The relation between engagement quality control review hours and auditor changes: evidence from South Korea
Abstract
The purpose of this study is to analyze whether engagement quality control review (EQCR) hours affect auditor changes and whether abnormal audit fees and changes in management have moderating effects on the relation between EQCR hours and auditor changes. The logit regression model is designed to investigate the relation between EQCR hours and auditor changes. The study finds evidence that EQCR hours are higher before auditors are changed. It also documents that abnormal audit fees weaken and that changes in management strengthen the positive relation between EQCR hours and auditor changes. In summary, high EQCR hours increase the probability of auditor changes, and the results imply that EQCR hours are a proxy for the audit risk perceived by auditors. This research is the first empirical study to test the relation between EQCR hours and auditor changes.
Keyword : engagement quality control review, auditor changes, audit fees, changes in management, audit hours, audit risk
How to Cite
Song, J.-W., & Kim, Y.-S. (2021). The relation between engagement quality control review hours and auditor changes: evidence from South Korea. Journal of Business Economics and Management, 22(5), 1269-1287. https://doi.org/10.3846/jbem.2021.14934
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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An, H. L., & Choe, K. H. (2017). The effects of managers’ real earnings management activities on audit quality control review hours. Productivity Review, 31(4), 33–59 (in Korean). https://www.kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002307139
Bae, G. S., Lee, J. E., Rho, J. H., & Choi, S. U. (2015). Auditors’ differential responses to audit risks through quality control review hours. Korean Accounting Review, 40(6), 81–117 (in Korean). http://kiss.kstudy.com/thesis/thesis-view.asp?key=3379968
Bae, K. H., Kang, J. K., & Kim, J. M. (2002). Tunneling or value added? Evidence from mergers by Korean business groups. The Journal of Finance, 57(6), 2695–2740. https://doi.org/10.1111/1540-6261.00510
Beattie, V., & Fearnley, S. (1995). The importance of audit firm characteristics and the drivers of auditor change in UK listed companies. Accounting and Business Research, 25(100), 227–239. https://doi.org/10.1080/00014788.1995.9729912
Beattie, V., Goodacre, A., Pratt, K., & Stevenson, J. (2001). The determinants of audit fees: Evidence from the voluntary sector. Accounting and Business Research, 31(4), 243–274. https://doi.org/10.1080/00014788.2001.9729619
Becker, C. L., DeFond, M., Jiambalvo, J., & Subramanyam, K. R. (1998). The effect of audit quality on earnings management. Contemporary Accounting Research, 15(1), 1–24. https://doi.org/10.1111/j.1911-3846.1998.tb00547.x
Bell, T. B., Landsman, W. R., & Shackelford, D. S. (2001). Auditors’ perceived business risk and audit fees: Analysis and evidence. Journal of Accounting Research, 39(1), 35–43. https://doi.org/10.1111/1475-679X.00002
Carcello, J. V., Hermanson D. R., Neal, T. L., & Riley, R. A. (2002). Board characteristics and audit fees. Contemporary Accounting Research, 19(3), 365–384. https://doi.org/10.1506/CHWK-GMQ0-MLKE-K03V
Catanach, A., Irving, J. H., Williams, S. P., & Walker, P. L. (2011). An ex post examination of auditor resignations. Accounting Horizons, 25(2), 267–283. https://doi.org/10.2308/acch-10030
Choi, J. H., Kim, J. B., & Zang, Y. (2010). Do abnormally high audit fees impair audit quality? Auditing: A Journal of Practice & Theory, 29(2), 115–140. https://doi.org/10.2308/aud.2010.29.2.115
