1. Audit Partner Disclosure: Potential Implications for Investor Reaction and Auditor Independence Tamara A. Lambert Benjamin L. Luippold Chad M. Stefaniak Conference on Regulation and the Audit Industry

2. Outline Tamara PCAOB – Audit partner disclosure – Proponents / opponents Where disclosure occurs Research question Model of audit independence – Three propositions Ben Hypotheses Method – Participants – Procedures – Design – Variables Results – Investment choice Allocation – Mediation analysis – Experience Conclusion 2

3. PCAOB: Audit Partner Disclosure 3

4. ProponentsOpponents No increased accountability Increased legal liability Ill-informed audit quality inferences Independence conflicts Increased accountability Increased transparency Improved audit quality 4

5. Where Partner Disclosure Occurs 5

6. Will disclosing the identity of the audit partner in the audit report lead to improved audit quality / investor protection? Research Question

7. Model: Audit partner disclosure may lead to independence impairment Three propositions Audit Partner Identity Disclosure Potential Audit Partner Independence Impairment 7

8. Model: Proposition 1 No well-calibrated measures available (Francis 2004) Accounting information transfer (Gleason et al. 2008) Representativeness heuristic (Kahneman 2011) Audit Partner Identity Disclosure Fusing of Partner Reputation with Client 8

9. Model: Proposition 2 Ill-informed partner-related inferences may lead to – Increased focus on individual reputation – Client attraction / retention concerns Audit / earnings quality proxies used by academics Audit Partner Identity Disclosure Fusing of Partner Reputation with Client Audit Partner Incentive Shift 9

10. Model: Proposition 3 Auditors role to reduce information risk – Conflicting investor / management incentives Increased prominence of individual reputation – Implicit permission for individuals to act in their own interests (Hunton et al. 2011) Audit Partner Identity Disclosure Fusing of Partner Reputation with Client Audit Partner Incentive Shift Potential Audit Partner Independence Impairment 10

11. Hypothesis 1 Information transfer as a proxy for reputation fusing Negative information is contagious – Firms within an industry (Gleason et al. 2008) – Firms audited by Arthur Andersen (Huang and Li 2009) – Firms that share a common director (Chen and Goh 2010) Representativeness may play a role (Kahneman 2011) 11

12. Audit partner identity disclosure will result in partner-based (reputational) information transfer between reporting entities. Hypothesis 1

13. Hypothesis 2 Would partner disclosure require other changes to audit report? (PCAOB 2009) – Partner signing firm’s name is evidence that audit report is product of the firm (PCAOB 2008, 2009) – Partner disclosure could confuse investors about what audit opinion means Less knowledge = more reliance on representativeness (Gigerenzer and Goldstein 1996) 13

14. Modifying the audit report with language intended to highlight the audit firm’s responsibility for the audit will reduce the amount of partner-based (reputational) information transfer resulting from audit partner identity disclosure. Hypothesis 2

15. Method: Participants 380 participants Investment clubs and Qualtrics ≈ 48 years old All have investing experience ≈ 4 years experience w/ fin. info. 15

16. Method: Procedure Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Current Ratio 2.352.252.372.382.23 Days Sales of Inventory 2832272539 Return on Assets 12.39.812.612.98.1 Profit Margin 14.511.414.714.88.3 Market Share 8.416.748.58.75.53 Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Current Ratio 2.352.252.372.382.23 Days Sales of Inventory 2832272539 Return on Assets 12.39.812.612.98.1 Profit Margin 14.511.414.714.88.3 Market Share 8.416.748.58.75.53 16

17. Method: Procedure Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Current Ratio 2.352.252.372.382.23 → 1.97 Days Sales of Inventory 2832272539 → 65 Return on Assets 12.39.812.612.98.1 → 4.8 Profit Margin 14.511.414.714.88.3 → 5.0 Market Share 8.416.748.58.75.53 → 5.22 Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Current Ratio 2.352.252.372.382.23 → 1.97 Days Sales of Inventory 2832272539 → 65 Return on Assets 12.39.812.612.98.1 → 4.8 Profit Margin 14.511.414.714.88.3 → 5.0 Market Share 8.416.748.58.75.53 → 5.22 17

18. Method: Procedure Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Audit Partner David Lastings David Lastings James Keaton Thomas Edwards Current Ratio 2.352.252.372.382.23 → 1.97 Days Sales of Inventory 2832272539 → 65 Return on Assets 12.39.812.612.98.1 → 4.8 Profit Margin 14.511.414.714.88.3 → 5.0 Market Share 8.416.748.58.75.53 → 5.22 Company Amer. Comp. Comp. World Elec. USA US Tech. Wired States Big 4 FirmFirm ABC Firm DEF Audit Partner David Lastings David Lastings James Keaton Thomas Edwards Current Ratio 2.352.252.372.382.23 → 1.97 Days Sales of Inventory 2832272539 → 65 Return on Assets 12.39.812.612.98.1 → 4.8 Profit Margin 14.511.414.714.88.3 → 5.0 Market Share 8.416.748.58.75.53 → 5.22 18

