A cross-national investigation of auditors’ professional skepticism: The role

of informal institutions

Olof Bik

Nyenrode Business University, Breukelen, the Netherlands

Reggy Hooghiemstra

University of Groningen, the Netherlands

This version: August 31, 2016

                                                             Corresponding author: Olof Bik, Nyenrode Business University, Center for Auditing & Assurance, P.O. Box 130, 3620 AC Breukelen, The Netherlands. Phone: +31 346 295 869. Mail: o.bik@nyenrode.nl. We gratefully acknowledge the helpful comments of Stephan Asare, Barbara Majoor, Christine Nolder, and Arnold Wright. We also appreciate the comments received at ISAR 2016 in Singapore, at the 2016 BAFA Audit & Assurance conference in Oxford, and at seminars at the Essex Business School, the University of Groningen, and Nyenrode Business University.

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A cross-national investigation of auditors’ professional skepticism:

The role of informal institutions

ABSTRACT

The marked interest of researchers, practitioners, and regulators in strengthening auditors’ professional skepticism has recently developed into an increased focus on safeguarding skepticism internationally, such as with “other auditors” in a global group audit. This is important because auditors working with other auditors from other jurisdictions face variations in professional skepticism due to differences in the local environment. In this study we use archival, proprietary data representing internal audit quality assessments of 1,152 individual audit engagements from 29 countries of a Big 4 audit firm to assess the impact of cross-national differences in informal institutions (i.e., the underlying traditions, customs, values, religious beliefs, and other unwritten and often implicit societal rules that guide behavior) on auditors’ professional skepticism. Largely consistent with our expectations, we find that professional skepticism is lower in countries that are more collectivistic and are characterized by higher levels of societal trust. As predicted, we also find a positive association between professional skepticism and religiosity. However, we do not find evidence that professional skepticism and power distance are negatively associated. An important implication of our findings is that, as we document that auditors are influenced by the informal institutions of the society they live in, if researchers, practitioners, and regulators are interested in effectively strengthening professional skepticism internationally, they need to take a country’s informal institutions into account, e.g., in training, knowledge sharing, or standard setting, and may want to consider different approaches for different regions in the world.

Keywords: Auditor behavior; cross-national differences; informal institutions; international auditing; national culture; professional skepticism; religion; societal trust.

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INTRODUCTION

Professional skepticism is widely considered fundamental to auditors’ examinations

of clients’ financial statements assertions and safeguarding a high-quality audit (e.g.,

Public Company Accounting Oversight Board 2011, 2015a; European Commission

2010; International Auditing and Assurance Standards Board 2012, 2015a; Carpenter

and Reimers 2013; Hurtt et al. 2013; Quadackers et al. 2014). Indeed, a lack of

professional skepticism played an important role in a majority of, for example, SEC

enforcement actions (Beasley et al. 2001; Glover and Prawitt 2014) and it is

considered an important, globally recurring root cause for audit quality deficiencies

(e.g., IFIAR 2016), especially how it relates to auditors’ considerations of fraud (e.g.,

PCAOB 2015b). As such it is hardly surprising that auditing researchers,

practitioners, and regulators show a marked interest in understanding and explaining

its determinants in an effort to improve audit quality (e.g., Nelson 2009; Carpenter

and Reimers 2013; Hurtt et al. 2013; Quadackers et al. 2014; IAASB 2015a; PCAOB

2015a). For example, scholars and public policy makers call for better understanding

how external environmental and contextual factors can affect professional skepticism

(e.g., Hurtt et al. 2013; IAASB 2015a), such as the business environment, laws and

regulations, as well as local norms and (national) culture. The importance of these

factors is echoed in IFAC’s (2010) response to the European Commission’s Green

Paper when IFAC observes a need for cross-national research exploring behavioral

elements that may hurt professional skepticism, “including [national] factors that lead

individuals to compromise their professional skepticism despite stringent regulations”

(IFAC 2010, 6). The need for cross-national research exploring behavioral elements

that may hurt professional skepticism seems even more pressing as auditors’ variation

in professional skepticism in an international environment has recently developed into

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a concern for standard setters and regulators focusing on “other auditors” in relation

to revising “group” auditing standards (e.g., IAASB 2015b; PCAOB 2016b). Both the

IAASB and the PCAOB observe that working with other auditors from other

jurisdictions may be challenging when there are differences in customs, language,

culture or religion: “Especially where the environment of the component [auditor] is

very different from the domestic environment (e.g., in relation to business practices,

legal structures, law and regulations, and customs)” (IAASB 2015b, 56), working

with other auditors in other jurisdictions “may present challenges (…) when there are

differences in language, culture or religion” (PCAOB 2016, 29-30). Underlying this

call for cross-country research on professional skepticism is that auditors exercise

considerable discretion in applying the ISAs in response to local requirements and

relationships (cf. Barret et al. 2005).

We respond to these calls for cross-country research on professional

skepticism by providing evidence on the effects of informal institutions on auditors’

professional skepticism. Informal institutions refer to the national-level “traditions,

customs, moral values, religious beliefs, and all other norms of behavior that have

passed the test of time” (Pejovich 1999, 166). Drawing from new institutional

economics (North 1991; Williamson 2000) and social norm theory (e.g., Sunstein

1996; Cialdini 1993; Cialdini and Trost 1998; Bicchieri and Xiao 2009), we posit that

informal institutions significantly contribute to explaining variations in auditors’ fraud

risk assessments, which is considered a primary aspect of professional skepticism.

Underpinning our analysis is the idea that auditors are influenced by the informal

institutions (i.e., assumptions, beliefs, norms, and values) of the society they live in.

Moreover, judgmental assessments like fraud risk assessments are expected to be

driven by attitudes, beliefs, feelings, and intentions (Nolder and Kadous 2015; IAASB

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2012, 2015a; PCAOB 2016a) and, thus, may most directly be affected by underlying

differences in informal institutions. This is further underlined by global auditing

standards (e.g., IAASB 2014, ISA 240; PCAOB 2016, AS 2401), which indicate that

auditors should not have their professional skepticism impaired by beliefs whether

client’s management is honest and possesses integrity. Building on prior theorizing

and empirical evidence (e.g., Cohen et al. 1993; McGuire et al. 2012; Hurtt et al.

2013; Kanagaretnam 2015a; Omer et al. 2015), we focus on the effects of three

informal institutions which we postulate and hypothesize to be related to auditors’

professional skepticism, namely: national culture (more specifically, collectivism and

power distance), religiosity, and societal trust.

Our analyses are based on unique, proprietary data from a Big 4 audit firm

comprising internal assessments of audit process quality of 1,152 audit engagements

reflecting local audit practices in 29 countries. The data enable us to construct a multi-

item measure of professional skepticism (i.e., fraud risk assessments). To measure

national culture we use country-level data from House et al. (2004) and, in line with

prior research (e.g., Guiso et al. 2006, 2008, 2009; Nanda and Wysocki 2012;

Kanagaretnam et al. 2015a,b; Parboteeah et al. 2015; Pevzner et al. 2015), our

measures of religiosity and societal trust are from the World Values Survey. The

ability to rely on a large international sample of empirical data adds to the strength of

the conclusions that can be drawn from a cross-national study (cf. Smith et al. 2002),

making our study particularly suitable to examine the relation between national-level

informal institutions and auditors’ professional skepticism.

We find robust evidence, generally consistent with our expectations, that

cross-national differences in auditors’ professional skepticism are associated with

informal institutions. Indeed, we find that professional skepticism is lower in

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countries that are more collectivistic and are characterized by higher levels of societal

trust. As predicted, we also find a positive association between professional

skepticism and religiosity. However, we do not find evidence that professional

skepticism and power distance are negatively associated. In conclusion, while

professional skepticism is considered fundamental to the professional behavior of

auditors and is at the very core of auditing’s global professional standards (the ISAs),

our findings document that auditors are influenced by the informal institutions of the

society they live in. In other words, national-level informal institutions matter in

safeguarding professional skepticism internationally.