Copley, P. A., Doucet, M. S., & Gaver, K. M. (1994). A simultaneous equations analysis of quality control review outcomes and engagement fees for audits of recipients of federal financial assistance. The Accounting Review, 69(1), 244–256. https://www.jstor.org/stable/248270
Data Analysis, Retrieval and Transfer System (DART) (n.d.). http://dart.fss.or.kr
Davidson III, W. N., Jiraporn, P., & DaDalt, P. (2006). Causes and consequences of audit shopping: An analysis of auditor opinions, earnings management, and auditor changes. Quarterly Journal of Business and Economics, 45(1–2), 69–87. https://www.jstor.org/stable/40473415
DeAngelo, L. E. (1981b). Auditor size and audit quality. Journal of Accounting and Economics, 3(3), 183–199. https://doi.org/10.1016/0165-4101(81)90002-1
DeAngelo, L. E. (1982). Mandated successful efforts and auditor choice. Journal of Accounting and Economics, 4(3), 171–203. https://doi.org/10.1016/0165-4101(82)90008-8
DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: The use of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10(1), 3–36. https://doi.org/10.1016/0165-4101(88)90021-3
DeAngelo, L. E. (1981a). Auditor independence, “low balling”, and disclosure regulation. Journal of Accounting and Economics, 3(2), 113–127. https://doi.org/10.1016/0165-4101(81)90009-4
DeFond, M., & Jiambalvo, J. (1994). Debt covenant violations and manipulations of accruals. Journal of Accounting and Economics, 17(1–2), 145–176. https://doi.org/10.1016/0165-4101(94)90008-6
DeFond, M., & Subramanyam, K. (1998). Auditor change and discretionary accruals. Journal of Accounting and Economics, 25(1), 35–67. https://doi.org/10.1016/S0165-4101(98)00018-4
Dye, R. A. (1991). Informationally motivated auditor replacement. Journal of Accounting and Economics, 14(4), 347–374. https://doi.org/10.1016/0165-4101(91)90008-C
Dodgson, M. K., Agoglia, C. P., Bennett, G. B., & Cohen, J. R. (2020). Managing the auditor-client relationship through partner rotations: The experiences of audit firm partners. The Accounting Review, 95(2), 89–111. https://doi.org/10.2308/accr-52556
Emby, C., & Favere-Marchesi, M. (2010). Review partners and engagement partners: The interaction process in engagement quality review. Auditing: A Journal of Practice & Theory, 29(2), 215–232. https://doi.org/10.2308/aud.2010.29.2.215
FN-GUIDE (n.d.). https://www.fnguide.com
Francis, J. R., & Wilson, E. R. (1988). Auditor changes: A joint test of theories relating to agency costs and auditor differentiation. The Accounting Review, 63(4), 663–682. https://www.jstor.org/stable/247906
Ghosh, A., & Tang, C. Y. (2015). Auditor resignation and risk factors. Accounting Horizons, 29(3), 529–549. https://doi.org/10.2308/acch-51074
Gipper, B., Hail, L., & Leuz, C. (2020). On the economics of mandatory audit partner rotation and tenure: Evidence from PCAOB data (Stanford University Graduate School of Business Research Paper, No. 17–56). https://ssrn.com/abstract=3023725
Higgs, J. L., & Skantz, T. R. (2006). Audit and nonaudit fees and the market’s reaction to earnings announcements. Auditing: A Journal of Practice & Theory, 25(1), 1–26. https://doi.org/10.2308/aud.2006.25.1.1
International Federation of Accountants. (2009). International standard on auditing 220: Quality control for an audit of financial statement. https://www.ifac.org/system/files/publications/files/A011%202012%20IAASB%20Handbook%20ISA%20220.pdf
Jeong, D. S., & Lee, J. E. (2019). Effects of engagement partner’s audit experiences on audit quality, as combined with auditor quality controls at engagement- and audit firm-levels. Study on Accounting, Taxation & Auditing, 61(3), 1–31 (in Korean). https://www.kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002506487
