Does Audit Committee Disclosure of Partner-Selection Involvement Signal Greater Audit Quality?

Abstract

We investigate whether audit committees use voluntary disclosures to signal the committees’ higher level of involvement in the audit partner-selection process, which contributes to higher levels of audit quality. Audit committees more involved in the partner-selection process should ensure the selection of a more rigorous partner. We test this conjecture by first identifying partners new to audit engagements. We then compare audit quality for companies whose audit committees disclose involvement in the selection of the new partner to those without this disclosure. We find that this disclosure is positively associated with audit quality (measured using discretionary accruals, misstatements, and meeting consensus analyst forecasts by a very small margin). Our results are more salient for complex companies and those with powerful audit committees. These findings highlight that audit committees use their disclosures to signal involvement in the partner-selection process and are relevant to the Securities and Exchange Commission.

Audit committee voluntary disclosure describing external auditor oversight: Does it reflect higher audit quality?

“…The second regression's dependent variable is Fees dependency (a proxy for audit quality) as it measures the economic bonding between the auditor and the bank. We select these two dependent variables because when audit committee members are involved in selecting the lead audit partner, they make sure that the partner provides a high audit quality (Downes et al., 2021). Also, in their discussion of selecting the lead audit partner, the audit committee members will ensure that the economic bonding is maintained at low levels so that the auditor independence is not jeopardized.…”

“…Downes et al. (2021) analyze whether voluntary disclosures in the audit committee report signal more involvement by the audit committee in the audit process. Their findings demonstrate that voluntary disclosure is used as a signal of higher audit committee involvement that leads to higher audit quality.…”

“…In an efficient director labor market, effective directors are expected to perform an appropriate and timely monitoring; thus, issues should be identified and remedied before growing to a scandal. One way to signal a strong audit process oversight is to provide voluntary disclosure in the audit committee report (Downes et al., 2021). The audit committee report content is the official communication tool between audit committee members and shareholders.…”

“…Whenever a restatement is issued for a prior period, it is a clear indication that a material weakness in internal control existed at the time (Feng et al., 2021). Stakeholders view restatements as an audit committee failure in its role of overseeing the financial reporting process (Downes et al., 2021) and as an output measure to proxy audit quality (Carcello et al., 2011; Cohen et al., 2014).…”

“…Prior studies on this voluntary disclosure have mixed results. Some studies describe voluntary disclosure as real activities undertaken by audit committees to improve the financial reporting quality (Al‐Shaer & Zaman, 2021; Downes et al., 2021; Reidenbach, 2013; Ye, 2018), while others suggest that those disclosures are mainly impression management or tools to reinforce legitimacy (Al‐Shaer et al., 2021; Draeger et al., 2021; Sahyoun & Magnan, 2020). In this study, we analyze whether the activities described in the voluntary disclosures are real steps taken by audit committees to monitor the external audit process that lead to higher audit quality or are used for impression management and legitimacy reinforcement.…”