This study examines the "off-the-job" behavior of individuals in office-level leadership positions across the Big 4 audit firms in the U.S. In their leadership role, the managing partner is responsible for setting the tone at the top of an office through formal communication of firm-wide policies and an informal example through their behavior and preferences. Given this role, I predict that engagements conducted within offices led by individuals who are willing to break the rules will exhibit characteristics synonymous with increased audit risks. Relying on their history of legal infractions to identify rule-breaking behavior, I find managing partners with prior infractions are associated with engagements that reflect increased misstatement risk and detection risk (i.e., lower auditor effort). Additional tests reveal that the results are concentrated in offices that are located further away from alternative governance mechanisms within the same audit firm. Importantly, after controlling for the risk of misstatement, I find the pricing of misstatement risk declines significantly on engagements in offices with infraction managing partners. The results are robust to alternative measures of managing partners' prior infractions and the use of entropy balancing techniques, along with several other robustness tests. Collectively, my study contributes to our limited knowledge of the quality control structures in place at large audit firms and provides a potential mechanism for tone at the Big 4 audit firms to vary across offices. / Doctor of Philosophy / In their leadership role, office managing partners are the "top executive" appointed to lead the Big 4 audit offices across the U.S. While audit firms have reputation and litigation incentives to provide high quality audits, these incentives do not necessarily apply to individual auditors. Therefore, audit firms are required to formalize a system of quality controls—including leadership and tone at the top—to ensure promote professional skepticism, stress quality service, and reduce overall audit risk on engagements. Relatedly, during inspections, the PCAOB examines whether the actions and communications by managing partners in local leadership positions demonstrate a commitment to audit quality and compliance with applicable regulations and professional standards.
Grounded in revealed preference theory, I rely on a managing partner's history of legal infractions to identify offices led by partners with impulsive, risk-taking, and present-oriented personalities. Criminology and psychology research empirically validate the cross-situational consistency of individual behavior and decisions over time and in different settings. In other words, individuals who commit legal infractions—including less severe traffic violations such as parking tickets—exhibit a preference or propensity to break the rules. To the extent that an individual's leadership style is influenced by their personal ethics, values, and attitudes, I expect variation in a managing partner's history of legal infraction to reflect variation in their leadership style and office tone towards audit risk on engagements.
Consistent with this prediction, I find managing partners with prior infractions are associated with engagements that reflect increased misstatement risk and detection risk (i.e., lower auditor effort). Additional tests reveal that the results are concentrated in offices that are located further away from alternative governance mechanisms within the same audit firm. Importantly, after controlling for the risk of misstatement, I find the pricing of misstatement risk declines significantly on engagements in offices with infraction managing partners. The results are robust to alternative measures of managing partners' prior infractions and the use of entropy balancing techniques, along with several other robustness tests. Collectively, my study contributes to our limited knowledge of the quality control structures in place at large audit firms and provides a potential mechanism for tone at the Big 4 audit firms to vary across offices.
| Identifer | oai:union.ndltd.org:VTETD/oai:vtechworks.lib.vt.edu:10919/109652 |
| Date | 12 April 2022 |
| Creators | Valentine, Delia Fidelas |
| Contributors | Accounting and Information Systems, Stein, Sarah E., Davidson, Robert H., Acito, Andrew A., Erickson, Matthew James |
| Publisher | Virginia Tech |
| Source Sets | Virginia Tech Theses and Dissertation |
| Language | English |
| Detected Language | English |
| Type | Dissertation |
| Format | ETD, application/pdf |
| Rights | In Copyright, http://rightsstatements.org/vocab/InC/1.0/ |
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