Johnstone, K. M. (2000). Client acceptance decisions: Simultaneous effects of client business risk, audit risk, auditor business risk, and risk adaptation. Auditing: A Journal of Practice & Theory, 19(1), 1–25. https://doi.org/10.2308/aud.2000.19.1.1
Johnstone, K. M., & Bedard, J. C. (2003). Risk management in client acceptance decisions. The Accounting Review, 78(4), 1003–1025. https://doi.org/10.2308/accr.2003.78.4.1003
Kim, Y. S., Kang, S. A., & Park, S. H. (2021). The effect of management style on financial statement comparability: Evidence from Korean business groups. Asia-Pacific Journal of Accounting and Economics, 28(4), 454–471. https://doi.org/10.1080/16081625.2019.1566870
Kinney, W. R., & Libby, R. (2002). Discussion of the relation between auditors’ fees for nonaudit services and earnings management. The Accounting Review, 77(Suppl. 1), 107–114. https://doi.org/10.2308/accr.2002.77.s-1.107
Kothari, S., Leone, A., & Wasley, C. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163–197. https://doi.org/10.1016/j.jacceco.2004.11.002
Krishnan, J. (1994). Auditor switching and conservatism. The Accounting Review, 69(1), 200–215. https://www.jstor.org/stable/248267
Lei, D., Zhou, Y., & Wang, Y. (2000). Auditor-client disagreements, auditor resignations, and audit fees changed by successor auditors. Journal of Applied Business Research, 36(1), 15–28. https://doi.org/10.19030/jabr.v36i1.10321
Lennox, C., Wang, C., & Wu, X. (2020). Opening up the “black-box” of audit firms: The effects of audit partner ownership on audit adjustments. Journal of Accounting Research, 58(5), 1299–1341. https://doi.org/10.1111/1475-679X.12333
Lustgarten, S., & Shon, J. (2013). Do abnormal accruals affect the life expectancy of audit engagements? Review of Quantitative Finance and Accounting, 40(3), 443–466. https://doi.org/10.1007/s11156-012-0276-1
Matsumura, E. M., & Tucker, R. R. (1995). Second partner review: An analytical model. Journal of Accounting, Auditing & Finance, 10(1), 173–200. https://doi.org/10.1177/0148558X9501000113
Mitra, S., Jaggi, B., & Al-Hayale, T. (2016). Auditor’s downward switch, governance, and accounting conservatism. Journal of Accounting, Auditing & Finance, 31(4), 551–581. https://doi.org/10.1177/0148558X15590227
Public Company Accounting Oversight Board. (2009). Auditing standard No 7: Engagement quality review (AS No. 7). PCAOB Release 2009–004. Washington. https://pcaobus.org/oversight/standards/archived-standards/pre-reorganized-auditing-standards-interpretations/details/auditing-standardno-7_1836
Schwartz, K. B., & Menon, K. (1985). Auditor switches by failing firms. The Accounting Review, 60(2), 248–261. https://www.jstor.org/stable/246789
Simon, D. T., & Francis, J. R. (1988). The effects of auditor change on audit fees: Tests of price cutting and price recovery. The Accounting Review, 63(2), 255–268. https://www.jstor.org/stable/248104
Simunic, D. A. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research, 18(1), 161–190. https://www.doi.org/10.2307/2490397
Simunic, D. A., & Stein, M. T. (1996). The impact of litigation risk on audit pricing: A review of the economics of and the evidence. Auditing: A Journal of Practice & Theory, 15, 119–133.
Sung, O. H. (2007). Estimation of risk-adjusted discount rate for the technology valuation of smallsized venture firm. In Commercialization and Transfer of Technology: Major Country Case Studies (pp. 231–240). Nova. http://www.novapublishers.org/catalog/product_info.php?products_id=5586
Tucker, R. R., & Matsumura, E. M. (1997). Second-partner review: An experimental economics investigation. Auditing: A Journal of Practice & Theory, 16(1), 79–98.
