butcher et al - 2012 - perceptions of audit service quality and auditor retention

Perceptions of Audit Service Quality and Auditor Retention ija_457 1 22 Kym Butcher, 1 Graeme Harrison 2 and Philip Ross 1 1 University of Western Sydney, Australia 2 Macquarie University, Australia Prior research has argued that perceptions of the breadth and quality of auditor-sourced services relative to rival audit firms are of paramount importance to client management when making auditor retention decisions. However, the audit quality factors affecting auditor retention are under-researched. This study examines the association between perceptions of audit service quality and auditor retention in the compulsory audit tendering context of local government in the Australian state of New South Wales. This context overcomes constraints of unlimited tenure and high costs of changing auditors in prior studies of auditor retention in voluntary tendering contexts, and has high retention rates at tender and evidence of council satisfaction with audit quality. We use a questionnaire survey of 48 audit service quality attributes drawn from the audit service quality literature and administered to finance professionals and internal auditors across all New South Wales local councils. We hypothesize a positive association between perceived audit service quality and auditor retention due to council satisfaction with audit quality. We generate factor scores to test the hypothesis in a logistic regression and find evidence that higher-order audit quality factors of relationship (via the expertise dimension) and service qualities (via the responsiveness to client needs dimension) are associated with auditor retention, and are worthy of attention by audit firms in order to enhance client commitment and their likelihood of being retained as an incumbent auditor. Key words: Audit service quality, auditor retention, compulsory audit tendering, local government audit, relationship commitment in professional services SUMMARY Prior research has argued that perceptions of the breadth and quality of auditor-sourced services relative to rival audit firms are of paramount importance to client management when making auditor retention decisions. However, the audit quality factors affecting auditor retention are under-researched. This study examines the association between perceptions of audit service quality and auditor retention in the compulsory audit tendering context of local government in the Australian state of New South Wales. This context overcomes Correspondence to: Kym Butcher, School of Accounting, University of Western Sydney, Sydney, Australia. Email: k.butcher@uws.edu.au International Journal of Auditing doi:10.1111/j.1099-1123.2012.00457.x Int. J. Audit. ••: ••–•• (2012) ISSN 1090-6738 © 2012 Blackwell Publishing Ltd constraints of unlimited tenure and high costs of changing auditors in prior studies of auditor retention in voluntary tendering contexts, and has both high retention rates at tender and evidence of council satisfaction with audit quality. We use a questionnaire survey of 48 audit service quality attributes drawn from the audit service quality literature and administered to finance professionals and internal auditors across all New South Wales local councils. We draw on the marketing model used by Ismail et al. (2006) to hypothesize a positive association between perceived audit service quality and auditor retention due to council satisfaction with audit quality. We use the audit service quality taxonomy of Duff (2009) in confirmatory factor analysis, as well as an exploratory factor analysis of the 48 attributes, to generate factor scores to test the hypothesis in logistic regression where the dependent variable is auditor retention, measured as a dichotomous decision, intention to retain or rotate the incumbent auditor. We use the taxonomies of Carcello, Hermanson and McGrath (1992) and Schroeder, Solomon and Vickery (1986) in sensitivity analysis. The study provides consistent evidence that two of Duff’s (2009) four higher-order audit quality factors, specifically, relationship (via the expertise dimension) and service qualities (via the responsiveness to client needs dimension), are of paramount importance to clients when making auditor retention decisions and, thus, worthy of attention by audit firms in order to enhance client commitment and their likelihood of being retained as an incumbent auditor. 1. INTRODUCTION Perceptions of the breadth and quality of auditor-sourced services relative to rival audit firms are of paramount importance to client management when making auditor retention decisions (Hackenbrack & Hogan, 2005: 7). Duff (2009: 401) argues that current issues of ‘the globalization of business, commercialization of practice and stakeholder dissatisfaction with the level of audit quality are focusing auditors’ minds on improving the quality of service they offer to their clients’. Morton and Scott (2007: 18) argue that clients’ perceptions of service quality are associated with intentions or decisions to continue to purchase services from the same provider. Consequently, to improve their likelihood of being retained, audit firms need to be concerned with both the quality of services offered and clients’ perceptions of the quality of those services (Guy, Harris & Williams, 1979: 17). There is a considerable body of research on perceptions of audit quality attributes (e.g., Schroeder et al., 1986; Carcello et al., 1992; Aldhizer, Miller & Moraglio, 1995; Davis, 1995; Behn et al., 1997; Chen, Shome & Su, 2001; Kilgore, 2010). There have also been many studies that have examined client perceptions of audit quality attributes associated with auditor rotation and change (e.g., Healy & Lys, 1986; Williams, 1988; Haskins & Williams, 1990; Johnson & Lys, 1990; Woo & Koh, 2001), and