How Does Disclosure of Component Auditor Use Affect Nonprofessional Investors' Perceptions and Behavior?

Abstract

Drawing on prior research and source credibility theory, this study examines nonprofessional investors' acquisition and evaluation of component auditor use as disclosed in Form AP, and whether and how this evaluation influences their investment decisions. I find that very few investors voluntarily access component auditor information. When asked to review the Form AP, investors perceive the audit team as more trustworthy when a component auditor is not used, leading them to perceive the audited financial statements as more reliable. However, the perceived competence of the audit team and investment behavior are not affected by component auditor use. Regulators express concerns regarding component auditor use, but results suggest that while investors share some concerns about the audit, their concerns are not significant enough to influence investment behavior, which complements archival research. Results also suggest that component auditor use could have an unintended consequence for the lead auditor's responsibility for the audit.

Effects of regulatory enforcement style and audit firm remedial actions on investors' perceptions of audit quality

“…Taken together, these findings suggest that investors' decision‐making is likely to be influenced by their perceptions of auditors' performance and the audit process (Brown & Popova, 2019; Christensen et al, 2016; Hux, 2021). Thus, of particular interest in our study is investors' perception of whether auditors have performed their work to a high level of audit quality.…”

“…Moreover, Brown and Popova (2019) find that investors react more affectively towards auditors receiving a negative‐trending audit quality indicator portfolio, and subsequently reduce their equity stake in the company. Meanwhile, Hux (2021) finds that the disclosure of the use of component auditors in an audit engagement lowers non‐professional investors' perceived trustworthiness of the audit team.…”

“…First, protecting investors, in particular safeguarding investors' and the public's interest is the audit regulator's main statutory mission (PCAOB, 2021). Prior research also emphasizes the importance of studying the judgments of non‐professional investors, given the regulators' focus on protecting non‐professional investors' interest and maintaining a fair information environment (Cohen et al, 2022; Hux, 2021; Kelton & Montague, 2018). Although the regulators' intent in enforcing inspection findings is to improve the audit firm's audit procedures, as negative findings are disclosed through different channels, non‐professional investors are alerted to these findings.…”

Comments of the AFAANZ Auditing and Assurance Standards Committee on Proposed International Standard on Auditing 600 (ED 600)

“…Christensen et al (2016) similarly find that investors focus more on audit inputs and process than outputs when considering audit quality. Component auditors play a significant role in the conduct of group audits and research Hux (2020) shows that knowledge of component auditor use in an audit impacts investor perceptions of audit team trustworthiness and financial statement reliability.…”

“…Regulators continue to express concerns about the conduct of group audits (e.g., IFIAR, 2020). Academic research suggests that the extent to which component auditors are involved in a group audit is associated with negative audit quality outcomes (e.g., Carson et al, 2019;Burke et al, 2020;Downey and Westermann, 2020) and highlights that investors negatively react to the use of component auditors (e.g., Demek et al, 2020;Hux, 2020;Impink et al, 2020). The work of the IAASB in this area is, therefore, very timely, and very much in the public interest.…”