Warner, J. B., Watts, R. L., & Wruck, K. H. (1988). Stock prices and top management changes. Journal of Financial Economics, 20, 461–492. https://doi.org/10.1016/0304-405X(88)90054-2
Weisbach, M. S. (1988). Outside directors and CEO turnover. Journal of Financial Economics, 20, 431– 460. https://doi.org/10.1016/0304-405X(88)90053-0
Wells, P. (2002). Earnings management surrounding CEO changes. Accounting and Finance, 42(2), 169–193. https://doi.org/10.1111/1467-629X.00073
Woo, E. S., & Koh, H. C. (2001). Factors associated with auditor changes: A Singapore study. Accounting and Business Research, 31(2), 133–144. https://doi.org/10.1080/00014788.2001.9729607
Zhang, J. H. (2018). Accounting comparability, audit effort, and audit outcomes. Contemporary Accounting Research, 35(1), 245–276. https://doi.org/10.1111/1911-3846.12381
American Institute of Certified Public Accountants. (1986). Division for CPA firms SEC practice section: SECPS manual. AICPA, New York.
An, H. L., & Choe, K. H. (2017). The effects of managers’ real earnings management activities on audit quality control review hours. Productivity Review, 31(4), 33–59 (in Korean). https://www.kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002307139
Bae, G. S., Lee, J. E., Rho, J. H., & Choi, S. U. (2015). Auditors’ differential responses to audit risks through quality control review hours. Korean Accounting Review, 40(6), 81–117 (in Korean). http://kiss.kstudy.com/thesis/thesis-view.asp?key=3379968
Bae, K. H., Kang, J. K., & Kim, J. M. (2002). Tunneling or value added? Evidence from mergers by Korean business groups. The Journal of Finance, 57(6), 2695–2740. https://doi.org/10.1111/1540-6261.00510
Beattie, V., & Fearnley, S. (1995). The importance of audit firm characteristics and the drivers of auditor change in UK listed companies. Accounting and Business Research, 25(100), 227–239. https://doi.org/10.1080/00014788.1995.9729912
Beattie, V., Goodacre, A., Pratt, K., & Stevenson, J. (2001). The determinants of audit fees: Evidence from the voluntary sector. Accounting and Business Research, 31(4), 243–274. https://doi.org/10.1080/00014788.2001.9729619
Becker, C. L., DeFond, M., Jiambalvo, J., & Subramanyam, K. R. (1998). The effect of audit quality on earnings management. Contemporary Accounting Research, 15(1), 1–24. https://doi.org/10.1111/j.1911-3846.1998.tb00547.x
Bell, T. B., Landsman, W. R., & Shackelford, D. S. (2001). Auditors’ perceived business risk and audit fees: Analysis and evidence. Journal of Accounting Research, 39(1), 35–43. https://doi.org/10.1111/1475-679X.00002
Carcello, J. V., Hermanson D. R., Neal, T. L., & Riley, R. A. (2002). Board characteristics and audit fees. Contemporary Accounting Research, 19(3), 365–384. https://doi.org/10.1506/CHWK-GMQ0-MLKE-K03V
Catanach, A., Irving, J. H., Williams, S. P., & Walker, P. L. (2011). An ex post examination of auditor resignations. Accounting Horizons, 25(2), 267–283. https://doi.org/10.2308/acch-10030
Choi, J. H., Kim, J. B., & Zang, Y. (2010). Do abnormally high audit fees impair audit quality? Auditing: A Journal of Practice & Theory, 29(2), 115–140. https://doi.org/10.2308/aud.2010.29.2.115
Copley, P. A., Doucet, M. S., & Gaver, K. M. (1994). A simultaneous equations analysis of quality control review outcomes and engagement fees for audits of recipients of federal financial assistance. The Accounting Review, 69(1), 244–256. https://www.jstor.org/stable/248270
Data Analysis, Retrieval and Transfer System (DART) (n.d.). http://dart.fss.or.kr
Davidson III, W. N., Jiraporn, P., & DaDalt, P. (2006). Causes and consequences of audit shopping: An analysis of auditor opinions, earnings management, and auditor changes. Quarterly Journal of Business and Economics, 45(1–2), 69–87. https://www.jstor.org/stable/40473415