Our findings have a number of important implications for practitioners,

regulators, and academics. First, our findings suggest that an “one-size-fits-all”

approach by internationally operating audit firms or by group audit teams to harness

auditors’ professional skepticism internationally, e.g., through training, knowledge

sharing, or standardized global audit methodologies, may not be effective, unless the

effects of informal institutions are taken into account. Secondly, our findings provide

evidence to standard setters and regulators that “group” auditing standards designed to

address multi-jurisdictional audits may necessitate the inclusion of explicit guidance

for group lead auditors’ effectively managing cross-border teams, due to those “other

auditors” being influenced by differences in informal institutions. Lastly, we

contribute to the literature on the ex-ante determinants of professional skepticism

(e.g., Nelson 2009; Carpenter and Reimers 2013; Hurtt et al. 2013; Nelson et al. 2015;

Nolder and Kadous 2015) by providing ex-post empirical support for the suggestion

by Hurtt et al. (2013) that external environmental, contextual characteristics matter,

vary cross-nationally, and affect audit judgment. Furthermore, we add to the literature

on the role of institutions in accounting and auditing (e.g., Cohen et al. 1995; Arnold

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et al. 1999; Choi and Wong 2007; Nolder and Riley 2014; Bik and Hooghiemstra

2016) by showing that informal institutions matter even when we control for formal

institutions (such as legal protection and legal origin) and by showing that a wider

perspective is called for than national culture alone in explaining the effects of

informal institutions on cross-national differences in professional skepticism, by

including societal trust and religiosity.

The remainder of this paper is organized as follows. The next section reviews

previous literature and develops the hypotheses. This section is followed by an outline

of the research design. The empirical findings are then presented, followed by

conclusions, discussions, limitations, and suggestions for future research.

LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

Professional Skepticism and Auditors’ Fraud Risk Assessments

While acknowledging that there is no universally accepted definition of professional

skepticism (e.g., Nolder and Kadous 2015), we follow Nelson who defines

professional skepticism as “auditor judgments and decisions that reflect a heightened

assessment of the risk that an assertion is incorrect, conditional on the information

available to the auditor” (2009, 1). Generally speaking it seems that auditors who

exhibit higher levels of professional skepticism need relatively more persuasive

evidence to be convinced that an assertion is correct (Nelson 2009; Carpenter and

Reimers 2013; Hurtt et al. 2013; Quadackers et al. 2014). In line with previous studies

we focus on auditors’ fraud risk assessments as these are considered reflections of

professional skepticism in general and of skeptical judgments in particular (e.g.,

Carcello and Neal 2000; Choo and Tan 2000; Payne and Ramsay 2005; Nelson 2009;

Carpenter and Reimers 2013; Hurtt et al. 2013; Nolder and Kadous 2015). For

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example, Carpenter and Reimers (2013) find empirical support for auditors’ fraud risk

assessments as operationalization of skeptical judgments. They posit, in line with

global auditing standards (e.g., ISA 240; AS 2401), that being professionally skeptical

“should increase auditors’ awareness of the possibility that fraud can exist, thus [...]

increasing their fraud risk assessment” (Carpenter and Reimers 2013, 51). In a similar

vein, Payne and Ramsay (2005) show that auditors who are inclined to assess fraud

risks to be low are less skeptical than those who are inclined to assess fraud risks as

moderate or high. Therefore, and in line with Nolder and Kadous’ (2015) attitude

conceptualization of professional skepticism, we posit that the evaluative response of

professional skepticism, driven by the skeptical beliefs, feeling, and intentions,

becomes apparent in the fraud risk procedures conducted by the auditor.

Professional Skepticism and Informal Institutions

According to North’s (1991) seminal work, institutions are “the rules of the game in a

society” (1991, 3) and, hence, they largely determine the appropriateness and

legitimacy of behaviors and help reduce uncertainty by limiting the set of choices of

individuals (North, 1991). Prior research has used nation-level institutions to explain

cross-country differences in a plethora of phenomena. For instance, research in

business and finance shows that nation-level institutions help explain differences in

executive compensation (e.g., Van Essen et al. 2012), corporate social responsibility

(e.g., Ioannou and Serafeim 2012), as well as IPO and M&A activity (e.g., Lewellyn

and Bao 2014; Ahern et al. 2015). In the accounting literature nation-level institutions

are used to explain differences in, for instance, earnings quality (e.g., Leuz et al.

2003; Doupnik 2008; Francis and Wang 2008; Han et al. 2010) and corporate

disclosure levels (e.g., Bushman et al. 2004; Orij 2010; Ernstberger and Grüning

2013; Hooghiemstra et al. 2015). Lastly, the auditing literature shows that institutions

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can explain audit fees (e.g., Choi et al. 2008), the importance of auditors as a

monitoring mechanism (e.g., Francis et al. 2003; Choi and Wong 2007), and auditor

choice (e.g., Hope et al. 2008).

Institutions comprise both formal and informal institutions. Formal institutions

refer to the set of political, judicial, and economic rules in a society (e.g., North 1991;

Garrido et al. 2014). Generally speaking formal institutions consist of codified rules

such as constitutions, laws and regulations. Examples of formal institutions include

legal origin (e.g., Crossland and Hambrick 2011) and laws (and/or regulations) that

protect the rights of shareholders or creditors (e.g., La Porta et al. 1998, 2000). While

early papers mainly focused on the role of these formal institutions, contemporaneous

studies increasingly focus on informal institutions (e.g., Guiso et al. 2006, 2008,

2009; Crossland and Hambrick 2011; Ioannou and Serafeim 2012; Nanda and

Wysocki 2012; Kanagaretnam et al. 2013; Boubakri et al. 2015; Omer et al. 2015;

Pevzner et al. 2015).

Informal institutions refer to “traditions, customs, moral values, religious

beliefs, and all other norms of behavior that have passed the test of time” (Pejovich

1999, 166). In a similar vein, they have been defined as “stable, valued, recurring

patterns of behaviors” (Ioannou and Serafeim 2012, 837). These descriptions

emphasize that informal institutions comprise unwritten and often implicit rules in a

society that guide human behavior and interaction in that society (North 1991). They

also suggest that informal institutions change very slowly (North 1991; Williamson

2000) and that (national) culture constitutes only one aspect of the informal

institutions prevailing in a country (e.g., Lewellyn and Bao 2014; Boubakri et al.

2015). Informal institutions encompass other aspects as well (Helmke and Levitsky

2004), including societal trust (e.g., Zak and Knack 2001; Schoorman et al. 2007;

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Nanda and Wysocki 2012) and religion (e.g., Williamson 2000; Casson et al. 2010;

Williamson and Kerekes 2011).

As informed by social norm theory (e.g., Sunstein 1996; Cialdini 1993;

Cialdini and Trost 1998; Bicchieri and Xiao 2009; Parboteeah et al. 2008, 2015;

McGuire et al. 2012; Kanagaretnam et al. 2015b), national culture, societal trust, and

religiosity are important informal institutions that have “a strong norm setting

influence on societal members through its norms and [educational experiences] that

set behavior expectations” (Parboteeah et al. 2015, 449). Over time, these institutions

have explicated and reinforced specific principles guiding legitimate and appropriate

behavior in a society and, as such, are expected to directly affect auditors’

professional skepticism judgments. Below, we will hypothesize how culture,

religiosity and societal trust affect professional skepticism.

National Culture

National culture refers to “shared motives, values, beliefs, identities, and

interpretations or meanings of significant events that result from common experiences

of members of collectives” (House et al. 2004, 57). In a similar vein, national culture

has been described as “the collective programming of the mind” (Hofstede 2001).

National culture guides human behavior since it provides members of a society with

schematic, mental models about what is “good” versus “bad” and “appropriate”

versus “inappropriate”. As these schematic, mental models have been acquired over

time through experience and learning, they have a marked impact on behavior. For

instance, Crossland and Hambrick (2011, 800) suggest that when faced with

uncertainty and ambiguous information, individuals almost automatically resort to

those mental models that they have learned over their life (i.e., their collective

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programming). In a similar vein, Hofstede (2001) notes that the more judgment a task

requires, the more it is influenced by values and cultural dimensions.

