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Journal ArticleDOI

Auditor expertise: Evidence from the public sector

01 Sep 2012-Economics Letters (North-Holland)-Vol. 116, Iss: 3, pp 432-435
TL;DR: The authors studied the relationship between public auditor expertise and fiscal performance and found that states requiring the auditor to hold a professional degree feature significantly higher credit ratings and lower expenditures and debt than states that did not require it.
About: This article is published in Economics Letters.The article was published on 2012-09-01 and is currently open access. It has received 13 citations till now. The article focuses on the topics: Credit rating & Public sector.

Summary (1 min read)

Introduction

  • This paper is the first attempt to study the relationship between public auditor expertise and fiscal performance.
  • I find that states requiring the auditor to hold a professional degree feature significantly higher credit ratings and lower expenditures and debt.

1. Auditor expertise

  • In the political process the quality, quantity and timing of information is, to a great extent, determined by transparency and supervision requirements (e.g., Alt and Lassen, 2006).
  • In the corporate auditing literature, one of the main drivers of audit quality is auditor expertise.
  • Due to electoral pressure or career concerns, public decision makers face incentives to misreport.

2. Data on US state auditors

  • I take advantage of the decentralizedUS federal structure.
  • Every state has its own constitution and legal framework defining the details of its auditing institution.
  • The standard approach for studies on the influence of fiscal institutions on government performance adopts fiscal measures such as expenditure or debt as dependent variables.
  • Similar approaches have been used by, e.g., Depken and Lafountain (2006) and Schelker (2012) to study the influence of fiscal institutions and corruption, and by, e.g., Mansi et al. (2004) in the context of corporate auditing quality.
  • The data on state credit ratings are collected from Moody’s Investor Services, Fitch Ratings and Standard & Poor’s.

3. Empirical strategy

  • When estimating the effect of auditor expertise on the normalized credit rating I estimate tobit models that take into account that Rst is censored at −1 and 0.
  • The states without GOB rating are Arizona, Colorado, Iowa, Idaho, Nebraska and South Dakota.
  • When approaching this potential selection problem, I do not find a significant correlation between auditor characteristics and the excluded states.
  • I estimate random effects (RE) as well as fixed effects (FE) models.
  • All regressions include a set of standard state-specific covariates.

4. Empirical results

  • Table 1 presents the regression results of auditor expertise on GOB ratings.
  • The linear fixed effects regressions in columns 5 and 6 show that the coefficients remain statistically significant, while the impact is somewhat higher in magnitude.
  • On average, the states demanding the auditor to hold at least a CPA feature approximately a one notch higher credit rating compared to states without such a requirement.
  • Index capturing various removal procedures for the auditor.

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Citations
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Journal ArticleDOI
01 May 2013-Kyklos
TL;DR: In this paper, the impact of auditor expertise, term length and rotation requirements on government performance at the US state level has been investigated and the authors find evidence indicating that greater auditor expertise and rotation requirement have a positive effect on state credit ratings.
Abstract: Corporate auditors review and evaluate financial statements. Audit quality depends on auditor expertise and independence. To enhance auditor independence the selection process and auditor rotation requirements have been debated intensively. The available empirical evidence is not conclusive and suffers from serious endogeneity problems. I propose learning from the public sector where auditors play a similar role and present empirical evidence on the impact of auditor expertise, term length and rotation requirements on government performance at the US state level. I find evidence indicating that greater auditor expertise and rotation requirements have a positive effect on state credit ratings.