DeAngelo, L. E. (1981b). Auditor size and audit quality. Journal of Accounting and Economics, 3(3), 183–199. https://doi.org/10.1016/0165-4101(81)90002-1
DeAngelo, L. E. (1982). Mandated successful efforts and auditor choice. Journal of Accounting and Economics, 4(3), 171–203. https://doi.org/10.1016/0165-4101(82)90008-8
DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: The use of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10(1), 3–36. https://doi.org/10.1016/0165-4101(88)90021-3
DeAngelo, L. E. (1981a). Auditor independence, “low balling”, and disclosure regulation. Journal of Accounting and Economics, 3(2), 113–127. https://doi.org/10.1016/0165-4101(81)90009-4
DeFond, M., & Jiambalvo, J. (1994). Debt covenant violations and manipulations of accruals. Journal of Accounting and Economics, 17(1–2), 145–176. https://doi.org/10.1016/0165-4101(94)90008-6
DeFond, M., & Subramanyam, K. (1998). Auditor change and discretionary accruals. Journal of Accounting and Economics, 25(1), 35–67. https://doi.org/10.1016/S0165-4101(98)00018-4
Dye, R. A. (1991). Informationally motivated auditor replacement. Journal of Accounting and Economics, 14(4), 347–374. https://doi.org/10.1016/0165-4101(91)90008-C
Dodgson, M. K., Agoglia, C. P., Bennett, G. B., & Cohen, J. R. (2020). Managing the auditor-client relationship through partner rotations: The experiences of audit firm partners. The Accounting Review, 95(2), 89–111. https://doi.org/10.2308/accr-52556
Emby, C., & Favere-Marchesi, M. (2010). Review partners and engagement partners: The interaction process in engagement quality review. Auditing: A Journal of Practice & Theory, 29(2), 215–232. https://doi.org/10.2308/aud.2010.29.2.215
FN-GUIDE (n.d.). https://www.fnguide.com
Francis, J. R., & Wilson, E. R. (1988). Auditor changes: A joint test of theories relating to agency costs and auditor differentiation. The Accounting Review, 63(4), 663–682. https://www.jstor.org/stable/247906
Ghosh, A., & Tang, C. Y. (2015). Auditor resignation and risk factors. Accounting Horizons, 29(3), 529–549. https://doi.org/10.2308/acch-51074
Gipper, B., Hail, L., & Leuz, C. (2020). On the economics of mandatory audit partner rotation and tenure: Evidence from PCAOB data (Stanford University Graduate School of Business Research Paper, No. 17–56). https://ssrn.com/abstract=3023725
Higgs, J. L., & Skantz, T. R. (2006). Audit and nonaudit fees and the market’s reaction to earnings announcements. Auditing: A Journal of Practice & Theory, 25(1), 1–26. https://doi.org/10.2308/aud.2006.25.1.1
International Federation of Accountants. (2009). International standard on auditing 220: Quality control for an audit of financial statement. https://www.ifac.org/system/files/publications/files/A011%202012%20IAASB%20Handbook%20ISA%20220.pdf
Jeong, D. S., & Lee, J. E. (2019). Effects of engagement partner’s audit experiences on audit quality, as combined with auditor quality controls at engagement- and audit firm-levels. Study on Accounting, Taxation & Auditing, 61(3), 1–31 (in Korean). https://www.kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002506487
Johnstone, K. M. (2000). Client acceptance decisions: Simultaneous effects of client business risk, audit risk, auditor business risk, and risk adaptation. Auditing: A Journal of Practice & Theory, 19(1), 1–25. https://doi.org/10.2308/aud.2000.19.1.1
Johnstone, K. M., & Bedard, J. C. (2003). Risk management in client acceptance decisions. The Accounting Review, 78(4), 1003–1025. https://doi.org/10.2308/accr.2003.78.4.1003
Kim, Y. S., Kang, S. A., & Park, S. H. (2021). The effect of management style on financial statement comparability: Evidence from Korean business groups. Asia-Pacific Journal of Accounting and Economics, 28(4), 454–471. https://doi.org/10.1080/16081625.2019.1566870
