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November 24, 2021 01:44 PM

Do accounting firms make promises to potential clients that are inconsistent with public interest concerns about audit firm independence?

Posted by Dan_Stone

EAR paper blog / abstract

 

Do accounting firms make promises to potential clients that are inconsistent with public interest concerns about audit firm independence? Do audit firms “sell” audits to clients primarily based on public interest concerns (e.g., independence), or, on promises to serve the clients’ business need promises? Is the audit firms’ pitch, i.e., selling points to the client, related to the fees proposed for the audit? In our recently published EAR paper, “Impression Management in Public Sector Audit Proposals: Language and Fees” Yu-Tzu Chang and I explore these issues with a unique data set that Dr. Chang hand collected. Specifically, many governmental auditing engagement proposals in the United States are available through governmental open record requests. Dr. Chang spent many months making and following up on these requests. The result is a sample of about 350 governmental audit proposals from 15 US states. The engagements in our sample included state and governmental units, school districts, counties, cities, colleges, and other types of governmental entities.   

To investigate our research questions, we used text analytics software that identified the extent to which audit proposals included language (i.e., words) related to “professionalism,” i.e., auditor independence and competence, versus “commercialism,” i.e., audit firm cooperation with the client and the audit firm’s willingness to partner with the client and to serve the clients’ business interests. To identify professionalism versus commercialism, we created word lists of these concepts. We also collected data about the types of engagements and the proposed engagement fees.

Some of the results justify regulators’ concerns about the promises that audit firms make to their potential clients. Specifically, most of the audit proposals in our sample (about 40%) use primarily commercialism language (i.e., describing how the audit firm will help the clients’ business) and propose low audit fees. We also find that the quality of the internal audit office in the US state has an influence on the success of audit firms’ engagement proposals. That is, in US states with a weak internal audit office, more commercial language in the audit proposal increases the chances that the audit firm will win the engagement. However, this result is not true in states with a high quality internal audit office. This suggests that the quality of a US state’s internal audit office may influence audit quality in that state.

Our results are concerning; they suggest that many US audit firm governmental audit proposals propose a low fee and promise, primarily, to the serve the clients’ business interests as opposed to promising to protect independence and the public interest. We also find that proposals that have more commercial language are also more likely to propose lower audit fees. In summary, our research suggests that evidence supporting concerns about the promises made by audit firm to their prospective clients in our sample of US governmental auditing engagement proposals.
 

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About Dan_Stone

University of Kentucky
Gatton Endowed Chair

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