As auditors are members of the society they live in, their professional audit

judgments are likely affected by the schematic, mental models prevailing in a society

(e.g., Patel et al. 2002). Indeed, in the last two decades we have witnessed a

heightened interest in how differences in national culture affect auditors’ professional

behavior (e.g., Cohen et al. 1995; Yamamura et al. 1996; Arnold et al. 1999; Patel and

Psaros 2000; Barret et al. 2005; Smith and Hume 2005; Bik 2010; Curtis et al. 2012;

Nolder and Riley 2014; Bik and Hooghiemstra 2016). One area that has remained

relatively unexamined, however, is professional skepticism. For example, in their

review of the professional skepticism literature, Hurtt et al. (2013) suggest that the

impact of cross-national cultural differences on professional skepticism is an

important area for future research.

While national culture can be characterized by several cultural dimensions (for

instance, the House et al. study includes nine different dimensions), in line with

Kostova’s (1997) recommendations as well as prior research in international

accounting, auditing, and strategy (e.g., Cohen et al. 1993; 1995; Patel and Psaros

2000; Tsui and Windsor 2001; Patel et al. 2002; Hurtt et al. 2013; Crossland and

Hambrick 2011; Boubakri et al. 2015), we focus on the impact of two cultural

dimensions that are theoretically the most relevant to professional skepticism: (in-

group) collectivism and power distance. Below we address how differences in these

cultural dimensions affect the extent of auditors’ professional skepticism. Consistent

with Hurtt et al. we essentially expect that auditors from countries scoring higher on

power distance and lower on collectivism may be less inclined to “make a critical

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assessment of the evidence which may lead to a lack of skeptical judgment and

action” (2013, 17).

Collectivism versus individualism Individualism versus collectivism is related

to the extent to which individuals are supposed to look after themselves autonomously

or remain integrated and embedded in groups (Hofstede 2001; House et al. 2004). In

countries higher on collectivism, such as Brazil, China, and Russia, the interests of the

group take precedence over those of the individual, which is based on the recognition

that individuals are interdependent and have duties and mutual obligation to other

group members (e.g., Oyserman et al. 2002; House et al. 2004). In general, members

of a society scoring higher on collectivism have a stronger need to maintain harmony

in the group (e.g., Oyserman et al. 2002). In contrast, in countries higher on

individualism, such as Germany, the United Kingdom, and the United States of

America, personal independence, rights above duties, personal autonomy, promoting

self-reliance, and self-fulfillment are more central and decisions based on individual

needs prevail (e.g., Hofstede 2001; Oyserman et al. 2002).

Differences in the level of collectivism are found to have significant

implications for auditors’ willingness to be professionally skeptical (e.g., McKinnon

1984; Arnold et al. 1999; Endrawes and Monroe 2012). Specifically, Cohen et al.

(1995, 43) argue that “[t]he strong independence-based focus of Western auditing

practice reflects individualist cultural values”, which according to Hughes et al.

(2009, 32) may result in a greater likelihood that auditor pose tough questions and

rely on their personal judgments. For example, auditors are expected to pose tough

questions to management when needed based on their fraud risk assessment.

Moreover, people in individualistic cultures tend to have a skeptical view of others

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and are more likely to use the standards of their professional peers, i.e., the auditing

standards, as the frame of reference (Westerman et al. 2007).

In contrast, asking tough questions and, hence, implicitly doubting

management’s integrity seems more difficult in collectivistic cultures (Cohen et al.

1993) because in such cultures “a direct approach by an auditor, although polite and

courteous, could be viewed as confrontational” (Yamamura et al. 1996, 349-350).

Indeed, Hurtt et al. theorize that auditors from (in-group) collectivistic countries do

“not perform additional audit work to address a possible audit problem, nor make a

critical assessment of the evidence which may lead to a lack of skeptical judgment

and action” (2013, 71). Moreover, the emphasis on maintaining harmony, which

prevails in collectivistic societies, may result in auditor independence having a

different meaning than intended by the (Western-oriented) international standard

setters (e.g., Patel and Psaros 2000). In turn, the emphasis on harmony could also lead

to a lack of apprehensiveness, implying that auditors do not try to really get to the

bottom of an issue or rather take an answer for what it is (e.g., McKinnon 1984).

Indeed, this line of reasoning implies that it is challenging for auditors from (in-

group) collectivistic countries to pose probing questions to management. Accordingly

and, in line with Hughes et al. (2009), we expect that auditors from collectivistic

cultures may be less likely to engage in rigorous fraud risk assessments, since it will

mean that they have to enquire with management and potentially ask probing,

confrontational questions. Therefore, we hypothesize:

Hypothesis 1: The level of (in-group) collectivism and the extent of auditors’

professional skepticism are negatively associated.

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Power Distance Power distance has been defined as the degree to which

members of a society expect and agree that power should be stratified and

concentrated at higher levels (e.g., House et al. 2004). Subordinates in higher power

distance countries, such as Argentina, China, Germany, and Russia, have learned that

it can be dangerous to question authority and express disagreement (House et al.

2004). In these cultures, “people blindly comply with the orders of those in authority,

[…] submissively obey those in power, and are more likely to follow cues set from

above” (Westerman et al. 2007, 242-243).

Differences in power distance are likely to affect auditors’ professional

skepticism. For example, Cohen et al. (1993) reason that auditors in the less

hierarchical countries, such as Australia, the Netherlands, Sweden, and the United

States of America, are better able to maintain high ethical standards even under

pressure from a higher ranked individual. More importantly, the extent of power

distance has also been shown to affect the interactions of auditors and their clients.

For instance, auditors from high power distance cultures tend to be more susceptible

to obedience pressure (e.g., Lord and DeZoort 2001), disregard self-discovery (e.g.,

Endrawes and Monroe 2012), and show less resilience towards client pressure in

resolving and negotiating audit conflicts (e.g., Cohen et al. 1993; Patel et al. 2002; Lin

and Fraser 2008). Moreover, Hughes et al. (2009, 31) observe that these auditors

“may be less likely to question senior client personnel, more willing to acquiesce to

the pressures of a powerful client and less willing to question the financial results

developed by clients (McKinnon 1984; Patel et al. 2002; Yamamura et al. 1996)”.

Obviously, this results in behaviors contrary to what is expected from an auditor who

exhibits sufficient levels of professional skepticism. Accordingly, we hypothesize:

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Hypothesis 2: The level of power distance and the extent of auditors’

professional skepticism are negatively associated.

Religiosity

Religiosity refers to the degree to which individuals in a society adheres to religious

values, beliefs, and practices (e.g., Parboteeah et al. 2015). Religiosity comes with

certain behavioral role expectations (e.g., Sunstein 1996; Weaver and Agle 2002) and

has a major role in guiding attitudes and behaviors in a society (cf. Leventis et al.

2015). Prior studies show that more religious individuals tend to more highly value

honesty, prioritize ethics in decision-making, and be more conservative and risk

averse (e.g., Terpstra et al. 1993; Barnett et al. 1996; Parboteeah et al. 2008; 2015;

Hilary and Hui 2009; Leventis et al. 2015).Moreover, social norm theory (e.g.,

Cialdini 1993; Cialdini and Trost 1998) argues that the influence of religiosity on

individual behavior is ubiquitous. Specifically, one of the main arguments of social

norm theory is that “even if someone is not religious and that person resides in a more

religious environment, ‘religion enters freely into everyday interaction and becomes

part of the normative system’ (Stark and Bainbridge 1996, 164)” (as cited in

Parboteeah et al. 2015, 449; see also, e.g., Cialdini and Trost 1998; Bicchieri and

Xiao 2009; McGuire et al., 2012).). Accordingly, we posit that the level of religiosity

in a society will influence auditors’ professional skepticism judgments even if an

auditor her- or himself may not be a religious person.

In line with the idea that religiosity has a widespread impact, researchers have

become increasingly interested in the influence of religiosity on finance and

accounting. For example, research links religiosity to economic attitudes that

ultimately support economic growth (e.g., cooperation, working women, thriftiness,

and the market) (Guiso et al. 2003), financial reporting quality (e.g., Dyreng et al.

