kilgore et al - 2011 - the relative importance of audit quality attributes

Motivated by the significance of auditing and perceptions of audit quality in enhancing the reliability and credibility of financial statements, this article investigates the relative im

Alan Kilgore, Renee Radich & Graeme Harrison

T he importance of auditing and perceptions of

au-diting to the efficient operation of capital markets

is well recognised For example, Wallman (1996)

and Coffee (2001) argue that without high quality audits

the capital market would be inefficient and the cost of

capital higher Similarly, Monroe and Tan (1997: 35)

conclude ‘the quality of an audit can affect the reliability

of audited financial information, which in turn plays

an important role in capital markets’ Audit quality

is, therefore, fundamental in providing the confidence

that capital market participants require and plays an

important role in the effective allocation of economic

resources

As a result of a series of corporate collapses and

audit failures, perceptions of audit quality have been at

issue over recent decades These events and the ensuing

investigations have resulted in changes to regulatory

arrangements In Australia the ninth stage of the

Corporate Law Economic Reform Program (Audit Reform

and Corporate Disclosure) Act 2004 (CLERP 9) proposed

a range of measures designed to enhance the general

cor-porate disclosure framework The Australian Securities

Exchange’s Corporate Governance Council also issued a

report entitled Principles of Good Corporate Governance

and Best Practice Recommendations (2003) Similarly,

in the United States (US) the Corporate and Auditing

Accountability, Responsibility, and Transparency Act of

2002, commonly called the Sarbanes-Oxley Act (2002)

(SOX), was enacted in response to financial reporting

irregularities (McGowan and Brisendine 2003) Various

governance initiatives were also implemented in the

United Kingdom (UK), including the issuance of the

Combined Code in 2003.

More recently the global financial crisis (GFC) has

seen policy makers once again focus attention on the

importance of an effective audit function as a key

compo-nent in effective capital markets and attempt to identify

key drivers of audit quality For example, in the US, the

Advisory Committee on the Auditing Profession (2008)

was established to provide advice to the US Treasury

Department on the auditing profession In the UK the

Financial Reporting Council released The Audit Quality

Framework (2008) and in Australia, the Treasury released

Audit Quality in Australia – A Strategic Review (2010).

Corporate collapses and audit failures have threatened the credibility of the audit function, with audit quality once again being a major issue Motivated by the significance of auditing and perceptions of audit quality in enhancing the reliability and credibility of financial statements, this article investigates the relative importance of audit team and audit firm attributes in perceptions of audit quality

by users of audit services Data are gathered from 81 users

of audit services and analysed using adaptive conjoint analysis in order to measure the relative importance of audit team and audit firm attributes in perceptions of audit quality The results show that, in general, users of audit services perceive audit team attributes as being relatively more important than audit firm attributes in perceptions of audit quality The findings of the study have implications for regulators and the accounting profession concerned with improving confidence in corporate governance and the effectiveness and integrity

of the audit process, and for audit firms in monitoring and promoting the quality of their audit services.

Correspondence

Alan Kilgore, Department of Accounting and Corporate Governance, Macquarie University, NSW 2109, Australia Tel: + 61 2 9850 8564; fax: + 61 2 9850 8497; email: alan.kilgore@mq.edu.au

doi: 10.1111/j.1835-2561.2011.00141.x

These investigations and regulatory changes make it

clear that there has been considerable dissatisfaction with

the effectiveness of corporate governance, the quality of

the audit process and the roles of auditors and auditing

In response, regulators and the accounting profession

have taken a number of policy measures to improve

audit quality in both fact and appearance Recent

examples include the SEC’s proposed ban on audit

firms undertaking non-audit services (NAS) in 2000

(SEC 2000) and the rapid adoption of SOX following

Enron’s collapse (Francis 2004) However, these policy

decisions have been made despite the fact that the

empirical evidence regarding factors that can enhance or

impair audit quality is inconclusive and uncertain This

study provides empirical evidence on the factors that are

perceived to affect audit quality, specifically the relative

importance of audit team and audit firm attributes in

affecting audit quality as perceived by users of audit

services

This study contributes to the literature in three ways

First, there is only limited empirical evidence of the

factors that affect perceptions of audit quality by users

of audit services However, research into perceptions of

audit quality is important because it is perceptions that

determine the credibility of the audit report (Shockley

1981) and that have the potential to erode public

confidence in the integrity of the financial reporting

system (Pany and Reckers 1988) Consequently, gaining

an understanding of factors that affect perceptions

of audit quality is important because it can help

regulators and the accounting profession to formulate

policy based on empirical evidence rather than on

a priori assumptions (Schelluch and Thorpe 1995).

