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DIVERSIFICATION BY THE AUDIT OFFICE AND ITS IMPACT ON AUDIT
QUALITY
Sharad AsthanaProfessor, Department of Accounting
College of BusinessUniversity of Texas at San Antonio
One UTSA CircleSan Antonio, TX, USA 78249
Phone: (210) 458-5232E-mail: [email protected]
September 28, 2012
HISTORY OF THE PAPER….
OCTOBER 2010 ARTICLE ON “COMMUTING STRESS” AND “WORK QUALITY”
OCTOBER 2010-FEBRUARY 2011 AUDIT OFFICE CLIENT HQ AUDIT
QUALITY
MARCH 2011 CHOI ET AL. APRIL 2011 DIVERSIFY TO “DIVERSIFICATION” JANUARY 2012 VERSION 1 COMPETED MARCH 2012 USED FOR COMPS SEPTEMBER 2012 PAPER PRESENTED
DISTANCE
RESEARCH QUESTION
OFFICE SIZE
DIVERSIFICATION
AUDIT
QUALIT
Y
BACKGROUND: AUDITING LITERATURE FRANCIS & YU (2009)
Relation of Office Size with Accruals; Small positive Earnings; Small increase in Earnings; GC opinion
CHOI ET AL. (2010) Relation of Office Size with Audit fees; Accruals
FRANCIS ET AL. (2012) Relation of Office Size with Restatements
CONCLUSION: Larger Audit Offices have better Audit Quality:
More engagement hours / in-house experience Less economically bonded to clients More collective Human Capital
BACKGROUND: DIVERSIFICATION LITERATURE RUMELT (1974) PALEPU (1985) HITT ET AL. (1997) GREENWOOD ET AL. (2005) ETGAR & RACHMAN-MOORE (2010)
Diversification Leads to Sales Expansion If Auditors are rational creatures then
Audit Offices must diversify to reduce risk; increase revenue; maximize profits; and gain market dominance
TWO TYPES OF DIVERSIFICATION
RELATED DIVERSIFICATION (NARROW FOCUS)
Economies of Scope/Scale: Benefit from use of the same resources across diverse markets and products
Economies of Experience: Benefit from coordination of resource flow across diverse markets
Results in Improved Output (Quality/Quantity)Kogut (1985) Wernerfelt & Montgomery (1988)
TWO TYPES OF DIVERSIFICATION
UNRELATED DIVERSIFICATION (WIDE FOCUS)
Sacrifice “Depth” for “Width” Spread available resources too “thin”
across diverse engagements.
Results in Reduced Output (Quality/Quantity) Palepu (1985)
TO SUM UP .........
PROXIES FOR DIVERSIFICATION
UNRELATED DIVERSIFICATION (WIDE FOCUS)
INDUSTRY DIVERSIFICATION CLIENT DIVERSIFICATION GEOGRAPHIC DIVERSIFICATION
RELATED DIVERSIFICATION (NARROW FOCUS)
SERVICE DIVERSIFICATION
PROXIES FOR AUDIT QUALITY
AUDIT FEESo Francis et al. (2005)o Choi et al. (2008 & 2010)
DISCRETIONARY ACCRUALS MEET OR BEAT EARNINGS
EXPECTATIONSo Francis and Yu (2009)o Reichelt and Wang (2010)o Choi et al. (2012)
MAIN FINDINGS…
Industry diversification, client diversification, and geographic diversification have adverse effects on audit quality.
Service diversification has beneficial effect on audit quality.
HYPOTHESES… H1a: Ceteris paribus, diversification at the audit
office level leads to client and sales expansion. H2a: Ceteris paribus, audit quality will be
negatively associated with industry diversification at the audit office level.
H3a: Ceteris paribus, audit quality will be negatively associated with diversification of client-size at the audit office level.
H4a: Ceteris paribus, audit quality will be negatively associated with diversification to distantly located clients.
H5a: Ceteris paribus, audit quality will be positively associated with diversification across services provided by the audit office.
RESEARCH DESIGN…
RESEARCH DESIGN…
SUMMARY OF RESULTS
CONCLUSIONS… Industry diversification, client
diversification, and geographic diversification have adverse effects on audit quality, possibly because such diverse audit engagements strain the resources of the audit office.
Service diversification has beneficial effect on audit quality, possibly due to knowledge spill-over effect from providing multiple services to the same client.
CONTRIBUTIONS…
The findings of this paper are important since they identify additional factors that explain audit quality at the audit office level and extend the recent research on audit office performance in the local audit market.
As a consequence of these results, future researchers are advised to control for diversification at the audit office level, in addition to controls for office attributes suggested by extant research.
IF WE KNEW WHAT IT WAS WE WERE DOING, IT WOULD NOT BE CALLED RESEARCH, WOULD IT? ~ALBERT EINSTEIN