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University of Arkansas, Fayetteville ScholarWorks@UARK Theses and Dissertations 8-2016 Audit-Related Services and Audit Quality: Evidence from Benefit Plan Audits Jaclyn Prentice University of Arkansas, Fayetteville Follow this and additional works at: http://scholarworks.uark.edu/etd Part of the Accounting Commons Recommended Citation Prentice, Jaclyn, "Audit-Related Services and Audit Quality: Evidence from Benefit Plan Audits" (2016). Theses and Dissertations. 1671. http://scholarworks.uark.edu/etd/1671 This Dissertation is brought to you for free and open access by ScholarWorks@UARK. It has been accepted for inclusion in Theses and Dissertations by an authorized administrator of ScholarWorks@UARK. For more information, please contact scholar@uark.edu, ccmiddle@uark.edu. Audit-Related Services and Audit Quality: Evidence from Benefit Plan Audits A dissertation submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Business Administration by Jaclyn Prentice Southeastern Oklahoma State University Bachelor of Business Administration in Accounting, 2004 Southeastern Oklahoma State University Bachelor of Science in Mathematics, 2004 University of Texas at Dallas Master of Science in Accounting Information Management, 2012 August 2016 University of Arkansas This dissertation is approved for recommendation to the Graduate Council. Dr. Gary F. Peters Dissertation Director Dr. Ken Bills Committee Member Dr. Jonathan Shipman Committee Member ABSTRACT The following study examines a material but less understood component of the public audit marketplace, namely the provision of “audit-related” services to financial statement audit clients. I use the benefit plan audit service setting to examine the company and benefit plan characteristics associated with auditor selection and the impact of audit-related services on financial statement audit quality. I provide market evidence of distinct shifts in the use of the same audit firm for the financial statement audit and other audit-related services over time as well as characteristics of the choice of auditors. I then test whether having the same audit firm for both types of audit services is associated with financial statement audit quality as measured by missed misstatements (revealed through future restatements). I find that companies that engage the same audit firm for their financial statement audit and benefit plan audit are less likely to have subsequent restatements. I also test whether having the same audit firm for both types of audit services is associated with switching the financial statement audit firm. I find that companies that engage the same audit firm for their financial statement audit and benefit plan audit are associated with a lower likelihood of switching their financial statement audit firm. Overall, my results suggest that choosing the same auditor for both the financial statement audit and audit-related services is associated with a higher level of financial statement audit quality consistent with knowledge spillover between the financial statement and benefit plan audits. My findings also suggests that who provides audit-related services, and whether or not that provider has changed, affects the perception of switching costs for the financial statement audit. Acknowledgments I am grateful for the support and guidance of my dissertation committee: Gary Peters (chair), Ken Bills, and Jonathan Shipman. I would also thank workshop participants at the University of Arkansas, the University of North Dakota, and Oklahoma State University for helpful suggestions and comments. I thank Burch Kealey at the University of Nebraska for his assistance with Direct Edgar, a helpful tool in hand collecting information. I thank my family for their encouragement. I thank my husband, David, for his support in accomplishing my goals and dreams. Dedication I dedicate this dissertation to my wonderful husband, David Prentice. He has encouraged and supported me. I love him always and forever. TABLE OF CONTENTS I. INTRODUCTION .....................................................................................................................1 II. BACKGROUND, PRIOR LITERATURE, AND HYPOTHESES DEVELOPMENT ............6 Benefit Plan Audits ..............................................................................................................6 Benefit Plan Audit Complexity ............................................................................................8 Increased Services and Monitoring ....................................................................................10 Benefit Plan Industry Specialist .........................................................................................11 Audit Quality and Audit-Related Services ........................................................................12 The Changing Provision of Audit-Related Services ..........................................................15 Company, Audit, and Benefit Plan Characteristics ..........................................................16 The Benefit of Benefit Plans? ............................................................................................18 Auditor Switching ..............................................................................................................21 III. SAMPLE SELECTION, DATA COLLECTION, AND DESCRIPTIVES ............................23 Sample Selection and Data Collection ...............................................................................23 Descriptive Statistics..........................................................................................................26 IV. RESEARCH DESIGNS ...........................................................................................................28 Characteristics of Having the Same Auditor ....................................................................28 Audit Quality ....................................................................................................................34 Benefit Plan Audit Quality and Benefit Plan Quality ......................................................38 Characteristics of Switching Benefit Plan Auditors .........................................................43 Switching the Financial Statement Auditor ......................................................................44 V. RESULTS ................................................................................................................................46 Characteristics of the Same Audit Firm Providing Audit and Audit-Related Services ...46 Audit Knowledge Spillover – Benefit Plan Audit to the Financial Statement Audit .......48 Audit Knowledge Spillover – Financial Statement Audit to the Benefit Plan Audit .......51 Benefit Plan Auditor Switching........................................................................................52 Financial Statement Auditor Switching ...........................................................................53 VI. CONCLUSION ........................................................................................................................54 REFERENCES ..............................................................................................................................57 APPENDIX A: Variable Definitions ............................................................................................62 LIST OF TABLES 1. Sample Selection Panel A – Number of Observations .........................................................................................67 Panel B – Observations by Year ..............................................................................................67 Panel C – Observations by Fama French 12 Industry..............................................................67 Panel D – Frequency of Signature Date of Benefit Plan Opinion by Month and Year ...........68 2. Descriptive Statistics Panel A – Selected Descriptive Statistics ...............................................................................69 Panel B – Difference in Means by SameAU...........................................................................71 Panel C – Selected Pearson Correlations ...............................................................................72 Panel D – Percentage of Companies with SameAU by Year .................................................73 Panel E – Disaggregation of Companies with SameAU and DifferentAU by Year and Type of Auditor ...............................................................................................................73 3. Characteristics of Companies Engaging the Same Audit Firm Panel A – Measuring Benefit Plan Complexity using Direct Edgar Data..............................74 Panel B – Measuring Benefit Plan Complexity using Form 5500 Data .................................75 4. Association between Misstatements and SameAU Panel A ...................................................................................................................................76 Panel B ...................................................................................................................................77 Panel C – Benefit Plan Complexity ........................................................................................78 5. Association between Payroll- Related Misstatements and SameAU Panel A – Payroll-Related Misstatements................................................................................80 Panel B – Benefit Plan Complexity .........................................................................................81 6. Association between Debt- Related Misstatements and SameAU Panel A – Debt-Related Misstatements ...................................................................................82 Panel B – Benefit Plan Complexity .........................................................................................83 7. Characteristics of Benefit Plan Audit Quality .........................................................................84 8. Characteristics of Benefit Plan Quality....................................................................................85 9. Characteristics of Switching Benefit Plan Auditors Panel A – Descriptive Statistics, SameAU in the Prior Year ...................................................86 Panel B – Descriptive Statistics, DifferentAU in the Prior Year..............................................87 Panel C – Switching Benefit Plan Auditor ..............................................................................88 10. Characteristics of Switching Financial Statement Auditors Panel A – Descriptive Statistics ...............................................................................................89 Panel B – SameAU and Switching ...........................................................................................90 Panel C – Selecting a New Benefit Plan Audit Firm ...............................................................91 LIST OF FIGURES 1. Timeline for Knowledge Spillover from the Benefit Plan Audit to the Financial Statement Audit 2. Timeline for Knowledge Spillover from the Financial Statement Audit to the Benefit Plan Audit 3. Percentage of Companies with SameAU by Audit Firm 4. Percentage of Benefit Plan Audits by Audit Firm I. INTRODUCTION The Sarbanes-Oxley Act of 2002 (SOX) established greater restrictions on the services that financial statement auditors can provide to their clients due to concerns over the potentially detrimental effects of impaired auditor independence (SEC 2007; U.S. House of Representatives 2002). As a result, many audit committees have questioned their company’s use of auxiliary audit services even when allowed by law (Abbott, Parker, and Peters 2011; Gaynor McDaniel, and Neal 2006; Abbott, Parker, Peters, and Raghunandan 2003a). In contrast, many market proponents argue that the provision of services outside the financial statement audit may improve the quality of audits as a result of knowledge spillover (SEC 2001). While the restrictions and debate have focused primarily on “nonaudit” services, financial statement auditors are often used to provide “audit-related” services outside of the financial statement audit.1 Audit-related services provide a setting to examine the characteristics of auditor choice and the potential benefits of auxiliary services provided by the financial statement auditor. In this study, I examine how the provision of benefit plan audit services has changed over time and I examine the characteristics of engaging the financial statement auditor for benefit plan 1 SOX (2002) defines audit as “an examination of the financial statements of any issuer by an independent public accounting firm in accordance with the rules of the Board or the Commission, for the purpose of expressing an opinion on such statements.” The Securities and Exchange Commission (SEC) (2003) defines audit-related services as “assurance and related services that traditionally are performed by the independent accountant.” SOX (2002) defines nonaudit services as “any professional service provided to an issuer by a registered public accounting firm, other than those provided to an issuer in connection with an audit or a review of the financial statements of an issuer.” When examining the potential impact of auxiliary services provided by the financial statement auditor, prior literature often considers audit-related services to be a category of nonaudit services (Paterson and Valencia 2011; Kinney, Palmrose, and Scholz 2004). Regulators consider audit-related services to be a subset of nonaudit services in that audit-related fees are not categorized as audit fees within the company’s required auditor fee disclosures (SEC 2015). The SEC also lists employee benefit plan audits as a type of service that would be included under the category “audit-related fees” (SEC 2014). 1