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DIVERSIFICATION BY THE AUDIT OFFICE AND ITS IMPACT ON AUDIT QUALITY

Sharad Asthana Professor, Department of Accounting College of Business University of Texas at San Antonio One UTSA Circle San Antonio, TX, USA 78249 Phone: (210) 458-5232 E-mail: sharad.asthana@utsa.edu September 28, 2012.

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DIVERSIFICATION BY THE AUDIT OFFICE AND ITS IMPACT ON AUDIT QUALITY

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  1. Sharad Asthana Professor, Department of Accounting College of Business University of Texas at San Antonio One UTSA Circle San Antonio, TX, USA 78249 Phone: (210) 458-5232 E-mail: sharad.asthana@utsa.edu September 28, 2012 DIVERSIFICATION BY THE AUDIT OFFICE AND ITS IMPACT ON AUDIT QUALITY

  2. 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 HISTORY OF THE PAPER…. DISTANCE

  3. RESEARCH QUESTION

  4. 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: AUDITING LITERATURE

  5. 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 BACKGROUND: DIVERSIFICATION LITERATURE

  6. 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

  7. UNRELATED DIVERSIFICATION (WIDE FOCUS) • Sacrifice “Depth” for “Width” • Spread available resources too “thin” across diverse engagements. • Results in Reduced Output (Quality/Quantity) • Palepu (1985) TWO TYPES OF DIVERSIFICATION

  8. TO SUM UP .........

  9. UNRELATED DIVERSIFICATION (WIDE FOCUS) • INDUSTRY DIVERSIFICATION • CLIENT DIVERSIFICATION • GEOGRAPHIC DIVERSIFICATION RELATED DIVERSIFICATION (NARROW FOCUS) • SERVICE DIVERSIFICATION PROXIES FOR DIVERSIFICATION

  10. AUDIT FEES • Francis et al. (2005) • Choi et al. (2008 & 2010) • DISCRETIONARY ACCRUALS • MEET OR BEAT EARNINGS EXPECTATIONS • Francis and Yu (2009) • Reichelt and Wang (2010) • Choi et al. (2012) PROXIES FOR AUDIT QUALITY

  11. Industry diversification, client diversification, and geographic diversification have adverse effects on audit quality. • Service diversification has beneficial effect on audit quality. MAIN FINDINGS…

  12. 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. HYPOTHESES…

  13. RESEARCH DESIGN…

  14. RESEARCH DESIGN…

  15. SUMMARY OF RESULTS

  16. 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. CONCLUSIONS…

  17. 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. CONTRIBUTIONS…

  18. If we knew what it was we were doing, it would not be called research, would it? ~Albert Einstein

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