auditor selection and appointment (e.g., George & Solomon, 1980; Addams & Davis, 1994; Abbott & Parker, 2000; Velury, Reisch & O’Reilly, 2003; Godfrey & Hamilton, 2005). The consensus of this literature is that dissatisfaction with the quality of the incumbent auditor is the main reason for auditor displacement (e.g., Burton & Roberts, 1967; Bedingfield & Loeb, 1974; Williams, 1988; Beattie & Fearnley, 1995; Behn et al., 1997). The corollary to this finding is that if clients are satisfied with, or have a favourable perception of, certain audit quality attributes of their incumbent auditor, they will remain with the incumbent (Pandit, 1999). However, there is little empirical research directly examining the audit quality attributes associated with auditor retention decisions. Apart from a small number of practitioner studies (e.g., Stanny, Anderson & Nowak, 2000; Rummel, Davidson & Action, 1999; Gabhart & Miller, 1984), only Pandit (1999) and Morton and Scott (2007) have examined directly the association between client perceptions of audit service quality attributes and auditor retention. Pandit (1999) examined the association between five dimensions of audit quality (the audit firm’s responsiveness to client needs; industry expertise of the audit firm; the audit firm’s executive involvement in the audit; conduct of the audit fieldwork; and quality of the audit staff) and client intentions to remain loyal to, and retain, their incumbent auditor. The five dimensions were selected from the 12 factors identified by Carcello et al. (1992) from their list of 41 attributes affecting perceptions of audit quality. Pandit (1999) found that two of the five dimensions (the audit firm’s executive involvement and responsiveness to client needs) were associated with the intention to retain an incumbent auditor. Although hypothesized, no association was found between the industry 2 K. Butcher et al. Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd expertise of the audit firm or the conduct of the audit fieldwork and intention to retain the incumbent auditor. The result for industry expertise was acknowledged as contrary to prior research (e.g., Shockley & Holt, 1983; Beattie & Fearnley, 1995). It was not possible to test the hypothesis for the quality of the audit staff because of low factor loadings for this dimension. Morton and Scott (2007) developed a 28-item measure of audit service quality based on the behavioural audit survey literature, exploratory research and the SERVQUAL scale of Parasuraman, Zeithaml and Berry (1985). Using a sample of 136 chief financial officers of Australian companies, Morton and Scott (2007) found only a weak association between perceived audit service quality and retention of the auditor. They argued that this result might be because there was no legislative limit on auditor tenure and because the cost of changing auditor is high. The purpose of our study is to examine the association between perceptions of audit service quality attributes and auditor retention in a context that comprises a high auditor retention rate and client satisfaction with audit service quality, and that also overcomes the limitations of Pandit (1999) and Morton and Scott (2007). The context is that of compulsory audit tendering (CAT) in New South Wales (NSW) local government. In this context, legislation, specifically the NSW Local Government Act 1993, mandates tenders for audit services be called by local councils every six years irrespective of whether the council is satisfied or dissatisfied with its incumbent auditor, or wants or intends to change auditors (NSW Government, 1993, Sec. 423; Butcher et al., 2011). The typical outcome of audit tendering is auditor rotation (Butterworth & Houghton, 1995), with the voluntary audit tendering studies of Beattie and Fearnley (1998a, 1998b) and Johnson (1993) reporting rotation rates of 82 per cent and 73 per cent, respectively. However, a high rate of auditor retention exists in the CAT context of NSW local government with empirical research providing evidence that despite the (compulsory) opportunity to rotate, an increasing number of NSW local councils have chosen to retain their audit firm, with the auditor retention rate increasing from 59 per cent at the time of the first compulsory tender in 1995 to 86 per cent following the third (in 2007) (Butcher et al., 2011). Further, Boon, McKinnon and Ross (2008) found that NSW local councils reported high levels of satisfaction with their audit service quality. Additionally, the CAT context does not suffer the constraints of no legislative limit on auditor tenure and the high cost of changing auditor that Morton and Scott (2007) argued might have confounded their results and caused the weak association they found between audit service quality and auditor retention. First, CAT legislates a limit on auditor tenure of six years. Second, as councils have to call tenders every six years, the costs of tendering and auditor bid evaluation and selection have to be incurred irrespective of whether the council reappoints its incumbent auditor or appoints a new auditor. Our study also overcomes limitations of Pandit (1999). As noted above, Pandit (1999) drew on the 12 audit service quality factors of Carcello et al. (1992), but selected only five for study. One of the five (quality of the audit staff) could not be tested because of low factor loadings and another (industry expertise) produced results contrary to prediction and prior research. We use the complete list of attributes and factors from Carcello et al. (1992). This allows a comprehensive examination of the association between audit service quality and auditor retention. In summary, given the CAT context in NSW local government of high auditor retention rates and council satisfaction with audit quality, we use this context to