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Interplay of Research, Standard Setting and Regulation. Panel members: Jean C. Bedard, Bentley University Joe Carcello, University of Tennessee Mike Stein, Old Dominion University and PCAOB Academic Fellow. The Panel’s Focus.

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Interplay of research standard setting and regulation

Interplay of Research, Standard Setting and Regulation

Panel members:

Jean C. Bedard, Bentley University

Joe Carcello, University of Tennessee

Mike Stein, Old Dominion University and PCAOB Academic Fellow

The panel s focus
The Panel’s Focus

  • To illustrate the role of research in setting and evaluating auditing standards and related regulations

    • In the context of a taxonomy of research types

    • To ground our discussion, we focus on specific recent examples

  • We cover auditing standards/regs of the PCAOB, the SEC, and the US Auditing Standards Board

    • Although some references to non-US standards arise

Policy evaluation in social science
Policy Evaluation in Social Science

  • An informal word (or two) about policy evaluation

    • This is a large field of research, based in economics, sociology, military history, health care...

    • In general, a policy is good if it makes society better off

    • The challenges to such assessments are obvious:

      • What does “better off” mean? There are both costs & benefits

      • How do we measure “better off”?

      • Who is “better off”? There are always trade-offs!

      • What are the unintended consequences?

The interplay in auditing
The “Interplay” in Auditing




Impact on Auditors, Preparers, Users


Taxonomy of auditing research related to standards regulations
Taxonomy of Auditing Research Related to Standards/Regulations

  • Research identifies a problem, and standards/regs are subsequently developed to address it

  • A standard/reg is considered or proposed to address a problem, and research assesses its potential impact

  • A standard/reg is promulgated but is nonspecific - research evaluates alternative ways of implementing it

  • A standard/reg is promulgated, research evaluates its impact since implementation

  • A standard/reg is promulgated, research looks back prior to implementation to assess whether it was indicated

Research assesses how nonspecific standards regs could be implemented
Research Assesses How Nonspecific Standards/ Standards/RegulationsRegs Could be Implemented

  • In this situation, a standard is promulgated, but leaves open how audit firms should implement it

    • Research can evaluate options, in the laboratory or in the field

  • Example: SAS 99 says that audit engagement teams must “brainstorm” about fraud, but does not say how. Two recent studies investigate:

    • Hunton & Gold (TAR 2010) manipulate brainstorming methods, finding that “open brainstorming” is inferior

    • Brazel, Carpenter, Jenkins (TAR 2010) field study shows that 91 percent of engagements use open brainstorming

Research looks back prior to implementation of a standard regulation
Research Looks Back Prior to Implementation of a Standard/Regulation

  • Research examines conditions prior to implementation to see whether conditions indicated it was needed, or other effects

  • Examples:

    • SOX limited provision of non-audit services. Kinney, Palmrose, and Scholz (JAR 2004) examine whether NAS affected auditor independence (measured as restatements) – findings fail to support the restrictions

    • SOX limited partner tenure on public engagements to 5 years. Bedard and Johnstone (2010) find higher hours and lower realization rates following partner turnover (2002-2003) – also, billing rates are higher for engagements with partner tenure > 5 years. Eliminating long-tenure partners may put pressure on firms to reduce the investment in learning about new clients.

Research identifies a problem for standard setters
Research Identifies a Problem for Standard-Setters Standard/Regulation

  • Beasley, Carcello, and Hermanson (COSO 1999)

    • COSO-sponsored study on fraudulent financial reporting between 1987-1997

    • Found high incidence of fraud involving revenue recognition – SEC used as support for SAB 101

    • Found weak governance – SEC used as support for not exempting smaller public companies from some of the governance changes recommended by the BRC

  • Carcello and Neal (The Accounting Review 2000, 2003)

    • Examine relations between audit committee characteristics and GC reporting, and between audit committee characteristics and auditor changes after a GC report

Ex ante research on possible or proposed standards regulations
Ex Ante Research on Possible or Proposed Standards/Regulations

  • A problem is identified - policy alternatives to address it can be assessed in advance through analytical modeling, a “natural laboratory”, or an experiment

  • Examples:

    • Carcello and Santore (Working paper, 2011) examine the likely effects on partners, firms, and society of implementing a partner signature requirement using an analytical model

    • Van de Poel and Vanstraelen (AJPT, forthcoming) find poor reporting under a “comply-or-explain” internal control standard in the Netherlands (i.e., low quality of explanations as to why companies are not complying)

    • Zimbelman (JAR 1999) investigates whether a separate and explicit fraud-risk assessment would improve planning judgments (later required by SAS No. 82)

Research evaluates the impact of an implemented standard regulation
Research Standards/Regulations Evaluates the Impact of an Implemented Standard / Regulation

  • A standard or regulation has been implemented and research considers its impact – probably the most frequent category

    • Bedard and Graham (TAR, forthcoming) – find that most Section 404 deficiencies are discovered by auditors, and that company managements tend to classify detected deficiencies as less severe than auditors (implying ineffective management testing)

    • Carcello, Vanstraelen, and Willenborg (TAR 2009) – examine whether a change to a more rule-based regime for GC reporting in Belgium improved auditor reporting

    • Carcello, Hermanson, and Huss (AJPT 1995) – examine whether SAS 59 improved auditor GC reporting prior to bankruptcy