Does Opinion Shopping Impair Auditor Independence Essay Example

auditor's attestation (quality of the audit), and the capital market's pricing rule. In this part he gives a formula that expresses the market price as a function of the market belief. He also stresses the tension between auditor fee and legal liability and whether the auditor decides to support the firm's preferred report.

Moreover, Lu makes a distinction from the point of view of the auditor between the practice of conservative accounting and aggressive accounting.

He concludes that auditor aggressiveness may lead to overstatements and auditor conservatism to understatements. Because from conservative accounting. And also the other way around, a gloomy report from conservative accounting is not as reliable as a gloomy report from aggressive accounting. In the fourth section about audit quality, two determinants of this arable are relevant: conservative accounting and aggressive accounting. Depending on the type, a larger auditor fee may cause a higher or lower audit quality (so not one way).

A larger audit fee for conservative accountants will lead to a higher audit quality and for aggressive accountants too lower audit quality. In the fifth section about auditor switching, Lu assumes that when an auditor supports a firm's preferred report, a firm has no incentive to switch auditors. So when a firm does switch, it is a 'red flag signal to the capital market: they perceive that switching firms eave failed to secure their predecessor auditors' approval or the preferred report.

Given this, a switching firm that has induced aggressive accounting before switching is perceived to be a low-profitability type (only this type might fail to receive its auditor's approval of the preferred report). What Lu also concludes in this

section is that a high-profitability firm that has not obtained approval of its preferred report dislikes the understatement possibility embedded in conservative accounting and so changes from conservative to aggressive accounting, which guarantees that the referred report will be sanctioned by the new auditor.

This is called vindication seeking.

On the other hand, a low-profitability firm unable to obtain approval of its preferred report likes the overstatement possibility afforded by aggressive accounting and so changes from conservative to aggressive accounting in the hope of receiving an approval of G from the new auditor. This section is concluded with an important trade-off: auditor switching may decrease understatements but increase overstatements and vice versa, which is the result of the switch from aggressive to conservative accounting.

In last section before the conclusion about the auditor fee, Lu provides the following findings: when auditor switching is feasible, the firm prefers conservative accounting to aggressive accounting before switching. Lu concludes that his findings contradict the conventional wisdom that opinion shopping impairs auditor independence and audit quality.

He shows that dismissal threats and opinion shopping impair neither auditor independence nor audit quality.

Furthermore, auditor switching decreases potential understatements and increases potential overstatements in financial statements, and because of the capital market's ND the successor auditor's reactions to auditor switching, firms cannot reap the full benefits of opinion shopping. 2. Strengths I.

The strength of the model and the inclusion of multiple determinants One strength of the article is that the model included in the research, contains several variables that take into account multiple (external) influences.

So for example, the F is the total auditor fee from business opportunities (for the

auditors), but when an auditor is unwilling to support the firm's preferred report, the firm may take away these business opportunities and appoints a new auditor. What then is build in in the model as a countervailing force against client pressure, is the legal liability L. I guess that the more forces are taken into account in conducting the research, the more reliable the outcomes are.

For the determination of audit quality for example, Lu does not only look at the audit itself, but considers that audit can be practiced in two ways: What always needs to be part of the introduction is the purpose of the research conducted.

Lu gives a clear explanation of the existing knowledge and how his particular research fits among all the articles written about this subject. He states hat there is a lot of discussion about opinion shopping and after that he indicates which questions still need to be addressed coming from those discussions.

His research is done to answer those questions and builds further on Dye (1991) and OTOH (1992). He also states in what way his research is different from that of them. Iii. The strength and completeness of the argumentation In the third, fourth, fifth and sixth sections of Lulu's article he provides his arguments and highlights the different aspects of them.

So for example for the audit fee he provides the determinants of the successor and predecessor auditor's fees.

After that, he gives the propositions that belong to the audit fee, which involve the relationship of aggressive and conservative accounting and the feasibility of auditor switching. Then the auditor fees and their impacts on audit

quality before and after auditor switching are compared. When providing propositions he clearly describes what he means with it. 3. Weaknesses I.

The structure of the article One major drawback of the article is the way it has been build up. The title of the article gives a research question, which will probably be (partly) answered in the conclusion.