examine the association between audit service quality and auditor retention. We use a questionnaire survey of 48 audit service quality attributes drawn from the literature and administered to finance professionals and internal auditors across all NSW local councils. We formulate a hypothesis based on theory drawn from the marketing model used by Ismail et al. (2006) and on Duff’s (2009) AUDITQUAL measure of audit quality. We find that audit firm expertise and responsiveness to client needs are associated with auditor retention and are, therefore, important attributes for audit firms to focus on to enhance the likelihood of being retained as the incumbent auditor. The paper is organized as follows. Section 2 provides background information on the CAT context of NSW local government. Section 3 draws on the audit service quality and marketing literatures to formulate a hypothesis about the association between audit quality attributes and auditor retention. Sub-hypotheses are formulated based on Duff’s (2009) AUDITQUAL model of audit quality. Section 4 discusses the method, including variable identification, survey design and administration, sample selection, method of Perceptions of Audit Service Quality and Auditor Retention 3 Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd analysis and specification of the model to test the hypothesis. Section 5 presents the results of testing the hypothesis using AUDITQUAL. Section 6 presents the results of sensitivity analysis using Carcello et al.’s (1992) audit quality attribute categories as adapted by Behn et al. (1997), and Schroeder et al.’s (1986) audit team and audit firm attribute categories. Section 7 presents the conclusions, limitations and suggestions for future research. 2. BACKGROUND This section provides demographic and descriptive information on NSW local government, and discusses the context of, and legislative requirements for, local government auditing in NSW. New South Wales (NSW) is the most populous of the eight states and territories in Australia, having approximately one-third (7.24 million) of the Australian population of 22.5 million. Although the area of NSW is 800,000 km 2 , the population density is just 8.44 per km 2 , with 63 per cent of the population living in the state capital, Sydney, and an urbanization rate of almost 80 per cent (Wikipedia, 2011). There are 152 local councils in NSW. Local councils are the third tier of government in Australia, the first and second being the federal and state/territory governments, respectively. Councils are subject to state government legislation; in the case of NSW by the NSW Local Government Act 1993 administered by the Division of Local Government, Department of Premier and Cabinet. Because of the demographics of the state, local council populations and areas differ greatly with an inverse ratio of population to area between metropolitan (particularly Sydney) and rural councils. The council with the highest resident population of 300,000 (Blacktown City Council within the Sydney metropolitan area) covers an area of just 240 km 2 (a population density of 1,250 per km 2 ), while the rural council of Urana has a population of just 1,300 but an area of 3,357 km 2 (a population density of 0.38 per km 2 ). The mean populations are 47,000 for all councils, 106,700 for Sydney councils and 27,500 for non-Sydney councils, Revenues correlate positively with population and population density, with a minimum of $5.9 million per annum (Urana), a maximum of $457.8 million (Sydney City) and a mean (median) of $61.6 million ($38 million) (NSW Government, 2011). Local councils are funded by their residential and commercial constituents (the community) through rates, user charges and fees (amounting to about two-thirds of income from all sources), and by the state government through general and specific purpose grants (amounting to about 17 per cent of total income) (NSW Government, 2011). The community and government delegate decision-making authority and responsibility to council managers and directors (councillors) for service provision within their areas and constituencies, typically road and infrastructure maintenance, community facilities (recreational, parks, libraries), town planning and development applications, and waste collection. The Local Government Act 1993 provides a number of mechanisms to monitor the accountability of councils to their government and community stakeholders. A major accountability mechanism is the annual report and the associated auditor’s report. Section 428 of the Local Government Act requires councils to prepare annual reports which include audited financial statements. The Act requires that the council’s annual report and audit report be submitted to the Minister for Local Government and the Executive of the Division of Local Government. Councils are also required to present their audited financial statements at a public council meeting no later than five weeks after receipt of the audit report. The legislative requirements for local council auditing in NSW changed significantly in 1993 with the introduction of CAT under the NSW Local Government Act of 1993, Section 422, and following the recommendations of the 1991 Report on the Audit of Local Government conducted by the Public Accounts Committee (Parliament of NSW, 1991). The Act (Section 424) described CAT as the process whereby an open tender for audit services is sought from qualified auditors every six years, with the incumbent auditor eligible to reapply. CAT was introduced to increase local government accountability, and to increase the competitiveness of the local government audit market in order that councils could obtain the best possible audit services in terms of costs and quality (NSW Government, 1992: 8, 36). Prior to 1993, only auditors holding a Local Government Auditing Certificate were eligible to audit local councils. In his submission to the 1991 Public Accounts Committee, the NSW Auditor-General described 4 K. Butcher et al. Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd the existing process of auditor appointment as being ‘far too narrow and restrictive’. In essence, it has created a ‘closed shop’ environment. Only auditors holding a Local Government Auditing Certificate are eligible for appointment and once appointed it is very difficult to remove them, even where a Council is dissatisfied with the service provided (Parliament of NSW, 1991: 68). CAT in the context of NSW local council audit operationalizes the six criteria argued by the US General Accounting Office (GAO) (1987) to be desirable in audit procurement: competition, solicitation, technical evaluation, a written agreement, multi-year agreements, and specialized finance professionals. CAT requires that audits are put to competitive and open tender every six years; tenderers are provided with a tender specification; tender specifications state that councils are not required to take the lowest bid and that both price and service-based quality factors will be taken into account; the tender specifications and engagement letter form the basis of the audit contract; appointment is for a mandated tenure period of six years; and appointment decisions are made by a tender committee comprising finance professionals with extensive local government knowledge. 3. THEORETICAL FRAMEWORK AND HYPOTHESIS DEVELOPMENT 3.1 Audit quality and audit service quality Duff (2009: 401) notes that the literature does not provide a consistent definition or operationalization of audit quality. Perhaps the most agreed upon definition is that of DeAngelo (1981) who defines audit quality as the probability that the auditor will both discover irregularities and breaches (due to the auditor’s technical competence) and report the irregularities and breaches (due to the auditor’s independence). There are various models used in the literature to operationalize, or measure, audit quality (see Francis, 2004 and Kilgore, 2007 for reviews of audit quality research), including those that focus on the service quality dimensions of audit quality. As for audit quality, there is no consensus on the conceptualization or operationalization of audit service quality, as different researchers focus on different models of service quality (Cronin & Taylor 1992; Ismail et al., 2006). Duff (2009: 401) states that ‘service quality can be thought of as a sustainable means of providing clients with what they want or need, better, and more effectively’. Prominent examples of models of service quality used in the auditing literature include SERVQUAL (Parasuraman, Zeithaml & Berry, 1991), AUDITQUAL (Duff, 2004, 2009), and models using audit quality attributes, the three most significant of which, according to Kilgore (2010), are Schroeder et al. (1986), Carcello et al. (1992) and Warming-Rasmussen and Jensen (1998). Duff (2009) notes that although prior models using audit quality attributes (such as Schroeder et al., 1986; Carcello et al., 1992 and Warming-Rasmussen & Jensen, 1998) contain similar attributes, these models have been developed and used in isolation from each other. By contrast, Duff’s (2004, 2009) model, AUDITQUAL, integrates the attributes from the prior audit quality literature into a multidimensional, structured model that has been tested for its psychometric properties over different time periods and samples, and has been found to demonstrate both construct validity and measurement equivalence as a measure of audit quality. AUDITQUAL consists of nine dimensions within four higher-order factors of competence, independence, relationship and service qualities. The competence factor relates to perceptions of the auditor to detect errors and comprises three dimensions of reputation, capability and assurance. The independence factor is uni-dimensional, while the relationship factor reflects the technical qualities of the auditor and is two-dimensional, comprising experience and expertise. The fourth factor, service qualities, reflects the ‘often-unobserved nature’ of the auditor–client relationship and comprises the three dimensions of responsiveness, empathy and non-audit services (Duff, 2009: 404). 3.2 The marketing model Theoretically, we use the marketing model employed by Ismail et al. (2006) who examined, for 500 publicly listed Malaysian companies, the relationship between audit service quality, client satisfaction and loyalty. The marketing model postulates that these three elements are distinct and that service quality leads to client satisfaction which, in turn, leads to client loyalty (Ismail et al., 2006: 742). Ismail et al. (2006: 739) cite Oliver’s (1980) cognitive model of the antecedents of Perceptions of Audit Service Quality and Auditor Retention 5 Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd satisfaction decisions in the marketing literature to argue that client satisfaction (or dissatisfaction) ‘results from experiencing a service and comparing that experience with the kind of quality of service that was expected’. Ismail et al. (2006: 741) also cite Andreassen and Lindestad (1998) in the services literature who argue that ‘customer satisfaction is the accumulated experience of a customer’s purchase and consumption experiences’. Rust and Zahorik (1993), in the services literature, and Storbacka, Strandvik and Gronroos (1994), in the marketing literature, argue that satisfied customers are more likely than dissatisfied customers to remain loyal. Client satisfaction is seen as mediating the association between service quality and loyalty (Ismail et al., 2006: 744). Empirical research in the marketing literature has found support for this model. In reviewing that literature, Ismail et