratic characteristics, such as self-control.
The findings also show that Big 4 lead auditors with a higher level of self-control
earn more audit revenue as proxied by the total clientele size. In addition, I observe
that for Big 4 lead auditors, generated audit revenue mediates the association
between self-control and compensation, meaning that the market (both intra and
35
extra firm) rewards high self-controlled Big 4 auditors by assigning them more
cooperating resources (audit revenue) in order to earn more compensation.
Moreover, for non-Big 4 lead auditors, self-control is related to compensation,
although the mediation effect of the generated audit revenue is not observed in this
association. This implies that the market does not compensate self-control in non-
Big 4 firms. One possible reason for this is that non-Big 4 firms are less known in
the market and have limited resources and a restricted range of clients. In other
words, a non-Big 4 lead auditor with high level of self-control has fewer
opportunities to signal his/her ability to the market, whereas, a Big 4 lead auditor
with high level of self-control can signal his/her quality to the market by virtue of
the firm’s reputation , its broad range of clients and its resources.
[Study III]: First, the majority of lead auditors perform audits in different
activities. In addition, it appears that the industry portfolios of lead auditors inside
audit offices are very similar. These findings cast doubt on the assumption in the
auditing literature that auditors are grouped based on industry specialisation (Nelson
and Tan 2005, 49). In other words, the results are inconsistent with the notion that
accounting firms organise their business in terms of industry. Second, among the
client company’s observable characteristics, size is the most common criterion for
client grouping. After size, profitability is the most common factors, whilst the risk,
probability of bankruptcy and earnings quality are the least common criteria. In
addition, groupings based on clients’ characteristics are different across accounting
firms and audit offices. The restul implies that a lead auditor’s assignment to the
level of accruals is more or less close to random in many audit offices and that the
assignment to earnings quality is office or audit firm level phenomena. An empirical
implication of these results is that a regression of earnings quality that does not
control for the fixed effects of accounting firms and audit offices suffers from an
omitted variable bias. Third, larger offices are more likely to group client portfolio
based on size. This indicates that as larger offices have more human capital and a
larger number of clients, these factors determine how clients are grouped.
Fourth, an index for the dispersion of lead auditors’ client portfolios is created. It
is observed that the index is negatively related to the earnings quality proxy. This
indicates that as the client portfolios of lead auditors disperse, the quality of audited
36
earnings decreases. This result is clearly in line with the literature on expertise,
which maintains that the accumulated experience and skills improve the quality of
audits. The results also have an empirical implication for the research design on
auditor-client compatibility research. This line of research argues that as the degree
of alignment between auditor and clients increases, the quality of audits also
increases. To test the degree of alignment, some client characteristics are chosen and
the distance between these variables and auditor’s client portfolio variables
calculated. Given this, the distance variable could partly capture the dispersion of
the lead auditor’s client portfolio. In other words, for lead auditors with a high value
of dispersion index, the calculated distance will be higher on average. As a result, it
is not certain whether compatibility has a negative effect on earnings quality or
dispersion. If this is the case, research on compatibility should also control for the
dispersion of lead auditors’ client portfolios, otherwise their compatibility proxy will
suffer from endogeneity.
[Study IV]: First, following pre-switch unclean audit opinions, switching private
firms are more likely to receive clean audit opinions. In addition, following pre-
switch clean audit opinions, switching private firms are more likely to receive
unclean audit opinions. Moreover, the probability of receiving unclean audit
opinions decreases as the predicted probability of dismissal threat increases. Finally,
switching is predictive of decreased earnings quality. This findings indicate that
auditors are willing to compromise their decisions in the private firm setting. Given
this, the results contradict prior findings (e.g. Hope and Langli 2010) that auditors
(because of the effect of professionalism) do not compromise their independence in
a low litigation environment. This contradictory finding could have arisen due to the
use of a different research design, namely a switching test rather than a fee
dependence test.