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2012; McGuire et al. 2012; Kanagaretnam et al. 2015a,b), reduced acceptance of

unethical behavior (e.g., Longenecker et al. 2004; Conroy and Emerson 2004;

Parboteeah et al. 2008), and conservative investments (Hilary and Hui 2009). In the

context of auditors’ professional behavior and consistent with Nelson’s (2009) model

indicating that auditors’ professional judgments are influenced by auditor traits, Omer

et al. (2015) link religiosity to auditor’s professional skepticism in terms of their

willingness to issue a going concern opinion when needed. They find that local

offices of public accounting firms located in more religious urban areas within the

United States are more inclined to issue going concern opinions (Omer et al. 2015),

which they interpret as evidence consistent with greater levels of professional

skepticism in these areas.

Various reasons may inform this positive association between religiosity and

professional skepticism. First, as religiosity stimulates ethical behaviors and honesty

(e.g., Terpstra et al. 1993; Barnett et al. 1996; Parboteeah et al. 2008, 2015), auditors

in societies that score higher in terms of religiosity, such as Brazil, Indonesia, or

(large parts of) the US, may be expected to show higher levels of professional

skepticism (Omer et al. 2015) compared to auditors in countries lower in religiosity,

such as the Netherlands or Sweden. Second, an audit risk perspective also suggests a

positive association. Leventis et al. (2015, 6) note that “being risk averse and more

conservative, managers may invest more intense audits and require auditors to

undertake extended processes to increase the degree of audit assurance”, hence,

requiring higher levels of professional skepticism. Accordingly, consistent with prior

theorizing and empirical evidence, we hypothesize that higher levels of religiosity at

the country-level is associated with greater auditors’ professional skepticism, as

follows:

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Hypothesis 3: The level of religiosity and the extent of auditors’ professional

skepticism are positively associated.

Societal trust

Societal trust constitutes the last informal institution we focus on. Societal trust can be

defined as “the subjective probability that individuals attribute to the possibility of

being cheated” (Guiso et al. 2008, 2557) or as the degree to which there is a

“willingness to rely on another party” (Doney et al. 1998, 604). These definitions

emphasize that trust involves beliefs (e.g., Sapienza et al. 2013) about the extent to

which one party runs the risk that one’s self-interest is jeopardized because the other

party abuses the trust in him to take advantage of the situation (e.g., Mayer et al.

1995; Doney et al. 1998). In other words, societal trust reflects the extent to which

people tend to believe each other easily. An increasing number of studies provide

empirical evidence that higher levels of societal trust are a significant determinant of

economic development (e.g., Zak and Knack 2001; Beugelsdijk et al. 2004; Guiso et

al. 2006, 2008). Generally speaking, the findings of these studies suggest that,

compared to low-trust countries, such as Brazil, Philippines, or Turkey, high-trust

countries (such as in Australia, Sweden, or Switzerland) exhibit greater economic and

capital market development.

More recently, scholars show the effects of societal trust on several financial

reporting phenomena (e.g., Nanda and Wysocki 2012; Kanagaretnam et al. 2015b;

Pevzner et al. 2015; Tan 2015). As one of the first in the accounting domain, Nanda

and Wysocki (2012) show that societal trust is significantly and positively associated

with financial reporting quality (e.g., lower levels of earnings management, more

timely recognition of bad news, and higher levels of voluntary disclosure). They

suggest that in high-trust societies individuals place a greater value on corporate

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information—information they believe is credible and, hence, use in their decision-

making processes. Consequently, in these high-trust societies, firms would be less

likely to withhold information because this would lead to higher reputational costs

given that investors would perceive non-disclosure as “bad” firm prospects and would

see firm management as less honest or credible (Nanda and Wysocki 2012). In

support of Nanda and Wysocki’s ideas are studies showing that in countries

characterized by higher levels of societal trust, both analysts’ stock market

recommendations (Tan 2015) and corporate earnings announcements (Prevzner et al.

2015) are perceived as more credible as indicated by a stronger share price reaction

following the issue of these types of information in high-trust countries than in low-

trust countries.

Kanagaretnam et al. (2013) extend these studies by showing that, compared to

low-trust societies, the level of corporate tax avoidance is lower in high-trust

societies. In line with social norm theory, Kanagaretnam et al. (2013) suggest that as

other members of society generally do not consider tax avoidance as acceptable

behavior, engaging in such activities would be seen as an action that violates a social

norm.  Kanagaretnam et al. expect that managers in high trust societies are more

likely to reciprocate the trust society places in them and, hence, are less likely to

exhibit behaviors that would call into question their integrity.

In line with the aforementioned studies we expect auditor’s professional

skepticism to be associated with societal trust as well. First, in high-trust societies

people tend to believe each other more easily than in low-trust societies, that is they

estimate the probability to be cheated by the other party to be lower (Mayer et al.

1995; Guiso et al. 2008). Second, as is implied by the findings from several

aforementioned studies in accounting (Nanda and Wysocki 2012; Kanagaretnam et al.

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2013; Pevzner et al. 2015), managers of firms located in high-trust societies are more

likely to reciprocate the trust society has placed in them and refrain from actions that

would hurt their integrity. Hence, it is expected that in high-trust societies, auditors

have a higher “generalized expectancy [...] that the word, promise, verbal or written

statement of another individual or group can be relied upon” (Rotter 1967, 651) (as

cited in Quadackers et al. 2014, 642) and thus may be more inclined to rely on the

information provided by others, including management. For auditors in high-trust

societies, this would also imply that they need relatively less persuasive evidence

before they are willing to conclude that an assertion is correct (Nelson, 2009).

Accordingly, we hypothesize:

Hypothesis 4: The level of social trust and the extent of auditors’ professional

skepticism are negatively associated.

METHODS

Sample and Data Collection

To empirically examine the impact of informal institutions on auditor professional

skepticism, we rely on unique data from a Big 4 audit firm. Specifically, our measure

of professional skepticism comes from data that were collected as part of an internal

quality process review that was performed throughout the firm’s global network of

affiliated audit firms. Our approach is consistent with Bell et al. (2015, 464) who

“develop audit quality measures using direct assessments of attributes of the audit

process made by internal [quality] reviewers”.

As per the instructions of the firm’s global quality review team, for each

country a number of audit engagements were selected, taking into account that the

selection should reflect size and nature of the local audit practice and client portfolios

in each of the countries (such as industry sectors, higher risk engagements, public-

20  

interest-entities, and large and medium-sized companies). Access to the data was

obtained after having received permission from the firm under arrangements of strict

confidentiality and anonymity.

All audit engagements related to audits for fiscal year 2005.1 In total, the

initial sample comprised 1,939 audit engagements for 116 countries. Combining audit

engagement data from the Big 4 audit firm with available country-level data to

measure informal institutions and to control for other country-level variables (see

below) resulted in a sample of 1,152 audit engagements from 29 countries.

Variables

Dependent variable – Professional skepticism

The global quality review team evaluated each audit engagement on a number of

attributes. One of these attributes related to the audit team’s assessments of fraud

risks. As discussed in the literature review section, auditors’ fraud risk assessments

are considered to reflect professional skepticism.

In our study, we use a team-level measurement of professional skepticism, as

“audits are generally conducted by groups” (Trotman et al. 2015, 56) and, hence,

professional skepticism becomes “apparent in the decisions that result from team

interactions” (Nelson et al. 2015, 5). While prior research focuses on individual-level

measures of professional skepticism (e.g., Nelson 2009; Hurtt et al. 2013), a team-

level measurement of professional skepticism is a more encompassing reflection of

how audit teams actually work. Specifically, audit engagements are typically

performed in “hierarchical teams in which most of the audit evidence is accumulated

by lower-level team members, making knowledge-sharing amongst team members

                                                            1 The agreement with the audit firm allowed us to report on the data only after taking into consideration a “cooling off” period.

21  

vital to an effective and efficient audit” (Nelson et al. 2015, 1). Hence, this implies

that judgment and decision making on audit-related issues, including fraud risk

assessments, largely involve interaction between the various members of an audit

team.

Following auditing standards (e.g., ISA 240), we identified four items in the

firm’s internal quality process data that relate to fraud risk assessment in the planning

phase of the audit engagement that provide the basis for skeptical judgments.

