From Observation to Research Success

1. From Observation to Research Success William R. Kinney, Jr. University of Texas at Austin Auditing Section Doctoral Consortium Los Angeles, California January 12, 2006

2. Outline • Overview of process • X, Y, V, and Z - a framework for planning • The scholarly researcher’s problem • Threats to research validity • Other barriers and special problems

3. 1. Process overview Suppose that you have an observation (bad “facts” or peculiar “facts” or claims) • What barriers must be overcome? (data/ estimation/ causal theories; research design; exposition) • Who will want to read the paper? • What is your comparative advantage?

4. 1. Process overview Suppose that you have an observation (bad “facts” or peculiar “facts” or claims) • What barriers must be overcome? (data/ estimation/ causal theories; research design; exposition) • Who will want to read the paper? • What is your comparative advantage? Hint: “One gets the biggest potatoes on the first pass through the field” (Irish agricultural economics principle per Frank O’Connor, University of Iowa)

5. The Sarbanes-Oxley Act . . . • Result of 25 year economic, technological, social, and professional/regulatory changes • Challenges • Relevance of GAAP • Reliability of auditing standards • Trustworthiness of auditors, independent directors, standards setters, financial intermediaries and employ-ment contracts that bind them • Mandates a new (3rd) role for accounting . . . this is a big new potato -- new states, new actions need new theories to explain/understand

6. 2. A Framework Y = f ( X, Vs, Zs ) Y = phenomenon to be explained X = your (new) theory about a cause of Y Vs = prior causes of Y Zs = contemporaneous causes of Y

7. X0 ? Y1 {V-3, V -2, V -1 } Z0 How does X (treatment) get there? Experiments vs. Archival studies Random assignment or independent of V vs. Self selection or V(s) determine X

8. 3. Scholarly Researcher’s Problem:  = risk that data incorrectly “accepts” new theory  = risk that data incorrectly “rejects” new theory  = true size of X effect on Y  = residual variation given research design (i.e., after effects of Vs and Zs) n = available sample size All five are related through a single, simple formula

9. 2 ) ( (Za + Zb).s d n = The Sample Size formula:

10.  = f ( n ) - - + - Researcher’s Problem (continued) is fixed at .05 or .10 by journal editors is the researcher’s risk of failing (you want to minimize) * *  = f ( X : Y relation)  = f ( Vs, Zs) nis semi-fixed by data availability or cost

11. _ Y| H0, n, s _ Y| HA, n, s b a d Accept H0 Reject H0 Graphically . . . (small d, small sb okay) Y 0

12. _ Y| HA, n, s b a d Accept H0 Reject H0 Graphically . . . (large d, large sb okay) _ Y| H0, n, s Y 0

13. _ Y| HA, n, s b b a 0 d Accept H0 Reject H0 Graphically . . . (small d, large sbyikes!) _ Y| H0, n, s Y

14. Independent Dependent 1 Theoretical Y (Y) Theoretical X (X ) Conceptual 2 3 5 Operational X Operational Y Operational 4 Other potentially influential variables Vs and Zs Control 4. Analyze Threats to Validity using Predictive Validity (Libby) Boxes

15. It is believable thatXcausesYif: • X and Y are correlated • Vs and Zs ruled out by design, including • Y causes X • X and Y caused by an omitted V or Z • Reason to believe that operational X and Y measure X and Y • Reason to believe that X : Y relation generalizes to other persons, times, and settings.

16. Validity threats linked to Libby boxes (and Vs and Zs) • Statistical Conclusion Validity (5) • Internal Validity (4) • Construct Validity (2 and 3) • External Validity ( 1 generalizes to ??)

17. Auditor independence and non-audit services: Was the U.S. government right? (Kinney, Palmrose, Scholz, JAR 2004) Does an audit firm’s dependence on fees for FISDI, internal audit, and certain other services to an audit client reduce financial reporting quality? The answer is important because a) the Sarbanes-Oxley Act presumes so, banning such services to audit clients, and b) some registrants now voluntarily restrict tax and other legally permitted services. Using fee data from 1995-2000 for restating and similar non-restating registrants, we find no consistent association between fees for FISDI or internal audit services with restatements, but find significant positive association between unspecified services fees and restatements and significant negative association between tax services and restatements.

18. 2 3 Non-audit fees Restatement 5 4 Industry, size, audit policies, acquisitions, etc. Libby boxes for KPS Independent Dependent 1 Lower quality financial reporting Auditor dependence on client Conceptual Operational Control

19. 5. Other barriers and problems Hint one: Your main contribution is: 1. New data 2. New estimation 3. New theory (or new problem) Whatever it is, Exploit it!

20. Hint Two: Broaden your contribution (and reader interest) by: 1. Making your theory elaborate 2. Using multi-methods and multi-measures 3. Generalizing your approach across contexts, disciplines, cultures, and time

21. Hint Three: In introducing your paper, tell the reader: 1. What problem or issue will be addressed 2. Why the problem or issue is important 3. How you will address the problem or issue (and what you found)

22. Order of importance of clear and compelling exposition Title Abstract Introduction Conclusions . . . rest of text

23. Research using Analysis • Need models for: • value of process vs. state reliability • role of subjective “fair presentation” • reporting and auditing “second moments” • economics of auditing as a regulated activity • auditing in context of corporate governance • rules-based vs. risk-based auditing standards • Barrier: extra parties and institutions hard to model

24. Research using Experiments • Questions: • How reliable is auditing of fair values? • Does SAB No. 99 work (Nelson et al. 2003)? • Will IAASB ED on accounting estimates work? • Does SAS No. 99 work? • Does ERM (COSO II) improve COSO? • Barrier: How to convince regulated audit firms that your experiments are valuable to them – what’s in it for them now?

25. Research using Archival data • What are the effects of • fee disclosures on profits and performance? • PCAOB as standards setter and regulator (similar to evaluating the FASB and SEC)? • SOX on innovation in auditing and standardized business measurement? • SOX provisions on attracting new CPAs? • Barrier - How to work with PCAOB and regulated audit firms as independent researchers – why should they help you?

26. Remember . . . • Planfor research success • write the threeparagraphs before you do the work • minimize bex ante • maximize validityex ante • Make your unique contribution apparent to all • Your present model of the world is simplified – be alert to revision via new problems, theories, data, andmethods(read, take courses, attend seminars in potentially related areas for new theories, monitor data sources, scan for useful research tools)

27. References • Cook, and D. Campbell, Quasi-experimentation design & analysis issues for field settings. Houghton Mifflin Co. (New York) 1971 (Validity types). • Kinney, W., "Empirical Accounting Research Design for Ph.D. Students," The Accounting Review, April 1986 (3 paragraphs and integration). • Libby, R., Accounting and human information processing: Theory and applications. Prentice-Hall, Inc., (Englewood Cliffs) 1981 (Boxes). • Runkel, P., and J. McGrath, Research on human behavior – A systematic guide to method. Holt, Rinehart, and Winston, Inc., (New York) 1972 (Boxes). • Simon, J., and P. Burstein, Basic Research Methods in Social Science (3rd ed.). Random House, (New York) 1985 (Chapter 3 – X, Y, Vs, Zs).