You would expect an introduction, which includes the purpose of conducting the research and writing the article. After that, the theoretical foundation to find out what knowledge is already there, followed by the research method, the results and conclusion. However, all these different parts are somewhat mixed up and some parts even lack.

For the understanding of the reader and the reliability of the article itself, one should be more complete and clear about how the given research question will be approached and answered.

Also, certain propositions are given, which do not actually belong to the section they are provided in. To illustrate this, in the 'audit fee' section, propositions are given about auditor switching and no indication is given of why they have done that. I'. Lack of strong argumentation for variables Another drawback is that the research question is not exactly in line with what has been researched and clear arguments for choosing certain variables lack.

Thus, what is missing is an explanation of why certain arguments are used in answering the research question.

So for example, why is Lu using a distinction between conservative and aggressive accounting to approach the question? And why does he determine the quality of the audit in terms of low and high profitability firms and whether aggressive or

conservative accounting is used? Another question that is not properly addressed is: how to determine whether auditors perform aggressive or conservative accounting. So assumptions are made about several relationships among variables but there are no strong arguments or clear evidence that these are funded. Iii.

The reliability and generalization of the article The third drawback of the article written by Lu, is the reliability and the generalization of his conclusions. It is not clear at all how the research is conducted, owe the propositions are measured and how the results could be generalized over answer to the question whether opinion shopping impairs the quality of the audit and the independence of the auditor.

However, he only produces propositions based on his own conclusions without actually researching that in real life firms and among auditors.

Moreover, Lu used only a couple of other articles so you could argue whether the theoretical foundation of his research is a good one. 4. Additional literature Like Lu, Gosh and Moon build further on the recent debate (somewhere around 2005) surrounding auditor independence, audit quality and auditor tenure. The last you can compare a little to the auditor rotation and auditor retention issue in the study of Lu (2006), because it is both related to the length of the period that one auditor does the books for a certain firm.

Like they indicate, they analyze the relationship between auditor tenure and audit quality as perceived by capital market participants and that is also what Lu does in some way.

What they conclude is that most of their results are consistent with the hypothesis that audited financial statements, and in particular

report earnings, are perceived as more reliable for firms with longer auditor tenure. That implicates that many capital market participant view longer tenure as having a favorable impact on audit quality.

They further indicate that mandatory limits on the duration of the auditor-client relationship, in Lulu's article mandatory retention, might impose unintended costs on capital market participants. This is one of the consequences of mandatory retention that could also be generalized to Lulu's study.

The recommendations for future research that Lu gives in his article have to do with the distinction between mandatory auditor retention and rotation and what policy is best in society.

Gosh and Moon also conclude that there are differences in outcomes for these different 'policies', or regimes as they call it. Audit quality is one important variable considered in most of the studies that try to address the questions coming from the previous mentioned debate. Because this is a very subjective variable it is not easy to determine how to measure this 'quality.

Myers et al. , like Gosh and Moon, also study the relationship between auditor tenure and audit quality and use two measures of earnings quality to proxy for audit quality (from prior literature).

Eventually they suggest that under the current system, increased auditor tenure does not lead to reduced audit and earnings quality. Their results do not imply that forcing firms to remain with the same auditor, in Lulu's research mandatory auditor retention, would improve earnings quality or audit quality. They state that Johnson and Lays (1990) show that allowing auditor turnover can improve audit quality because clients may switch to a more efficient provider as their needs

change. In this case, requiring a client to retain an auditor who is unable to provide adequate services could reduce audit quality.

Lu could have used both articles (since they are written in earlier years) to gain more insight in the relationship between mandatory auditor retention and audit quality. Also Myers et al. Did not provide evidence for the effect of mandatory auditor rotation on audit quality. 5. Further research Lu concludes his article with several new questions that arise from the research he conducted.

He makes a distinction between mandatory auditor retention and rotation and a combination of both worlds as policies for society. He concludes that for both about.

Because of the subjectivity of the subject of opinion shopping, auditor independence and the quality of the audit, there are always multiple ways to approach the research of it. For further research I would suggest to look more at the auditor rotation and retention and their influence on the quality of the audit.

Because this 'quality is very subjective and cannot be determined only by looking at the trade-off auditors make and whether they practice aggressive or conservative accounting, this variable should be looked at more detailed. So an improvement in measurement must take place to determine what high or low 'quality is.