Specifically, these items were: “During the planning phase of the audit did the audit

engagement team (including the audit engagement partner) share their knowledge of

fraud risks at the audited entity?”, “Did the audit engagement team discuss the

susceptibility of the entity’s financial statements to material misstatements due to

fraud?”, “Did the audit engagement team enquire management and others within the

entity regarding the risks of material misstatement due to fraud or error?”, and “Did

the audit engagement team identify and assessed the risks of material misstatement

due to fraud, and developed and documented their responses to identified risks?”

Based on factor analysis particularly suited for categorical (and binary) data

(in which the underlying correlation matrix used during the factor analysis process is

polychoric; see Meulman et al. 2004), we were able to extract a meaningful factor that

captures professional skepticism in a single construct involving all four items (eigen

value = 2,89 and total variance explained = 72%). Also Cronbach’s alpha indicates an

acceptable internal consistency between the four items (α = .72) (Nunnally 1978). As

part of the factor analysis we also extracted a factor score representing auditors’

professional skepticism (PROFSKEP), which was used in further analyses.

Independent variables - Informal institutions

22  

Culture. Following recent studies (e.g., Parboteeah et al. 2012; Cieslewicz

2014; Bik and Hooghiemstra 2016) we use House et al.’s (2004) cultural practices

scores to represent each country’s national culture.2 In our analysis we included the

raw power distance (PD) and in-group collectivism (IGC) scores (on a 1 to 7 scale)

for each individual country included in our final sample.3

Religiosity. Consistent with prior literature (e.g., Guiso et al. 2003;

Kanagaretnam et al. 2013; Welzel 2014;), we measure religiosity based on

respondents’ responses to questions included in the World Values Survey4 about the

importance of religion, religious practice, and the respondents’ self-perception as

religious or not. Specifically, we use Welzel’s (2014) agnosticism index to derive our

country-level measure of religiosity. Welzel’s (2014) agnosticism index is based on

respondents’ (recoded) answers on the following three questions: “How important is

religion in your daily life?”, “Apart from weddings and funerals, about how often do

you attend religious services these days?”, and “Independently of whether you attend

religious services or not, would you say you are (a) a religious person, or (b) not a

religious person, or (c) an atheist”. To create the agnosticism index, recoded

responses to these three questions are averaged, yielding a multi-point index from 0 to

1. To construct our country-level measure of religiosity (RELIGIOSITY), we first

                                                            2 As is discussed more elaborately in Bik and Hooghiemstra (2016) researchers studying the impact of culture on auditing (and accounting) generally use a limited number of well-known taxonomies of cross-national cultural differences including House et al. and Hofstede. 3 Please note that House et al. (2004) identified nine distinct cultural dimensions, namely: power distance, uncertainty avoidance, assertiveness, institutional collectivism, in-group collectivism, future orientation, performance orientation, humane orientation, and gender egalitarianism. Consistent with a number of recent cross-cultural studies (e.g., Han et al. 2010; Hooghiemstra et al. 2015; Bik and Hooghiemstra 2016), we do not include scores for the other dimensions into the analysis in order to circumvent possible multicollinearity problems. 4 The World Values Surveys (WVS) have been conducted in six waves in more than 90 countries. Respondents of the WVSs include individuals older than 17. The surveys are based on a fully standardized master questionnaire, translated (with back-translation checks) and pre-tested in local languages to ensure a maximal cross-cultural equivalence of the measures (Parboteeah et al. 2015). More details on fieldwork, questionnaire, sampling methods, and data are available online at: www.worldvaluessurvey.org.

23  

subtract the score on Welzel’s agnosticism index from one and subsequently

calculated the arithmetic mean per country (e.g., Guiso et al. 2003).

Societal trust. Consistent with prior research (e.g., Guiso et al. 2006; 2008;

Ahern et al. 2015; Kanagaretnam et al. 2013; Pevzner et al. 2015) our measure of

societal trust is based on respondents’ answer to the following question in the World

Values Survey: “Generally speaking, would you say that most people can be trusted

or that you need to be very careful in dealing with people?” Similar to prior research,

we then recoded the response to this question to 1 if a respondent indicates that most

people can be trusted and 0 otherwise. The mean of the response to this (recoded)

question is our country-level measure of societal trust (SOCTRUST).

Independent variables - Controls

We include several control variables from both the audit literature and the

literature on institutions in our regression models to control for other effects. They

include engagement-level and country-level variables.

Engagement-level control variables. The audit process, and as related to that,

the level of professional skepticism, is influenced by characteristics that are unique to

each individual audit engagement. First, we control for whether audit engagements

have to follow US GAAS as arguably, despite harmonization efforts by the IAASB,

US GAAS and ISAs still differ. As a priori the effect of applying either US GAAS or

ISAs is unclear, we control for it. USGAAS is a dummy variable assuming the value

of one if an audit engagement is conducted under the US GAAS regime, and zero

otherwise.

Second, we control for whether or not the audit engagement is classified as a

“public-interest-entity” (PIE). PIE engagements refer to audits of organizations that

are of significant public relevance because of their size or the nature of their business,

24  

such as listed companies, banks, pension funds, insurance companies, and state owned

enterprises or public institutions. Arguably, public-interest-entities involve

engagements that are more costly in terms of reputational damage and at the same

time are more complex. While the first one, reputation risk, would imply a positive

association with professional skepticism (Quadackers et al. 2014), the second one a

negative association as more complexity would possibly imply that the auditor is

faced with an information overload that can impair skeptical judgments (Hurtt et al.

2013). PIE is a dummy variable assuming the value of one if an audit engagement

classified as a public-interest-entity, and zero otherwise.

YEND is a dummy variable assuming the value of one if it involves an

engagement regarding financial statements that have a year-end on the 31st of

December, and zero otherwise. By including YEND we control for the possibility that

fraud risk assessments that may be performed closing to or during the “busy-season”

would be conducted under time pressure. We include year and industry dummies to

control for the time-series and cross-sectional differences in fraud risk assessments

conducted. Data regarding these engagement-level control variables were collected as

part of the annual audit process quality review of the audit firm noted earlier.

Third, we include a measure (SIZE) representing the size of the engagement in

terms of the (logarithm of the) total number of hours all audit team members have

spent on the engagement. Arguably, the more time the audit team has for an

engagement enables them to spend more time on assessing fraud risks implying

higher levels of professional skepticism. Indeed, Bell et al.’s (2015) study based on

internal assessments of audit quality finds that bigger engagements are associated

with a lower likelihood of receiving a bad assessment for overall audit quality and

with a smaller number of assessed audit deficiencies.

25  

Lastly, we control for possible industry effects5 to control cross-sectional

differences in professional skepticism.

Country-level control variables. While the focus of our study is on the impact

of informal institutions on professional skepticism, informal institutions do not

operate in a vacuum. Therefore, and consistent with prior cross-country auditing

research (e.g., Choi and Wong 2007; Choi et al. 2008; Francis and Wang 2008; Hope

et al. 2008), we include a number of country-level variables reflecting formal

institutions that also might be associated with professional skepticism. We include

these variables as prior studies indicate that institutional differences at the country

level play an important role in influencing auditor behaviors (cf. Choi et al., 2008) due

to differences in formal institutions, corporate governance environment, and

economic development. As there is no clear theory on the relation between

professional skepticism and our country-level control variables, we do not predict the

sign of their coefficients.

First, to control for the impact of formal institutions on professional

skepticism, we include both legal origin (COMMONLAW) and the extent to which

shareholders’ rights are protected (ADRI). Specifically, in line with prior research

(e.g., Nanda and Wysocki 2012; Pevzner et al. 2015), our proxy for investor

protection is the strength of minority investor protection as proxied by the value on

Djankov et al.’s (2008) index. COMMONLAW is a dummy variable assuming the

value of one if a country’s legal origin is common law based, and zero otherwise.

                                                            5 We use dummy variables as included in the Big 4 data and distinguish four broadly-defined industries (i.e., Industrial and Consumer Goods and Services (ICGS), Financial Institutions (FI), Information, Technology, Entertainment, and Communication (ITEC), Privately Owned Businesses (POB)). These dummy variables are equal to one if a firm belongs to a particular industry and zero otherwise. The reference group was “Privately owned businesses”.

26  

Data on legal origin comes from Rafael La Porta’s website.6 Generally speaking, the

rights of minority investors are reflected by better protection, as indicated by high

ADRI-scores, and by presence of common law.