Kinney, W. R., & Libby, R. (2002). Discussion of the relation between auditors’ fees for nonaudit services and earnings management. The Accounting Review, 77(Suppl. 1), 107–114. https://doi.org/10.2308/accr.2002.77.s-1.107
Kothari, S., Leone, A., & Wasley, C. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163–197. https://doi.org/10.1016/j.jacceco.2004.11.002
Krishnan, J. (1994). Auditor switching and conservatism. The Accounting Review, 69(1), 200–215. https://www.jstor.org/stable/248267
Lei, D., Zhou, Y., & Wang, Y. (2000). Auditor-client disagreements, auditor resignations, and audit fees changed by successor auditors. Journal of Applied Business Research, 36(1), 15–28. https://doi.org/10.19030/jabr.v36i1.10321
Lennox, C., Wang, C., & Wu, X. (2020). Opening up the “black-box” of audit firms: The effects of audit partner ownership on audit adjustments. Journal of Accounting Research, 58(5), 1299–1341. https://doi.org/10.1111/1475-679X.12333
Lustgarten, S., & Shon, J. (2013). Do abnormal accruals affect the life expectancy of audit engagements? Review of Quantitative Finance and Accounting, 40(3), 443–466. https://doi.org/10.1007/s11156-012-0276-1
Matsumura, E. M., & Tucker, R. R. (1995). Second partner review: An analytical model. Journal of Accounting, Auditing & Finance, 10(1), 173–200. https://doi.org/10.1177/0148558X9501000113
Mitra, S., Jaggi, B., & Al-Hayale, T. (2016). Auditor’s downward switch, governance, and accounting conservatism. Journal of Accounting, Auditing & Finance, 31(4), 551–581. https://doi.org/10.1177/0148558X15590227
Public Company Accounting Oversight Board. (2009). Auditing standard No 7: Engagement quality review (AS No. 7). PCAOB Release 2009–004. Washington. https://pcaobus.org/oversight/standards/archived-standards/pre-reorganized-auditing-standards-interpretations/details/auditing-standardno-7_1836
Schwartz, K. B., & Menon, K. (1985). Auditor switches by failing firms. The Accounting Review, 60(2), 248–261. https://www.jstor.org/stable/246789
Simon, D. T., & Francis, J. R. (1988). The effects of auditor change on audit fees: Tests of price cutting and price recovery. The Accounting Review, 63(2), 255–268. https://www.jstor.org/stable/248104
Simunic, D. A. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research, 18(1), 161–190. https://www.doi.org/10.2307/2490397
Simunic, D. A., & Stein, M. T. (1996). The impact of litigation risk on audit pricing: A review of the economics of and the evidence. Auditing: A Journal of Practice & Theory, 15, 119–133.
Sung, O. H. (2007). Estimation of risk-adjusted discount rate for the technology valuation of smallsized venture firm. In Commercialization and Transfer of Technology: Major Country Case Studies (pp. 231–240). Nova. http://www.novapublishers.org/catalog/product_info.php?products_id=5586
Tucker, R. R., & Matsumura, E. M. (1997). Second-partner review: An experimental economics investigation. Auditing: A Journal of Practice & Theory, 16(1), 79–98.
Warner, J. B., Watts, R. L., & Wruck, K. H. (1988). Stock prices and top management changes. Journal of Financial Economics, 20, 461–492. https://doi.org/10.1016/0304-405X(88)90054-2
Weisbach, M. S. (1988). Outside directors and CEO turnover. Journal of Financial Economics, 20, 431– 460. https://doi.org/10.1016/0304-405X(88)90053-0
Wells, P. (2002). Earnings management surrounding CEO changes. Accounting and Finance, 42(2), 169–193. https://doi.org/10.1111/1467-629X.00073
Woo, E. S., & Koh, H. C. (2001). Factors associated with auditor changes: A Singapore study. Accounting and Business Research, 31(2), 133–144. https://doi.org/10.1080/00014788.2001.9729607
Zhang, J. H. (2018). Accounting comparability, audit effort, and audit outcomes. Contemporary Accounting Research, 35(1), 245–276. https://doi.org/10.1111/1911-3846.12381