Overall, the results indicate that there is a heterogeneity among lead auditors’
performances. These findings indicate that at least three dimensions of performance
(i.e. audit quality, compensation and audit revenue generation) are not homogenous
across lead auditors in the same (tier) audit firm(s), and that lead auditors’ traits and
accounting firm type determine these differences. These results show that there is an
association between individuals (person) and performance. In addition, the results
37
imply that situation can increase or decrease the effect of individuals’ characteristics
on performance. Obviously, these results are not new, given that an impressive body
of knowledge already highlights the role of person on performance and the
moderating role of situation. What is new in this thesis is the role that scepticism,
self-control, client portfolio dispersion and similarity of performance play in the
auditing.
This study has a number of limitations. First, the thesis only documents
associations, not causation. All the models may have econometric problems, such as
omitted variable bias, measurement error and self-selection. I acknowledge that the
main variables of interest – scepticism, self-control, dispersion and switching – may
have measurement errors. The omitted variable and self-selection of lead auditors is
also a problem. An attempt has been made to minimise this risk by including
relevant control variables, although it is not certain that this potential problem has
been fully solved. It was difficult to find an instrument for the main variable of
interest, and to my knowledge no research has used an instrument for the survey-
gathered behavioural variable. I speculate that in the hypothetical scenario that a
researcher uses an instrument, such an instrument will be more likely endogenous as
well. Second, the data used in this thesis mainly relates to private firms.
Consequently, the results cannot be generalised to the public firm setting. In
particular, the results in Study III should be interpreted with caution since the data
might suffer from noise. In view of this, Study III should be seen as seeking to
introduce a method, rather than a study that provides empirical results. Third, as the
traits of scepticism and self-control are only measured at a particular point in time, it
may not necessarily reflect the traits of scepticism or self-control that were evident
at the time the audits were performed. Fourth, the paper mainly reports the observed
patterns and does not investigate the process. Richer data is needed that was not
available at the time of the study. Also, the investigative process may benefit from
the use of different qualitative methodologies. Fifth, the main dependent variable
also suffers from measurement errors. Although errors in the dependent variable are
usually of less concern, in some instances in this thesis the measurement error of the
dependent variable could be problematic. However, due to the availability of data,
no other dependent variable could be used. For instance, in the compensation tests,
38
auditors’ total compensation is used instead of the compensation schemes used by
audit firms due to the confidential nature of those schemes. Thus, the measure of
compensation is not fully representative of the schemes used by audit firms. In
addition, I did not have any access to information relating to audit fees and non-
audit fees. This may have reduced the quality of the analysis, particularly where
generated audit revenue is used as a variable of interest. Furthermore, following
prior research, earnings quality and propensity are used to issue modified audit
opinion as proxies for audit quality – proxies that are subject to the measurement
error.
To the best of my knowledge, this thesis is the first archival auditing study to
investigate professional scepticism, self-control, industry similarity and client
portfolio dispersion. Given the scarcity of research in these topics in archival
auditing, I am only able to provide limited empirical results. As the findings of this
thesis may offer some challenges when it comes to interpretation, future researchers
are encouraged to delve deeper into the links between person, situation and
performance in the auditing context. For the ‘person’ variable, future researchers
may want to try other instruments to proxy for professional scepticism, self-control
or portfolio dispersion. Moreover, future researchers may want to test the interaction
between individual level variables, such as self-control and professional scepticism,
specialisation and compatibility. Further, I suggest the inclusion of other personality
traits, such as conscientiousness in the models. For the situation variable, the
moderating role of auditing regulations on the person-performance link is relatively
unexplored. For instance, in some countries like Sweden, compulsory auditing for
small companies has recently been abolished. It would be interesting to study how
this change in the regulations affects the link between person and performance in the
auditing context. For the performance variable, auditing research is heavily
dominated by research in which quality of audit is considered as a performance.
Future research may therefore want to investigate the effect of person on the
efficiency dimension of performance.
39
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