13 citations

Journal ArticleDOI
TL;DR: In this article, Roychoudhury et al. examined the relationship between economic freedom and bond ratings at the state level and found that states with higher levels of economic freedom have higher credit ratings and lower borrowing costs.
Abstract: I. INTRODUCTION AND REVIEW The purpose of this paper is to test for a link between economic freedom and bond ratings at the state level. Our work extends a growing literature by testing for the effects that differences in economic freedom might have on financial markets. As noted by Roychoudhury and Lawson (2010), economic freedom "measures [of] the quality of institutions and policies" and allows researchers "to examine the impact of the institutional environment" (p. 150) on the general economic performance of an economy (i.e., economic growth) but also, thus far to a much more limited extent, on macro-finance issues, such as investment (Gwartney et al. 2006) and capital flows (Lothian 2006). This study, in the spirit of Roychoudhury and Lawson (2008; 2010), examines whether such institutional differences across states affect a more micro-level financial market phenomenon; the assignment of state bond ratings. This paper thus extends a growing literature that investigates the role that such institutional factors play in financial markets. For example, D'Souza et al. (2005) find that economic freedom is a positive and statistically important factor explaining performance improvements in newly privatized firms across 23 Organization of Economic Cooperation and Development countries. Smimou and Karabegovic (2010) report that improvements in economic freedom have a positive effect on equity market returns. Peyton and Belasen (2012), for example, show that higher levels of corruption are associated with lower levels of economic freedom, and together these factors reduce a country's ability to secure foreign investment. Hafer (2012) presents evidence supporting the idea that greater economic freedom is associated with more financial development across countries. Two recent studies have explored the role of economic freedom in a manner most closely related to the present study. Roychoudhury and Lawson (2010) find that countries with higher levels of economic freedom have significantly higher sovereign credit ratings than countries with lower levels of economic freedom. Jones and Stroup (2013) report that the pricing of single-state municipal bond closed-end funds is related to a state's economic freedom. This study also extends a broad literature that has attempted to explain bond ratings at the state level. In answering the question "What factors influence a state's bond rating?", the list of potential candidates is long. Liu and Thakor's (1984) early analysis pointed to the role that state economic characteristics play in explaining state bond ratings. Poterba and Rueben (1999; 2001) consider the effect of fiscal rules on the market for state bonds, concluding that "state fiscal institutions affect the required return that lenders demand when states enter the market for tax-exempt bonds" (p. 204). Johnson and Kriz (2005) find that states with more restricted abilities to increase expenditures and indebtedness and with specified expenditure limits also are states that, on average, tend to have higher credit ratings and lower borrowing costs. Deller et al. (2010) find that restrictive tax and expenditure limits lower local bond ratings, but do not influence bond ratings when applied to states, though the latter result varies across bond rating agencies. Studies also have looked at political aspects of state administration to explain bond ratings. Jimenez (2011) finds that states with management systems that reduce bureaucratic waste, or adopt management structures that are more efficient and transparent are more likely to experience improved bond ratings. Schelker's (2012a; 2012b) analysis of term limits and requirements that state auditors hold professional degrees indicates that both raise state bond ratings. Krueger and Walker's (2008) analysis indicates that turnover of existing coalitions of elected representatives and divided government (e.g., a state in which the governor and the majority of the state legislature are of two different parties) lowers bond ratings. …

10 citations

Journal ArticleDOI
TL;DR: In this paper, the authors investigate the effects of auditor characteristics on local governments' audit delay by studying 127 Indonesian local governments and find that auditor professional proficiency and auditor educational background have significant effect on the audit delay of local government financial statements.
Abstract: Overdue financial statements reporting, more specifically audit delay, can cause losses in its capacity in decision making. We investigate the effects of auditor characteristics on local governments’ audit delay by studying 127 Indonesian local governments. We find that auditor professional proficiency and auditor educational background have significant effect on the audit delay of local government financial statements. Our results also indicate the intersection of some auditor characteristics in affecting audit delay. Our findings mainly suggest that the auditor professional proficiency should be improved to shrink audit delay.

8 citations

Journal ArticleDOI
TL;DR: The authors examines the effect of U.S. state governments' fiscal transparency on their credit quality and concludes that although government credit quality essentially measures the debt default risk, it can also be used as a warning signal.
Abstract: This article examines the effect of the U.S. state governments’ fiscal transparency on their credit quality. Although government credit quality essentially measures the debt default risk, it can po...

7 citations

Journal ArticleDOI
TL;DR: In this paper, the Comptroller and Auditor General (C&AG) has been criticised for not complying with the Treasury Instructions and other regulations regarding submissions of returns, and the political will to comply with extant legal and regulatory frameworks is low note.
Abstract: Public Audit Offices are the guardian of the national purse and the pivot of the system of parliamentary control over finance. They help to institutionalize and nurture a culture of accountability, integrity, legitimacy and value for money in the conduct of public business. This in the long term serves as antidotes against institutional corruption. Study findings indicate that Zimbabwe’s audit systems are in the main consistent with regional and global experiences. Efforts are being undertaken to reconstitute and strengthen legal frameworks governing public auditing. Notwithstanding this, legal frameworks did not go deep enough to strengthen the independence of supreme audit institutions. Appointment, funding and reporting frameworks still have peeling effects on the operational independence of the Comptroller and Auditor General. Scenarios aground also suggest that the political will to comply with extant frameworks is low note. Audit recommendations are not seriously taken by Treasury, Accounting Officers and government ministers. There is need to update legal and regulatory frameworks to strengthen the operational independence of the C&AG and also to give it sanction powers to compel Ministries and departments to observe and comply with the Treasury Instructions and other regulations regarding submissions of returns. Efforts should also be directed towards capacitating the C&AG in term of attracting and retaining skilled and experienced staff in the legal and accounting field .