al. (2006) cite studies that provide consistent evidence that customer or client satisfaction is affected by perceptions of service quality (e.g., Yi, 1990), and that satisfaction is positively associated with client loyalty (e.g., Stauss & Neuhaus, 1997). Despite these findings, the evidence concerning the association between service quality and client loyalty is mixed in the marketing literature, perhaps due to the complexity of the loyalty construct and the different ways of measuring the construct, including cognitive, attitudinal and behavioural measures (Ismail et al., 2006: 741). Studies in the marketing area have found positive (Boulding et al., 1993; Bloemer, de Ruyter & Wetzels, 1998), negative (de Ruyter, Martin & Bloemer, 1998), and no relationship (Cronin & Taylor, 1992) between service quality and loyalty. In the auditing literature, there is considerable support for the model in terms of the relationship between service quality and satisfaction. Attributes of audit service quality have consistently being found to be associated with customer satisfaction (e.g., Behn et al., 1997, 1999; Samelson, Lowensohn & Johnson, 2006; Boon et al., 2008), and service quality (operationalized using Parasuraman et al.’s (1991) SERVQUAL model) has also been found to lead to client satisfaction (e.g., Ismail et al., 2006: 743). With the exception of Ismail et al. (2006), however, there is little research in the auditing literature on the relationship between client satisfaction and client loyalty. Additionally, there is little research on the relationship between audit service quality attributes and client loyalty expressed as auditor retention. The research that exists shows mixed results. Three practitioner studies (Gabhart & Miller, 1984; Rummel et al., 1999; Stanny et al., 2000) provide no common attributes. Rather, these studies find a range of attributes associated with experience with the incumbent auditor to be important, including data processing capabilities and the ability of the audit partner to communicate effectively (Gabhart & Miller, 1984), staff personalities and meeting deadlines (Rummel et al., 1999) and overall quality of services (Stanny et al., 2000).And, as noted in the introduction to thepaper, the two academic studies of Pandit (1999) and Morton and Scott (2007) that have examined the relationship between audit service quality and retention also provide mixed results. Ismail et al. (2006) examined the relationship between audit service quality, client satisfaction and client loyalty. They hypothesized positive relationships between service quality and satisfaction and between satisfaction and loyalty, arguing that clients who were satisfied with their auditor would retain that auditor’s services for a longer period and would buy additional non-audit services from the auditor. Ismail et al. (2006) used the five-dimensional marketing model SERVQUAL (Parasuraman et al., 1991) to measure audit service quality, with the five dimensions being tangibility, reliability, responsiveness, assurance and empathy. They used hierarchical regression to examine the mediating effect of client satisfaction on the association between audit service quality and loyalty. They found that the service quality factors of tangibility, reliability and empathy were associated with satisfaction, satisfaction was associated with client loyalty, and that satisfaction partially mediated the relationship between audit service quality and client loyalty via the reliability dimension of the five-dimensional model (Ismail et al., 2006: 750). Their finding supported the conjecture that client satisfaction is a mediator ‘to the extent that it carries the influences of audit service quality to client loyalty’ (Ismail et al., 2006: 749). 3.3 Hypothesis Based on the foregoing theory drawn from the marketing model that service quality is associated with client satisfaction and that satisfaction with audit quality is associated with client loyalty (Ismail et al., 2006), we expect a positive and significant relationship between perceptions of audit service 6 K. Butcher et al. Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd quality and auditor retention in our context of compulsory audit tendering (CAT) in NSW local councils. This context has been demonstrated to be one in which clients, local councils, are satisfied with audit service quality (Boon et al., 2008), and one in which the CAT regime is associated with audit quality. CAT has been proposed as a means of enhancing audit quality and auditor independence by improving the information set available during the auditor appointment process, and altering the supply of audit firms available to an organization from which to appoint an auditor (Jensen & Payne, 2005a, 2005b). The six-year mandatory tenure period in the NSW local council context is also associated with audit quality because, while it means the incumbent auditor should face no dismissal risk for the period, at the end of the period the council might not reappoint (retain) the incumbent, but might change auditors, meaning that the quality of the predecessor’s audit will be subject to scrutiny (Vanstraelen, 2000). This scrutiny is likely to be intense because new auditors have an incentive to provide superior audit service in the initial years of engagement to demonstrate their ability to deliver a quality audit (Craswell, Francis & Taylor, 1995). Our study employs the Duff (2009) model of AUDITQUAL to hypothesize and measure audit quality. We use AUDITQUAL because of its theoretical properties as an integrated multidimensional model of audit quality and its psychometric properties of construct validity and measurement equivalence. As noted earlier, AUDITQUAL consists of nine dimensions within four higher-order factors of competence, independence, relationship and service qualities. Our