Awareness of SEC Enforcement and Auditor Reporting Decisions

In this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions (ICOs) and first‐time going concern opinions (GCOs). Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors' concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse ICOs documented in our baseline tests reflects higher‐quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.

Section: Initial Resultssupporting

confidence: 87%

Auditor Responses to Shareholder Activism

Guo

Lin

Masli

et al. 2020

“…A potential barrier between the United States and other countries is their geographic proximity. Recent studies have found negative consequences of geographic dispersion in an auditing context, generally concluding that geographic dispersion creates information asymmetries and ineffective monitoring (Beck et al 2019; Choi et al 2012; DeFond et al 2018; Dong et al 2018). Greater geographic barriers make it more difficult for lead and component auditors to interact when questions or problems arise, and cooperation and knowledge sharing may suffer (Beck et al 2019).…”

Section: Background and Hypotheses Developmentmentioning

confidence: 99%

The Use and Characteristics of Foreign Component Auditors in U.S. Multinational Audits: Insights from Form AP Disclosures*

Burke

Hoitash

2020

This paper investigates the common, yet previously opaque, practice of using foreign audit firms (component auditors) to conduct portions of audit work for U.S. public companies. U.S. regulators have expressed concern for the transparency and quality of audits using component auditors. Employing data disclosed in the newly mandated PCAOB Form AP, we find that component auditor use is largely structural, determined by the size and complexity of clients' multinational operations. We do not find that the mere use of component auditors is detrimental to audit outcomes, but rather the amount of work conducted by component auditors is associated with lower audit quality (i.e., higher likelihood of misstatement), higher likelihood of nontimely reporting, and higher audit fees, which collectively suggest that component auditor engagements are associated with adverse outcomes. Furthermore, we find that only the work performed by less competent component auditors and those facing geographic and cultural/language barriers, including significant geographic and cultural distance, weak rule of law, and low English language proficiency, is associated with adverse audit outcomes. Overall, these findings provide initial archival evidence that the use of certain component auditors on U.S. multinational audits is associated with audit coordination issues, which suggests that PCAOB Form AP disclosures provide relevant information.

“…For example, Kedia and Rajgopal () find that firms located closer to SEC regional offices, where the SEC's enforcement staff are based, are more likely to restate their financial statements. DeFond et al () find that non‐Big 4 auditors' behavior is affected by their proximity to the SEC's regional offices and that this proximity affects enforcement. Given the disparate nature of these functions, which are in separate divisions with separate budgets and staffs, understanding how compliance activities are influenced by resource constraints is important…”

Section: Introductionmentioning

confidence: 99%

How Busyness Influences SEC Compliance Activities: Evidence from the Filing Review Process and Comment Letters

Gunny

Hermis

2019

The SEC reviews firm filings and issues comment letters on those filings. These comment letters play an important role in the assessment of firm value. These activities are seasonally compressed because over 70 percent of registrants have a December fiscal year‐end. Research in other settings finds that busyness leads to negative outcomes. We examine how busyness impacts the frequency, scope, and timeliness of comment letters. We find that the SEC issues fewer comment letters when busy, focuses its limited resources on the most severe cases of disclosure noncompliance, and extends the amount of time between receiving a firm's filing and issuing a comment letter. Despite this, we find no evidence that the SEC misses more serious compliance issues when busy. Our results have implications for policymakers responsible for allocating resources to the SEC.