7 citations

References
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Journal ArticleDOI
TL;DR: In this paper, the authors argue that audit quality is not independent of audit firm size, even when auditors initially possess identical technological capabilities, and when incumbent auditors earn client-specific quasi-rents, auditors with a greater number of clients have more to lose by failing to report a discovered breach in a particular client's records.

4,969 citations

Journal ArticleDOI
TL;DR: In this paper, the authors examine systematic differences in earnings management across 31 countries and propose an explanation for these differences based on the notion that insiders, in an attempt to protect their private control benefits, use earnings management to conceal firm performance from outsiders.

3,662 citations

Journal ArticleDOI
TL;DR: In this article, the authors examined the relation between audit quality and earnings management and found that clients of non-Big Six auditors report discretionary accruals that increase income relatively more than the discretionary accumruals reported by clients of big six auditors.
Abstract: This study examines the relation between audit quality and earnings management. Consistent with prior research, we treat audit quality as a dichotomous variable and assume that Big Six auditors are of higher quality than non-Big Six auditors. Earnings management is captured by discretionary accruals that are estimated using a cross-sectional version of the Jones 1991 model. Prior literature suggests that auditors are more likely to object to management's accounting choices that increase earnings (as opposed to decrease earnings) and that auditors are more likely to be sued when they are associated with financial statements that overstate earnings (as compared to understate earnings). Therefore, we hypothesize that clients of non-Big Six auditors report discretionary accruals that increase income relatively more than the discretionary accruals reported by clients of Big Six auditors. This hypothesis is supported by evidence from a sample of 10,379 Big Six and 2,179 non-Big Six firm years. Specifically, clients of non-Big Six auditors report discretionary accruals that are, on average, 1.5-2.1 percent of total assets higher than the discretionary accruals reported by clients of Big Six auditors. Also, consistent with earnings management, we find that the mean and median of the absolute value of discretionary accruals are greater for firms with non-Big Six auditors. This result also indicates that lower audit quality is associated with more “accounting flexibility”.

3,100 citations

Journal ArticleDOI
TL;DR: In this paper, the authors document evidence on the relation between auditor tenure and earnings quality using the dispersion and sign of both absolute Jones model abnormal accruals and absolute current accrual.
Abstract: In this study, we document evidence on the relation between auditor tenure and earnings quality using the dispersion and sign of both absolute Jones‐model abnormal accruals and absolute current acc...

1,419 citations

Journal ArticleDOI
TL;DR: In this paper, the authors examined whether the length of the relationship between a company and an audit firm (audit-firm tenure) is associated with financial reporting quality and found no evidence of reduced financial-reporting quality.
Abstract: This study examines whether the length of the relationship between a company and an audit firm (audit-firm tenure) is associated with financial-reporting quality. Using two proxies for financial-reporting quality and a sample of Big 6 clients matched on industry and size, we find that relative to medium audit-firm tenures of four to eight years, short audit-firm tenures of two to three years are associated with lower-quality financial reports. In contrast, we find no evidence of reduced financial-reporting quality for longer audit-firm tenures of nine or more years. Overall, our results provide empirical evidence pertinent to the recurring debate regarding mandatory audit-firm rotation — a debate that has, to date, relied on anecdotal evidence and isolated cases.

975 citations

Frequently Asked Questions (1)
Q1. What are the contributions in "Auditor expertise: evidence from the public sector" ?

This paper is the first attempt to study the relationship between public auditor expertise and fiscal performance. Auditors are a fundamental supervising institutions in the public as well as the corporate sector to ensure that reported information is accurate. This study focuses on the influence of professional expertise of the chief auditor. Hence, the hypothesis is thatmore competent auditors improve the quality and reliance of reported information, which results in improved government performance. In research on transparency and auditing, this strategy features several drawbacks: ( 1 ) fiscal variablesmight be biased due tomisreporting and ( 2 ) fiscal levels might not be informative about government efficiency. To obtain the market evaluation of anticipated audit quality I control for the influence of the reported state of public finance and I include real per capita debt and expenditures in the regression framework. 099 * * −0. 099 * * −0. 118 * * * −0. 107 * * −0. 114 * * −0. 139 * * * ( 0. 044 ) ( 0. 044 ) ( 0. 043 ) ( 0. 050 ) ( 0. 044 ) ( 0. 043 ) Auditor controls – Included Included Included Included Included Further controls – – – Included – – Year fixed effects – – Included Included – Included State fixed effects – – – Included Included Observations 384 384 384 384 384 384 R-squared 0. 261 0. 285 0. 202 0. 360 0. 152 0. 227 LM