study also employs 48 individual audit quality attributes drawn from the audit service quality literature. The attributes allow us to hypothesize and measure seven of the nine dimensions in AUDITQUAL, including the three dimensions of the competence factor (reputation, capability and assurance), independence, the two dimensions of the relationship factor (experience and expertise) and one dimension of the service qualities factor (responsiveness). The other two dimensions of this factor (empathy and non-audit services) are not measured within the 48 attributes and are not hypothesized. We hypothesize as follows: H 1 There is a significant and positive relationship between perceptions of audit service quality and auditor retention. This overall hypothesis is stated as seven sub-hypotheses using seven dimensions of Duff’s (2009) four-factor model of audit service quality. The sub-hypotheses are as follows: H 1a There is a significant and positive relationship between reputation and auditor retention. H 1b There is a significant and positive relationship between capability and auditor retention. H 1c There is a significant and positive relationship between assurance and auditor retention. H 1d There is a significant and positive relationship between independence and auditor retention. H 1e There is a significant and positive relationship between experience and auditor retention. H 1f There is a significant and positive relationship between expertise and auditor retention. H 1g There is a significant and positive relationship between responsiveness and auditor retention. 4. METHOD 4.1 Variable identification Figure 1 provides a comprehensive list of 48 attributes drawn from the audit service quality literature. The attributes are shown in Column 2 and the literature sources in Column 3. Figure 2 uses AUDITQUAL (Duff, 2009) to classify the 48 attributes into four higher-order categories and seven sub-categories: (i) competence (sub-categories of reputation, capability and assurance), (ii) independence (sub-category of independence), (iii) relationship (sub-categories of expertise and experience) and (iv) service qualities (sub-category of responsiveness). Columns 1, 2 and 3 of Figure 2 show the category name, sub-category number and sub-category name, respectively. Column 5 shows the individual attributes that are used in the survey questionnaire, classified into the seven sub-categories and four categories. Column 4 shows the numbering of the attributes in the questionnaire. The numbers in Perceptions of Audit Service Quality and Auditor Retention 7 Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd Attribute (survey item) no. Audit service quality attribute description Literature source 1 The audit firm has been performing the audit for at least 2–3 years Carcello et al. (1992), Chen et al. (2001) 2 The audit firm is considered to be a specialist in local government audit Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 3 The audit engagement partner has been on the audit for at least 2– 3 years Carcello et al. (1992) 4 The partner assigned to the audit engagement is very knowledgeable about the industry Carcello et al (1992), Behn et al. (1999), Pandit (1999), Chen et al. (2001) 5 The audit firm participates in the peer review process, and its most recent peer review report was a clean one Schroeder et al. (1986), Carcello et al. (1992), Aldhizer et al. (1995) 6 The audit firm actively encourages staff members to take courses and attend seminars in fields where the firm has major clients Schroeder et al. (1986), Carcello et al. (1992) 7 The audit firm that is conducting the audit provides no consulting services for the client Carcello et al. (1992), Chen et al. (2001) 8 The audit firm is skillful in devising acceptable accounting treatments for transactions that generate results that council management wants Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 9 The audit firm has a policy on the maximum number of hours per day and per week that its staff can work Carcello et al. (1992), Chen et al. (2001) 10 The audit firm develops stringent time budgets for each audit area and expects its people to meet them Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 11 The audit firm has a high audit staff turnover rate Chen et al. (2001) 12 The audit firm conducts a thorough study of the client’s system of internal control Carcello et al. (1992), Davis (1995), Pandit (1999), Chen et al. (2001) 13 The audit firm makes extensive use of computers in conducting the audit Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 14 The audit firm’s attitude is one of a sceptic, not one of a client advocate Carcello et al. (1992), Behn et al. (1999), Pandit (1999), Chen et al. (2001) 15 The audit firm is agreeable to completing the audit by a date the client has set Schroeder et al. (1986), Carcello et al. (1992), Davis (1995), Pandit (1999) 16 The auditors assigned to the engagement are very knowledgeable about accounting and auditing standards Carcello et al. (1992), Davis (1995), Behn et al. (1999), Pandit (1999) 17 The audit team members as a group always exercised due care throughout the engagement Behn et al. (1999) 18 The audit staff assigned to the engagement have very high ethical standards Carcello et al. (1992), Davis (1995), Behn et al. (1999), Pandit (1999), Chen et al. (2001) 19 There is frequent communication between the audit team and the council’s audit committee Schroeder et al. (1986), Carcello et al. (1992), Behn et al. (1999) 20 The audit firm conducting the audit has other local council audit clients Carcello et al. (1992), Aldhizer et al. (1995), Pandit (1999), Chen et al. (2001) 21 Audit team members are rotated off the audit periodically Schroeder et al. (1986), Carcello et al. (1992), Chen et al. (2001) 22 There is frequent communication between