Going-Concern Opinions: The Effects of Partner Compensation Plans and Client Size

Abstract

Partner compensation plans in large accounting firms tend to emphasize either local office profits or worldwide firm profits (“small-pool” or “large-pool” firms, respectively) (Trompeter 1994). Some have expressed concern over possible impairment of auditor independence when a small-pool compensation plan is used, and Trompeter (1994) found in an experimental setting that partners in small-pool firms were less likely to require income-decreasing adjustments. We examine, in an archival setting, the association of partner compensation plans and client size with auditors' propensity to issue going-concern audit opinions to stressed clients. We find no evidence that auditors' going-concern reporting decisions were directly affected by partner compensation plans. However, there is evidence of an interaction between partner compensation plans and client size. This interaction suggests that auditors in small-pool firms may be more sensitive to client size than partners in large-pool firms when making certain going-concern opinion decisions.

The auditor’s going concern decision and Types I and II errors: The Coase Theorem, transaction costs, bargaining power and attempts to mislead

“…The relationship between the size of the auditing firm and independence has also been raised as well as the increased difficulty the auditor faces in maintaining his objectivity in the face of the potential loss of a large client paying substantial audit and consultancy fees, i.e. there is greater economic dependence (DeAngello, 1981c;McKeown et al, 1991;Carcello et al, 2000;Lennox, 1999b). 1 More recent studies have recognised the importance to the audit firm of its reputation and the importance of auditor independence as a means of protecting it.…”

Auditor Independence and Audit Quality

“…On a partner level, Trompeter (1994) and Carcello, Hermanson, and Huss (2000) find that the economic importance of the client has a negative effect on the partner independence. Trompeter reports from his experiment that partners in firms with compensation scheme closely tied to client retention are less conservative in downward adjustment to income.…”

An analysis of Key Issues arising from Professor A. J. Briloff’s Paper entitled, “Garbage In/Garbage Out: A Critique of Fraudulent Financial Reporting: 1987–1997 (The COSO Report, 1999) The SEC Accounting Regulatory Process (AAERs)"

“…The growth of non-audit services clearly increases these temptations further. Carcello and Hermanson (2000) found no evidence to support the contention that auditors' going concern reporting decisions are directly influenced by partner compensation plans. However, they did find evidence of an interaction between partner compensation plans and client size.…”