SUMMARY
As a result of legal and regulatory requirements, audit firms in certain jurisdictions have recently started issuing transparency reports containing information on audit firm governance. In this study we investigate whether audit firm governance disclosure is associated with actual audit quality. Based on a sample of transparency reports of 103 audit firms in a number of EU countries, we find that there is variation in the extent and type of governance disclosures across audit firms. We, however, do not find an association with actual audit quality, apart from a weak association with an audit firm’s statement on the effectiveness of its internal quality control system.
INTRODUCTION
Audit quality research has a long history (e.g., Francis 2011). This is not surprising as audit quality is the raison d’etre ˆ of the audit market: the audit has no value without public trust in the quality of the audit (e.g., Maijoor and Vanstraelen 2012). Similarly, audit quality is an important area of concern for regulators because credible financial reporting is considered to be essential for the well functioning of the capital market (e.g., Bolkestein 2003). In the aftermath of the high-profile corporate failures at the beginning of the twenty-first century and the recent financial crisis, we observe that regulators perceive increased pressure for more intervention (e.g., FRC 2006; EC 2010; PCAOB 2011).
CONCLUSION
Since the governance of audit firms is considered to have a significant influence on audit quality, regulators expect that more transparency on audit firm governance may provide insight in firms’ audit quality, and as a result may provide incentives for audit firms to compete more directly on audit quality. We examine audit firm governance disclosures contained in transparency reports of 103 audit firms in four EU countries (Austria, Germany, The Netherlands, and the U.K.) to investigate whether transparency report disclosures enable audit quality differentiation among audit firms. To this end, we examine whether there is variation in the extent and type of disclosures in audit firm transparency reports, and whether these are associated with the underlying audit quality delivered by the audit firm.
We develop a transparency report disclosure score based on the items required by Article 40 of the Eighth EU Directive and recommendations by national oversight bodies, expert opinions, international standards, and our own review of transparency reports. In our analyses, we focus on those policies and procedures that are most likely to be informative about audit quality.
