ABSTRACT: We investigate whether non-GAAP reporting affects the audit process and thereby the quality of the related financial statements. First, we provide evidence that auditors in numerous countries, including the U.S. and the U.K, rely to varying degrees on non-GAAP profit before tax as a benchmark for determining quantitative materiality. Then, using Premium Listed companies on the London Stock Exchange, we document that U.K. auditor reliance on non-GAAP materiality benchmarks often results in a higher quantitative materiality amount and can lower audit quality. Although U.K. auditors appear skeptical of managers’ more aggressive non-GAAP adjustments, auditors adopt more of management’s low-quality adjustments when auditor independence is weaker. In sum, our results suggest that non-GAAP reporting can indirectly affect investors by reducing the rigor of the financial statement audit.

ABSTRACT: We hypothesize that audit committees whose members have no Big-Four auditing experience are likely to struggle when interviewing prospective Big-Four partners, leading such committees to draw on superficial, heuristic cues in lieu of conducting more substantive evaluations. To test this prediction, we obtain independent ratings of the facial attractiveness of audit partners identified from Form AP filings recently mandated by the U.S. Public Company Accounting Oversight Board (PCAOB). Our primary finding is that audit committees with no Big-Four-experienced members are more likely to favor partners whose photographs raters view to be highly attractive. We characterize attractiveness as a superficial attribute for auditor selection because we detect no relation between attractiveness and accruals- or restatement-based measures of financial reporting quality for audit committees with one or more Big-Four- experienced members, whereas we find an inverse association between attractiveness and financial reporting quality for committees without this experience, likely reflecting the statistical implication of a selection bias. We conclude that auditing expertise mitigates the influence of superficial considerations in auditor selection.

ABSTRACT: Prior research provides mixed evidence about whether competition among auditors impairs or improves audit quality. An impediment to this stream of research is the inability of researchers to observe the audit engagement bidding process. We develop a method of detecting bidding by applying a machine learning algorithm to non-incumbent (i.e., competitor) auditor views of public companies’ SEC filings. We validate our method using a proprietary sample where all instances of bidding are known. We then examine the associations between bidding, audit quality, and audit pricing. Contrary to concerns that competitive pressure may cause auditors to compromise their independence, we find that incumbent auditors perform higher quality audits during bidding years. This improvement in audit quality occurs regardless of whether the bidding ultimately results in an auditor change and persists for several years when the incumbent auditor wins reappointment. We also find that bidding is associated with modest audit fee concessions.

ABSTRACT: We use hand-collected data to show that approximately half of audit partners are assigned to clients headquartered more than 100 kilometers away from the partners’ home locations. Few of these partners relocate after receiving their assignments and, as a result, more than one-third of clients are audited by partners that must commute long distances to visit the client in person. We explore this phenomenon by first modeling how distance affects partner-client matching. We find that partners’ geographic proximity to a prospective client is an important matching criterion, but also that tradeoffs are made when other partner characteristics such as industry specialization are more likely to be important. Next, we show that audit quality is lower when partners reside farther from their clients. We corroborate our primary findings by showing that the association between partner distance and audit quality is mitigated when partners have access to direct flights to their clients’ headquarters and when clients are geographically dispersed. Our paper should be informative for regulators, practicing auditors, and academics interested in how partner-client matching affects audit outcomes.

ABSTRACT: Audit firms are organized as collections of geographically decentralized offices. Decentralization allows for increased proximity between offices and clients, improving the efficiency of auditors’ interactions with client personnel. Yet decentralization also decreases the proximity between offices within each firm, potentially impeding auditors’ interactions with each other. We show that decreased proximity between offices reduces inter-office audit quality “spillovers” and that this effect is driven primarily by reduced monitoring and knowledge sharing. Our findings expand the “within office” view of audit production by demonstrating the importance of interactions between offices and the role of geographic proximity in facilitating them.

ABSTRACT: We examine the decision relevance of a commonly suggested adjustment to how state governments report governmental pension liabilities by recalculating such pension liabilities using the return on a portfolio of high-quality municipal bonds as the discount rate. Calculated as the difference between the state's expected rate of return and the municipal bond return, we find that the discount rate adjustment associates with lower credit ratings and higher interest costs. We also find that credit rating agencies are more likely to issue conflicting ratings when the calculation of the discount rate adjustment involves greater uncertainty. Overall, while financial statement users agree about the need for and the direction of a pension liability rate adjustment, there is less consensus about the proper magnitude of this adjustment, suggesting that current accounting treatment of pensions in the public sector leads to costly uncertainty among financial statement users.