19. Audit Opinion Note. Each audit firm stresses in its audit reports that while the audit opinion is signed by both the audit partner and the audit firm, the audit opinion represents that of the entire firm. Additionally, each firm notes that the audit involves many firm employees and includes technical guidance and other resources from its national headquarters. Method: Procedure 19

20. Method: Experimental Design Firm Name Firm and Partner Name Firm Name and Modification Firm Name, Partner Name, and Modification 20

21. Method: Variables Main Variables Investment choice Investment allocation Restatement likelihood Supplemental Variables Financial information importance Fault (company, firm, partner) Influence of restatement Familiarity w/ financial information & auditing Attention checks Investment experience Experience w/ financial information Job title / employer Gender Age 21

22. Results: Investment Choice Firm NamePartner Name Report Modification American Computers10.1%9.0%14.1% Computer World3.4%4.5%3.9% Electronics USA14.3%17.3%18.8% US Technologies67.2%58.6%57.8% Wired States5.1%10.5%5.5% (n=119)(n=133)(n=128) Firm NamePartner Name Report Modification American Computers10.1%9.0%14.1% Computer World3.4%4.5%3.9% Electronics USA14.3%17.3%18.8% US Technologies67.2%58.6%57.8% Wired States5.1%10.5%5.5% (n=119)(n=133)(n=128) 22

23. Results: Investment in US Tech. 23

24. Results: Investment in US Tech. VariableExpected Sign Coefficient (S.E.) Intercept+ 0.916 (0.519) PARTNER- -0.561 (0.310) REPORT_MOD+ -0.200 (0.287) QUAL? -1.020 (0.473) ATTEND_PARTNER? 0.675 (0.277) ATTEND_REPORT_MOD? 1.051 (0.519) VariableExpected Sign Coefficient (S.E.) Intercept+ 0.916 (0.519) PARTNER- -0.561 (0.310) REPORT_MOD+ -0.200 (0.287) QUAL? -1.020 (0.473) ATTEND_PARTNER? 0.675 (0.277) ATTEND_REPORT_MOD? 1.051 (0.519) 24

25. Results: Allocation in US Tech. VariableExpected Sign Coefficient (S.E.) Intercept+ 33.165 (4.367) PARTNER- -5.543 (2.912) REPORT_MOD+ 1.683 (2.831) QUAL? -3.902 (3.714) ATTEND_PARTNER? 5.224 (2.724) ATTEND_REPORT_MOD? 9.895 (2.389) VariableExpected Sign Coefficient (S.E.) Intercept+ 33.165 (4.367) PARTNER- -5.543 (2.912) REPORT_MOD+ 1.683 (2.831) QUAL? -3.902 (3.714) ATTEND_PARTNER? 5.224 (2.724) ATTEND_REPORT_MOD? 9.895 (2.389) 25

26. Results: Mediation Analysis PARTNER RESTATE_UST INVEST_UST b = 0.611 (p = 0.057) b = -0.113 (p = 0.022) b = -0.559 (p = 0.041) b = -0.509 (p = 0.059) b = -0.559 (p = 0.041) 26

27. Results: Invest. in US Tech. by Exp. Less Experienced InvestorsMore Experienced Investors 27

28. Results: Invest. in US Tech. by Exp. Less Experienced Investors VariableExpected Sign Coefficient (S.E.) Intercept+ 1.589 (0.871) PARTNER- -0.890 (0.481) REPORT_MOD+ 0.273 (0.435) QUAL? -1.401 (0.793) ATTEND_PART NER ? 0.891 (0.404) ATTEND_REP ORT_MOD ? 0.646 (0.871) More Experienced Investors VariableExpected Sign Coefficient (S.E.) Intercept+ 0.533 (0.716) PARTNER- -0.380 (0.540) REPORT_MOD+ -0.930 (0.500) QUAL? -0.474 (0.635) ATTEND_PART NER ? 0.542 (0.502) ATTEND_REPO RT_MOD ? 1.602 (0.431) VariableExpected Sign Coefficient (S.E.) Intercept+ 1.589 (0.871) PARTNER- -0.890 (0.481) REPORT_MOD+ 0.273 (0.435) QUAL? -1.401 (0.793) ATTEND_PART NER ? 0.891 (0.404) ATTEND_REP ORT_MOD ? 0.646 (0.871) VariableExpected Sign Coefficient (S.E.) Intercept+ 0.533 (0.716) PARTNER- -0.380 (0.540) REPORT_MOD+ -0.930 (0.500) QUAL? -0.474 (0.635) ATTEND_PART NER ? 0.542 (0.502) ATTEND_REPO RT_MOD ? 1.602 (0.431) 28

29. Conclusions Model – Partner disclosure will fuse reputation with client – Fusing will shift audit partner incentives – Shift of incentives may impair independence Experiment – Partner disclosure results in information transfer – Contagion not mitigated by our report modification 29

30. Thank you Tamara A. Lambert Benjamin L. Luippold Chad M. Stefaniak Conference on Regulation and the Audit Industry