the audit team and council management Schroeder et al. (1986), Carcello et al. (1992), Davis (1995), Pandit (1999), Chen et al. (2001) 23 The audit firm keeps council management informed during the year about accounting and financial reporting developments that affect the council Carcello et al. (1992), Davis (1995), Chen et al. (2001) 24 The audit engagement partner and manager make frequent visits to the council during the conduct of the audit Carcello et al. (1992), Davis (1995), Pandit (1999) 25 The percentage that the council audit fee represents to the total audit fee revenue of the audit firm is not material Schroeder et al. (1986), Carcello et al. (1992), Chen et al. (2001) 26 The personnel on the engagement below manager level have passed the professional bodies’ exams Carcello et al. (1992), Chen et al. (2001) 27 The audit partner on the engagement is a CA/CPA Carcello et al. (1992), Aldhizer et al. (1995) 28 Before accepting a new client, the CPA firm conducts a pre- engagement investigation and goes through risk control procedures including the conduct of a background search on senior management of the prospective client Carcello et al. (1992), Chen et al. (2001) 29 The audit firm reports internal control deficiencies and the auditors’ recommendations on internal control are useful Davis (1995) 30 The audit firm tends to have decentralized offices rather than centralized offices Carcello et al. (1992) 31 The overall reputation of the audit firm is positive Schroeder et al. (1986), Carcello et al. (1992), Chen et al. (2001) 32 The work performed by inexperienced members of the audit team is supervised by the audit team manager Davis (1995) 8 K. Butcher et al. Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd Column 4 are not sequential as the attributes were randomly distributed in the questionnaire. 4.2 Survey design The survey questionnaire (designed following Dillman’s (2000) Tailored Design Method) consisted of two sections. The first section provided respondents with the list of 48 attributes. Respondents were requested to: ‘Assume that you have been asked to evaluate the quality of audit services provided by your incumbent auditor. Please indicate the extent to which you agree or disagree that each attribute will impact on your evaluation of the quality of audit services provided by your incumbent auditor’. Consistent with Butcher et al. (2011) and Beattie and Fearnley (1995), the request was framed as a generic task in order that respondents were not primed about the dependent variable of the study (intention to retain the incumbent auditor), and thus to avoid measurement invariance (Brown, 2006) that might confound the results of the study. A seven-point Likert-type scale was used ranging from -3 (strongly disagree that the attribute would impact their perceptions of audit service quality) to +3 (strongly agree). The order of the 48 attributes was randomized to avoid any potential bias resulting from demand characteristics or halo effect. The second section of the questionnaire contained demographic questions about the respondent (e.g., extent of experience) and the respondent’s council (e.g., size and location). The final question asked respondents: ‘If your council had to make an auditor appointment decision now, would it prefer to (i) retain the incumbent audit firm or (ii) appoint a new audit firm?’. Responses to this question formed the dependent variable of auditor retention. We used preferred intention to retain or rotate the incumbent auditor as the dependent variable to reflect the dichotomous nature of the decision. The demand-side studies of auditor selection also use this dichotomy (e.g., Woo & Koh, 2001). A measure of preferred outcome follows Pandit (1999), and is based on research that shows preference follows attitude and precedes behaviour, and is a commonly used approach in the broader behavioural literatures to measure the 33 In all your dealings with the audit firm and individual audit team members, the audit firm and audit team members never engaged in any actions that would compromise its/their independence, either in fact or in appearance Behn et al. (1999) 34 The audit firm has strict guidelines on the procedures that must be completed before signing the audit report Schroeder et al. (1986), Chen et al. (2001) 35 The cost to the audit firm of different audit procedures in terms of Carcello et al. (1992), Pandit (1999), Chen et al. (2001) time expended is the major criterion as to whether a procedure is used. 36 The audit firm has rarely been found negligent in lawsuits brought against it (alleging inadequate audit performance) Schroeder et al. (1986), Carcello et al. (1992), Chen et al. (2001) 37 The audit team members as a group have an adequate understanding of the operations of the council Aldhizer et al. (1995), Sucher et al. (1998), Chen et al. (2001) 38 The audit team members conducted the audit fieldwork in an appropriate manner Behn et al. (1999) 39 The audit firm makes extensive use of statistical techniques in conducting the audit Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 40 The audit report and work papers receive a second partner review Aldhizer et al. (1995) 41 The auditor adds value to the entity in terms of generating useful ideas for improvement Davis (1995), Sucher et al. (1998) 42 The size of the audit firm in terms of its total revenue and number of auditors is much larger than the average size in the region Chen et al. (2001) 43 The audit manager has been on the audit for at least 2–3 years Carcello et al (1992), Chen et al. (2001) 44 The audit supervisor has been on the audit for at least 2–3 years Carcello et al (1992), Chen et al. (2001) 45 The audit manager and supervisor assigned to the engagement are very knowledgeable about the industry Carcello et al. (1992), Behn et al. (1999), Pandit (1999), 46 The auditors are mindful of how busy the council’s key finance staff are and contact these individuals only to the extent necessary Carcello et al. (1992), Pandit (1999), Chen et al. (2001) 47 The external auditors co-operate with the internal auditors Davis (1995) 48 The number of hours spent by the audit team to complete the audit (from the beginning of fieldwork to the audit report date) is commensurate with a quality audit. Aldhizer et al. (1995) Figure 1: Literature review – Audit service quality attributes. Perceptions of Audit Service Quality and Auditor Retention 9 Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd Category name Sub-category number Sub-category name Survey attribute no. 30 31 36 1 Reputation 42 10 12 13 17 26 27 29 35 37 38 39 2 Capability 48 5 6 9 11 21 28 32 34 Competence 3 Assurance 40 7 8 14 18 25 Independence 4 Independence 33 2 4 Relationship 5 Expertise 16 20 45 1 3 43 6 Experience 44 15 19 22 23 24 41 46 Service qualities 7 Responsiveness 47 Figure 2: Audit service quality taxonomy as per Duff (2009). 10 K. Butcher et al. Int. J. Audit. ••: ••–•• (2012)© 2012 Blackwell Publishing Ltd [...]... attributes to NSW local council finance professionals and internal auditors Using the marketing model as a theoretical basis and Duff’s (2009) AUDITQUAL measure of audit quality, we hypothesized a positive relationship between perceived audit quality and auditor retention due to perceived satisfaction with audit service quality We found that two dimensions of audit quality, i.e., expertise and responsiveness... association between perceived audit quality attributes and the auditor retention decision We used the CAT context of NSW local government because of prior research evidence of council satisfaction with audit quality (Boon et al. , 2008) Int J Audit ••: ••–•• (2012) 18 and a high auditor retention rate (Butcher et al. , 2011) We administered a survey questionnaire consisting of 48 audit quality attributes.. .Perceptions of Audit Service Quality and Auditor Retention 11 Survey item The audit firm tends to have decentralized offices rather than centralized offices The overall reputation of the audit firm is positive The audit firm has rarely been found negligent in lawsuits brought against it (alleging inadequate audit performance) The size of the audit firm in terms of its total revenue and number of auditors... (2012) Perceptions of Audit Service Quality and Auditor Retention 15 Table 1: Results of t-tests of mean differences between potential retainers and rotators Panel A Factor scoresa Mean value of factor scoresa Potential retainers [Coded 1] (n = 164) Reputation Capability Assurance Independence Expertise Experience Responsiveness -0 .389 -0 .630 -0 .246 -0 .373 -0 .632 -0 .180 -0 .844 Significance (2-tailed)b,c... generally in local government and the private sector For firms operating, or seeking to operate, in the NSW local government audit market, our results provide direct evidence that council commitment to, and retention of, an audit firm is related to specific attributes of audit service quality, specifically audit Int J Audit ••: ••–•• (2012) Perceptions of Audit Service Quality and Auditor Retention firm... incumbent auditor The findings of non-significant associations between auditor retention and Duff’s (2009) higher-order audit quality factors of independence and reputation may indicate that these quality factors are relatively more important to clients in the initial selection of an auditor, or in a decision to change audit firms to properly align auditor client needs This conjecture is supported by Butcher. .. public sector audits in New Zealand’, unpublished Master of Business Studies thesis, Massey University, New Zealand DeAngelo, L E (1981), Auditor size and audit quality , Journal of Accounting and Economics, Vol 3, No 3, pp 183–99 de Ruyter, K., Martin, W & Bloemer, J (1998), ‘On the relationship between perceived audit quality, service loyalty and switching costs’, International Journal of Service Industry... two alternative measures of audit service quality: (i) the 12 factors (attribute categories) of Carcello et al (1992), as adapted by Behn et al (1997) and operationalized by Boon et al (2008) (hereafter © 2012 Blackwell Publishing Ltd referred to as Carcello et al. , 1992), and (ii) the 15 audit quality attributes identified by Schroeder et al (1986) Kilgore (2010: 29) notes that these are two of the... positively associated with auditor retention in the main analyses using the audit quality taxonomy of Duff (2009) and the exploratory factor structure of the 48 audit quality attributes We corroborated these findings in both the sensitivity analyses using the taxonomies of Carcello et al (1992) and Schroeder et al (1986) The other five dimensions of Duff’s (2009) audit quality dimensions; i.e., reputation,... fees (Boon et al. , 2005) However, a concern with increased competitiveness and downward pressure on fees is potential compromise of audit service quality through decreased audit effort and quality Our results suggest that audit service quality is not compromised in this context as we find that it is attributes associated with audit quality that have greater impact on evaluations of audit service for . audit quality (Boon et al. , 2008) Perceptions of Audit Service Quality and Auditor Retention 17 Int. J. Audit. ••: ••–•• (2012) © 2012 Blackwell Publishing Ltd and a high auditor retention rate (Butcher. necessary The external auditors co-operate with the internal auditors Figure 2: Continued Perceptions of Audit Service Quality and Auditor Retention 11 Int. J. Audit. ••: ••–•• (2012) © 2012 Blackwell. sample selection, method of Perceptions of Audit Service Quality and Auditor Retention 3 Int. J. Audit. ••: ••–•• (2012) © 2012 Blackwell Publishing Ltd analysis and specification of the model to