Second, consistent with, e.g., Choi and Wong (2007) and Hope et al. (2008),

we control for the economic development in a country. Specifically, we include the

logarithm of GDP per capita (in US $) (GDPPERCAP).

Finally, we include a measure reflecting the general perceptions of quality of

supervision by the board of directors in a country (CORPBRDS). Specifically, we use

the country’s score from IMD’s World Competitiveness Yearbook on the question

“Corporate boards do supervise the management of companies effectively”.

Participants, consisting of executives, were asked to indicate their response to this

question on a seven-point Likert scale, with higher scores indicating higher quality

supervision. According to Hurtt et al. (2013) client characteristics affect auditors’

skeptical judgments. Arguably, and in line with for instance agency theory,

monitoring by an effective board of directors provides managers less opportunities to

commit fraud.

Regression model

To test our predictions regarding the impact of our four aspects of countries’

informal institutions, we estimated the following OLS regression model (subscripts

are suppressed for notational convenience):

PROFSKEP = α0 + β1PD + β2IGC + β3RELIGIOSITY + β4SOCTRUST +

γ ENGAGEMENT + δ COUNTRY + ε

                                                            6 http://faculty.tuck.dartmouth.edu/rafael-laporta/research-publications last accessed on August 25th, 2016.

27  

where PROFSKEP, PD, IGC, RELIGIOSITY, and SOCTRUST are as defined

previously. ENGAGEMENT refers to the set of engagement-level control

variables and COUNTRY to the country-level control variables. Lastly, ε is

the error term.

RESULTS

Descriptive Analysis

The descriptive statistics are reported in Table I. The dependent variable,

PROFSKEP, has a mean (median) of 0.00 (0.64) and a range of -2.91 to 0.64.7

Regarding our test variables representing national culture, we observe that PD has a

mean (median) of 5.12 (5.15), while IGC has a mean (median) of 4.70 (4.37). With

respect to the other two informal institutions we observe that RELIGIOSITY and

SOCTRUST have a mean (median) of 0.54 (0.57) and 0.32 (0.34), respectively. An

investigation of the descriptive statistics indicate that the mean (median) number of

hours (SIZE) spent on a single audit engagement was 1958.44 (950). Moreover, we

observe that 48% of the audit engagements are conducted in countries with a common

law system (as shown by the mean value of COMMONLAW of 0.48). ADRI has a

mean (median) value of 3.83 (4.00). Finally, CORPBRDS has a mean (median) value

of 5.72 (5.89).

[Insert Table I about here]

Correlations

                                                            7 For ease of interpretation we also report the mean (median) using the untransformed score. Specifically, the simple summation of the number of questions on which an engagement would score “yes” (i.e., is scored as 1) also provides insight into professional skepticism. The mean (median) based on this measure (which has a range of 0-4), is 3.28 (4.00).

28  

Table II presents the Pearson correlations for our main variables. In a few cases, the

correlation coefficient between the independent variables is greater than |0.6|, which

may indicate possible multicollinearity issues. In particular, the correlations between

power distance (PD) and collectivism (IGC) (r = 0.68) is relatively high, which is

consistent with prior studies (Hofstede, 2001; House et al., 2004). Also in line with

prior research (e.g., Guiso et al. 2006, 2008) are the correlations between economic

development (GDPPERCAP) on the one hand and religiosity (RELIGIOSITY) (r = -

0.65) and societal trust (SOCTRUST) (r = 0.61), on the other. Moreover, and also

consistent with prior research (e.g., Hooghiemstra et al. 2015), we observe high

correlation coefficients between GDP per capita (GDPPERCAP) and collectivism

(IGC) (r = -0.75) on the other. Lastly, we find negative correlations between

SOCTRUST on the one hand and PD (r = -0.61) and IGC (r = -0.65) on the other. To

reduce concerns about multicollinearity, we obtained variance inflation factors. These

VIFs were all less than 5.0, and the average VIFs in the analyses were less than 2.7

indicating that multicollinearity should not be problematic. To minimize the impact of

extreme values, we winsorize each of the continuous variables used in the regressions

at the top and bottom 1 percent.

[Insert Table II about here]

Regression results

Table III presents the coefficients and Huber-White robust standard errors (in

brackets) from ordinary least squares regressions. In column (1) we present the results

of a “controls only” analysis. In columns (2) to (5) we respectively add IGC, PD,

RELIGIOSITY, and SOCTRUST. Lastly, column (5) presents the results based on the

full model.

29  

In column (2) of Table III, we see that the coefficient of IGC is significantly

negative (β = 0.21; p-value < 0.01). In the full model (column (6)), we find a

comparable result (β = 0.31; p-value < 0.01). These findings lend support to

hypothesis 1 and suggests that professional skepticism is lower for countries higher

on collectivism.

Furthermore, column (3) of Table III, shows that the association between PD

and PROFSKEP is not significant (β = 0.15; n.s.). Column (6) of Table III, shows a

marginally significant and positive association between PROFSKEP and PD (β =

0.26; p-value < 0.10). Hence, on the basis of the results presented in Table III we have

to reject hypothesis 2 which predicted a negative association between professional

skepticism and power distance.

In support of hypothesis 3, in column (4) of Table III, the association between

RELIGIOSITY and PROFSKEP is significantly positive (β = 0.91; p-value < 0.01),

which suggests that auditors from more religious countries exhibit higher levels of

professional skepticism. Also the full model shows a significantly positive

association, albeit at a lower significance level (β = 0.52; p-value < 0.10). These

results support hypothesis 3 which states that the level of religiosity and the extent of

auditors’ skeptical judgments are positively associated.

Lastly, in support of hypothesis 4, in column (5) of Table III, we find lower

levels of auditor professional skepticism for countries having higher levels of societal

trust (β = -0.94; p-value < 0.01). The results of the full model, as presented in column

(6) of Table III, reveal similar patterns as far as the relation between societal trust and

PROFSKEP is concerned.

[Insert Table III about here]

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The results regarding our engagement-level control variables remain relatively

stable throughout the various analyses and seem to suggest that professional

skepticism is higher for larger engagements. We find no evidence suggesting that

other engagement-level control variables are associated with professional skepticism.

The results with respect to our country-level control variables are as follows.

First, the results reported in Table III suggest that formal institutions also affect

professional skepticism. Specifically, while we find that professional skepticism is

higher in common law countries than in code law countries (as, for instance, is

indicated by the positive coefficient of COMMONLAW in model (6) (β = 0.30; p-

value < 0.01)), professional skepticism is negatively associated with the level of

investor protection as measured by ADRI (β = -0.19; p-value < 0.01). The positive

association between PROFSKEP and COMMONLAW possibly reflects an

environment in which auditors face heightened litigation risk (e.g., Choi and Wong,

2007). The negative association between ADRI and PROFSKEP seems to be in line

with the view that investor protection and auditing are “substitutes” (e.g., Choi and

Wong, 2007; Choi et al., 2008; Ernstberger and Grüning, 2013). In a similar vein, the

negative association between CORPBRDS and PROFSKEP (e.g., in model (6), β = -

0.19; p-value < 0.05) seems to suggest that the higher the quality of supervision of the

board of directors the less need the auditor may feel to be professionally skeptical.

Sensitivity analyses

In order to assess the reliability and generalizability of our findings we conducted

several robustness tests. First, one of the assumptions underlying OLS regressions is

that errors are independent and identically distributed. As we are dealing with data

regarding audit engagements located in 29 countries, we cannot fully rule out the

31  

possibility that these assumptions are violated and, consequently, that the OLS

estimates will be inefficient and the standard errors will be biased. Therefore, we re-

estimated the results using (feasible) generalized least squares where the individual

engagements are weighted by the reciprocal of the variance of their error terms. The

results (untabulated) of the full model are qualitatively similar as those reported in

Table III.

Even though the number of audit engagement for each country included in the

sample is fairly equally distributed (ranging from 10 to 120), we want to exclude the

possibility that the results reported in Table III are mainly due to a possible

overrepresented of audit engagements from a limited number of countries. Therefore,

and in line with Orij (2010), we exclude all observations from the two countries that

have the largest number of audit engagements in the sample. This reduced the sample

to 952 observations from 27 countries. The results (untabulated) of the full model

based on these 952 observations are qualitatively similar as those reported in Table

III.

Consistent with Lanis and Richardson (2013) as well as Becker (2005), we

excluded the non-significant control variables to avoid biased parameter estimates.

The results (untabulated) of the full model based on this model are qualitatively

similar as those reported in Table III.

To alleviate a concern that the multivariate regressions reported in Table III

omit some factors that might influence professional skepticism, we include two

additional controls. Specifically, echoing recent research, we control for differences

between countries in relation to the institutional setting for financial reporting (Brown

et al. 2014). We use Brown et al.’s measures of the quality of the public company

auditors’ working environment (AUDIT) and the degree of accounting enforcement

32  

activity (ENFORCE) by independent enforcement bodies. The inclusion of these

variables does not materially alter our conclusions regarding the impact of the four

informal institutions on professional skepticism, except that the effect of religiosity on

professional skepticism no longer is present in the full model (untabulated).

Moreover, the results indicate that while ENFORCE does not have an impact on

professional skepticism, higher scores on AUDIT is significantly and positively

associated with our measure of professional skepticism.

CONCLUSIONS, DISCUSSION, LIMITATIONS, AND FUTURE RESEARCH

Recently, the marked interest of researchers, practitioners, and regulators in

strengthening auditors’ professional skepticism (Nelson 2009; Carpenter and Reimers

2013; Hurtt et al. 2013; Quadackers et al. 2014; IAASB 2015a; PCAOB 2015a,b;

IFIAR 2016), has developed into an increased focus on safeguarding skepticism

internationally with “other auditors” throughout a global group audit in relation to

revising “group” auditing standards (IAASB 2015a, b; PCAOB 2016b). This is hardly

surprising, because (group) auditors working with other auditors in other jurisdictions

encounter numerous additional challenges due to differences in the local environment,

while at the same time striving for consistency in a quality-audit in accordance with

auditing standards.

Based on unique, proprietary data from internal audit quality assessments of

1,152 audit engagements in 29 countries across the globe of a Big 4 audit firm our

results show, largely consistent with our expectations, that differences in auditors’

professional skepticism are associated with differences in national-level informal

institutions (i.e., collectivism, religiousness, and societal trust). An overall implication

is that informal institutions matter in safeguarding professional skepticism

33  

internationally. If researchers, practitioners, and regulators are interested in

strengthening professional skepticism internationally, they need to take a country’s

informal institutions into account and may want to consider different approaches for

different regions in the world. Accordingly, our findings have important implications

for audit practitioners and firms’ management, audit regulators and public policy, and

researchers.

For internationally operating (group) auditors and audit firms, although

professional skepticism is considered fundamental to the professional behavior of

auditors and is at the very core of auditing’s global professional standards (the ISAs),

a uniform application of a global audit may remain an illusion (e.g., Cohen et al.

1995; Patel et al. 2002; Leung et al. 2005; Bik and Hooghiemstra 2016). The findings

of our study indicate that differences in informal institutions are likely to affect

auditors’ professional behavior in general and professional skepticism in particular.

Their influence adds to the complexity of organizational control in multinational audit

firms (Cohen et al. 1993) and disrupt attempts to provide so-called “seamless

services” in the local execution of global strategies (Barrett et al. 2005). The question

then is: can practitioners expect consistent skepticism across the globe – and, if not,

would it be wise to take an “one-size-fits-all” approach to harness professional

skepticism? Wouldn’t the biggest risk be to try to implement a global strategy in a

local environment without thinking about the local specificities (cf. Bik 2010)?

Implementing standardized firm-wide audit methodologies, knowledge sharing, and

training to harnessing an auditor’s ability to pose a challenging question may even be

counterproductive in certain countries. Although our results document that informal

institutions matter, we do not know whether there are other mechanisms in play that

may compensate for what appears to be impaired professional skepticism, and how.

34  

For example, given that auditors from different countries have different behavioral

expectations and norms of what is considered the required extent of being

professionally skeptical within the specific local environment, what would happen if

global firm management would prescribe certain detailed audit procedures above and

beyond what is considered conducive within the local environment? Similarly, given

the increasing national diversity of audit teams within the same local setting, what

would happen to the skeptical team interaction of, for example, a U.S.-based team

comprising various nationalities? Ultimately, professional skepticism becomes

“apparent in the decisions that result from team interactions” (Nelson et al. 2015: 5).

Or in that regard, how are such skeptical decisions affected by the values, beliefs, and

intentions of the audit partner leading the audit team? Would such interaction and

decisions be different in a team led by a U.S. team leader compared to say a Chinese

team leader? How and to what extent do team members assimilate to the local

environment by assuming the informal institutions of the host country or maintains

his/her home values?

While standards setters and regulators (e.g., IAASB 2015a; PCAOB 2016a,b)

are currently exploring ways to elevate (transparency over) professional skepticism of

lead (group) auditors and “other auditors”, they may want to be careful imposing

additional and detailed prescribed auditing standards and oversight without taking the

effect of local informal institutions into account. An important implication is that

“Western” auditing principles, do not necessarily work in “non-Western” regions—

regions that differ in respect of underlying traditions, customs, values, religious

beliefs, and other unwritten an often implicit societal rules that pervasively guide

professional behavior (cf. North 1991; Pejovich 1999). Hence, one globally uniform

set of auditing standards as such does not per definition lead to consistent application

35  

of those standards in an actual audit. Underlying values and beliefs are likely to be the

default when these standards are ambiguous or multi-interpretable (Leung et al.

2005). Auditing standards should not be considered in isolation and independent of

other elements in the institutional infrastructure – amongst which are informal

institutions (cf. Brown et al. 2014); i.e., “group” auditing standards may necessitate

the inclusion of explicit guidance for group lead auditors’ effectively managing

international audit teams. Similar to whether one would lock the house door in the

city compared to a rural area, other social mechanisms may be at work in the

“Western” world compared to “non-Western” regions. At the same time auditing

standards seem to prescribe to lock the door, wherever you are. For example, while

the auditing standards prescribe a number or required fraud risk assessment

procedures (e.g., ISA 240), auditors ultimately act and interact based on the local,

societal behavioral norms: how things work and should be done in that given society.

Indeed, auditors’ professional skepticism is conditional upon the information

available to the auditor (cf. Nelson 2009), which includes local societal mechanisms

at work and other external environmental and contextual factors (e.g., Hurtt et al.

2013). In other words, the less an auditor feels that such skeptical procedures would

be required in his/her local context, for example given local religiousness or societal

trust, the less likely he/she is to perform those procedures. By being too prescriptive,

standards setters and regulators run the risk of eliminating all room for auditors to be

skeptical appropriate to the local societal context. What unintended consequences

may result if that auditor would be compelled to perform those prescribed steps –

possibly unnecessarily? Would the effectiveness be negatively impacted because

skeptical procedures that are relevant within the local context are not conducted

because these are not prescribed by global standards? Or would teams be over-

36  

auditing due to an over-attention on professional skepticism resulting in loss of

efficiency and/or increasing audit fees? It may very well be that auditors in different

societies approach audits differently (i.e., process) based on the local context, e.g.,

being more or less skeptical than globally prescribed, while it does not harm financial

reporting quality (i.e., outcome). In other words, not following the required fraud risk

assessment steps may very well mean that there was a quality-audit based on

“countervailing behavioral norms” within that society – which norms the current

standards do not take into account. Which countervailing mechanisms these could be

is yet to be studied. When asking the question: “Are the ‘other auditors’ in

jurisdictions that we sleep tight about?”8, standards setters and regulators may want to

explore and consider difference approaches in different parts of the world for auditors

to tailor their audits to the local environment.

While we contribute to the emerging number of studies in accounting and

auditing on the determinants of professional skepticism (e.g., Nelson 2009; Carpenter

and Reimers 2013; Hurtt et al. 2013; Nelson et al. 2015; Nolder and Kadous 2015) by

providing empirical support for the suggestion by Hurtt et al. (2013) that external

environmental, contextual characteristics affect audit judgment and, hence, that

conclusions based on evidence gathered in the U.S. “do not necessarily hold in all

jurisdictions” (Simnett et al. 2015, 34), our study has certain caveats that potentially

offer interesting avenues for future research. First, while we show that professional

skepticism is associated with differences in country-level informal institutions, we

acknowledge that our study ignores possible within-country variations in religiosity

and societal trust between rural and urban areas (e.g., McGuire et al. 2012; Omer et

al. 2015). Hence, an avenue for future research could be to focus on a limited number

                                                            8 Based on informal discussions with a PCAOB representative during the 2016 ISAR conference.

37  

of countries to study whether, first, there are within-country variations in informal

institutions and, second, to the extent they do exist, how those differences affect

professional skepticism. Moreover, despite the frequent use of cultural and

institutional taxonomies as those of Hofstede (2001), House et al. (2004), and the

World Values Survey, they inevitably have their limitations, including that they have

been gathered in a sample that doesn’t focus on audit practitioners as such. Therefore,

measuring the existence of differences in informal institutions in a specific research

setting potentially adds to the in-depth understanding of the role of informal

institutions affecting professional skepticism. Furthermore, our data originate from

the period before various countries displayed an increased focus on auditors’

professional skepticism in safeguarding audit quality. While our reliance on data from

2005 may limit the generalizability of the results to a more contemporary period, at

the same time they can be considered a strength as our data reflect actual auditor

practices not influenced by regulators’ intervention. However, at the same time

getting access to data from a more contemporary period may prove to be a fruitful

area for future research as it helps examining how regulators’ interventions (for

instance, in the area of corporate governance, financial reporting, and auditing) affects

auditors’ professional behaviors in general and professional skepticism in particular.

Lastly, we were not able to link the individual audit engagements in the sample to

specific firms and had no access to engagement level information related to, e.g.,

future misstatements, going concern opinions, or accruals quality. Hence, a last

interesting area for future research is to assess the association between professional

skepticism and actual audit quality and test whether (informal) institutions moderate

this relation.

38  

Notwithstanding the study’s limitations, the findings provide important and

wider insights regarding the role of informal institutions in explaining cross-national

differences in professional skepticism, and as such may stimulate further research on

the way professional skepticism can effectively be strengthened throughout a global

audit.

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45  

Table I: Descriptive statistics

Mean Median Stdev Min Max

PROFSKEP 0.00 0.64 1.02 -2.91 0.64

ICGS 0.53 1.00 0.50 0.00 1.00

FI 0.20 0.00 0.40 0.00 1.00

ITEC 0.19 0.00 0.39 0.00 1.00

POB 0.08 0.00 0.28 0.00 1.00

USGAAS 0.11 0.00 0.31 0.00 1.00

PIE 0.53 1.00 0.50 0.00 1.00

YEND 0.90 1.00 0.29 0.00 1.00

SIZE (in hrs) 1958.44 950.00 2769.79 40.00 14750.00

GDPPERCAP (in US$) 27462.45 34322.88 15857.11 740.11 54798.57

ADRI 3.83 4.00 1.00 1.00 5.00

COMMONLAW 0.48 0.00 0.50 0.00 1.00

CORPBRDS 5.72 5.89 0.72 4.21 6.98

IGC 4.70 4.37 0.74 3.66 6.36

PD 5.12 5.15 0.32 4.11 5.64

RELIGIOSITY 0.54 0.57 0.17 0.29 0.89

SOCTRUST 0.32 0.34 0.15 0.05 0.68

Notes: This table presents descriptive statistics. Variables are as defined in the text. All statistics are based on n = 1,152.

46  

Table II: Pearson correlations

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

1 PROFSKEP 1.00 2 ICGS -0.02 1.00

3 FI 0.00 -0.53*** 1.00

4 ITEC 0.01 -0.51*** -0.24*** 1.00

5 USGAAS 0.07* 0.04 -0.07** 0.09*** 1.00

6 PIE 0.03 -0.13*** 0.21*** 0.09*** 0.18*** 1.00

7 YEND -0.04 0.00 0.02 -0.04 0.03 0.02 1.00

8 SIZE 0.19*** -0.05 0.06** .13*** 0.35*** 0.44*** 0.04 1.00

9 GDPPERCAP 0.04 -0.13*** 0.07* -0.02 0.11*** -0.05* 0.11*** -0.02 1.00

10 ADRI -0.21*** 0.05* 0.03 0.01 -0.12*** 0.08** -0.06** -0.12*** -0.20*** 1.00

11 COMMONLAW -0.01 -0.06** 0.04 0.02 0.10*** 0.06** -0.13*** -0.03 0.02 0.43*** 1.00

12 CORPBRDS -0.15*** -0.09*** 0.02 -0.01 -0.02 0.10*** 0.03 -0.12*** 0.07** 0.34*** 0.59*** 1.00

13 IGC -0.05 0.15*** -0.05* 0.04 -0.05 0.09*** -0.06** 0.17*** -0.75*** 0.16*** -0.11*** -0.25*** 1.00

14 PD 0.04 0.17*** -0.02 0.03 -0.07** -0.02 -0.05 0.11*** -0.56*** 0.13*** -0.27*** -0.56*** 0.68*** 1.00

15 RELIGIOSITY 0.12*** 0.08*** -0.02 -0.01 0.03 0.05* -0.06** 0.11*** -0.65*** -0.12*** 0.14*** 0.03 0.30*** 0.49*** 1.00

16 SOCTRUST -0.08*** -0.16*** 0.01 0.01 0.06* -0.05* 0.07** -0.13*** 0.61*** -0.16*** 0.11*** 0.30*** -0.61*** -0.65*** -0.59***

Notes: *, **, and *** indicate significance at the 0.10, 0.05, and 0.01 (all two-tailed), respectively. All correlations are based on n = 1,152. Variables are as defined in the text.

47  

Table III: Regression results

(1) (2) (3) (4) (5) (6)

INTERCEPT 1.033 2.967 -0.071 -0.480 0.563 0.705 [0.490]** [0.831]** [1.299] [0.691] [0.501] [1.370]

USGAAS ? -0.110 -0.116 -0.107 -0.118 -0.097 -0.106

[0.086] [0.085] [0.086] [0.086] [0.086] [0.083]

PIE ? -0.024 -0.025 -0.019 -0.019 -0.021 -0.011

[0.067] [0.067] [0.068] [0.067] [0.067] [0.067]

YEND ? -0.126 -0.112 -0.132 -0.143 -0.130 -0.130

[0.098] [0.098] [0.099] [0.097] [0.099] [0.099]

SIZE ? 0.149 0.167 0.147 0.143 0.137 0.157

[0.028]** [0.028]** [0.028]** [0.028]** [0.028]** [0.028]**

GDPPERCAP ? 0.016 -0.080 0.035 0.115 0.082 0.026

[0.028] [0.042]* [0.036] [0.037]** [0.032]** [0.044]

ADRI ? -0.211 -0.195 -0.222 -0.148 -0.230 -0.189

[0.032]** [0.032]** [0.034]** [0.041]** [0.032]** [0.047]**

COMMONLA ? 0.371 0.368 0.372 0.275 0.360 0.304

[0.084]** [0.084]** [0.084]** [0.097]** [0.084]** [0.099]**

CORPBRDS ? -0.241 -0.283 -0.203 -0.252 -0.183 -0.190

[0.059]** [0.061]** [0.076]** [0.059]** [0.060]** [0.074]**

IGC (H1) - -0.208 -0.311

[0.067]** [0.073]**

PD (H2) + 0.152 0.263

[0.153] [0.166]*

RELIGIOSITY + 0.905 0.515

[0.301]** [0.336]*

SOCTRUST - -0.943 -0.893

[0.288]** [0.343]**

Industry fixed effects

Included Included Included Included Included Included

R2 0.10 0.11 0.10 0.11 0.11 0.13

Highest VIF 3.96 4.00 4.12 3.99 4.02 4.15

Notes: Standard errors are in brackets and are corrected using the Huber-White (1980) procedure; *, **, and *** denote significance at the 0.10, 0.05, and 0.01 levels, respectively. The p-values are one-tailed for directional hypotheses and two-tailed otherwise. All analyses are based on n = 1,152. All variables are as defined in the text.