This evidence is also useful in ensuring that policies

and practices support confidence and credibility in the

audit function by encompassing attributes found to be

relatively more important in perceptions of audit quality

Second, the findings of this study extend the scope

of prior studies by examining the relative importance of

audit team and audit firm attributes in perceptions of

audit quality by examining whether users place greater

importance on one type of attribute compared to the

other Prior studies on perceptions of audit quality have

identified the distinction between, and importance of,

audit team and audit firm attributes (see, for example,

Schroeder et al 1986; Carcello et al 1992;

Warming-Rasmussen and Jensen 1998) However, these studies

have only examined the importance of audit quality

attributes in an absolute sense and have not examined

the relative importance (how important an attribute is

relative to all others) of attributes in perceptions of audit

quality

Third, some studies (see, for example, Schroeder

et al 1986; Carcello et al 1992) found that audit team

attributes were more important in assessing audit quality

than audit firm attributes By contrast, other studies

(see, for example, Warming-Rasmussen and Jensen 1998) found a greater emphasis on audit firm attributes compared to audit team attributes Additionally, there are sufficient variations in the number and type of attributes and subject groups used in prior studies that reduce their comparability and usefulness Using conjoint analysis, this study makes a unique and innovative contribution to the literature Conjoint analysis, which has not previously been used to measure the relative importance of audit quality attributes, allows direct evidence to be obtained regarding the relative importance of attributes in perceptions of audit quality

Literature Review and Research Questions

There is a vast body of literature relating to audit quality and its measurement Despite the extent of that literature, no single generally accepted definition

or generally accepted measure of audit quality has emerged Much of the audit quality literature derives from DeAngelo’s (1981) frequently cited definition of audit quality (the probability of both discovering and reporting a breach or misstatement in the accounting system or financial statements) Krishnan and Schauer (2000) observe that the two aspects of the DeAngelo (1981) definition are unobservable

Two approaches have been adopted to measuring audit quality; a direct and an indirect approach The direct approach is based on the assumption that the probability of discovery and reporting of breaches will

be reflected in outcomes of the audit, such as audit errors and financial statement outcomes Examples of studies using the direct approach include Brown and Raghunandan (1995) and Colbert and Murray (1998) (audit errors), Balsam et al (2003) (abnormal accruals) and Krishnan (2003) (valuation of earnings surprises) Research using the indirect approach is of two types The first type measures audit quality using surrogates for audit quality, such as audit firm size (see, for example, DeAngelo 1981; Francis 1984; Palmrose 1986; Francis and Simon 1987; Craswell et al 1995; Colbert and Murray 1998), audit tenure (see, for example, Geiger and Raghunandan 2002), provision of NAS (see, for example, Wines 1994; Barkess and Simnett 1994; Craswell 1999; Elstein 2001) and industry experience (see, for example, Craswell et al 1995; Hogan and Jeter 1999) These surrogate studies generally examine attributes of the audit firm, rather than the audit team, and typically examine only one attribute in each study

The second type adopts a behavioural perspective and assesses audit quality by examining the attributes perceived to be associated with audit quality Behavioural studies include Shockley (1981), Mock and Samet (1982), Knapp (1985), McKinley et al (1985), Schroeder

et al (1986), Knapp (1987), Sutton and Lampe (1990),

Gul (1991), Knapp (1991), Carcello et al (1992), Sutton

(1993), Beattie and Fearnley (1995), Moizer (1995),

Behn et al (1997), Warming-Rasmussen and Jensen

(1998), Behn et al (1999), Chang and Monroe (2001)

and Duff (2004) These behavioural studies typically

examine combinations of audit quality attributes, and

include both audit firm and audit team attributes

Two conclusions can be drawn from the behavioural

studies The first is that users of audit services attach

different degrees of importance to particular audit

quality attributes in their perceptions of audit quality

The second is that, in general terms, audit team attributes

are considered to be more important than audit firm

attributes in perceptions of audit quality Based on this

discussion, this study examines the following research

questions:

RQ1: Do users of audit services attach different relative

importance to audit quality attributes?

RQ2: Are audit team or audit firm attributes considered

relatively more important in perceptions of audit

quality by users of audit services?

The research questions are based on two assumptions

The first is that audit quality can be regarded as a set of

attributes with differing relative importance for users

of audit services This assumption has support in both

the theoretical and empirical literature The concept

of product quality in the economics-based literature,

summarised in Davidson and Monroe (1999), contends

that goods and/or services are considered to be composed

of sets or bundles of many different characteristics or

attributes Goods and/or services are only considered to

have value to consumers because of the various attributes

that combine together to form the good or service

Consumers will seek different attributes in the good or

service and will place different values on each attribute

depending on the consumers’ utility of the attribute

The ‘quality’ of an economic good or service can

therefore be viewed as the sum of the values placed on

the desired attributes contained in the good or service

With respect to the empirical literature, Simunic and

Stein (1987) find that audit services are not seen as

homogeneous but differentiated by users on the basis of

differences in the values placed on the attributes of audit

services Similarly, the studies that examine audit quality

from a behavioural perspective demonstrate that there

is a long list of attributes perceived to be important in

assessing audit quality and there is considerable variation

in the importance of those attributes to users of audit

services

The second assumption is that attributes perceived to

affect perceptions of audit quality may be classified as

one of two types; audit team and audit firm attributes

Audit team attributes are characteristics of the audit

team and audit partner and include the level of partner

attention to the audit, communication and quality of

working relationships between the audit team and client management, and the skills and experience of the audit team (drawing examples from Schroeder et al 1986) Audit team attributes also include the knowledge of the audit team and partner both generally and in relation

to the client’s industry, and the ethical standards of the audit team (Carcello et al 1992); and the technical competence of the audit team (Beattie and Fearnley 1995; Zerni 2008) Schroeder et al (1986) argue that, because the audit service is delivered by a relatively small number of professionals comprising the audit team, audit team attributes are likely to play an important role

in perceptions of audit quality Audit team attributes were also found to be important in perceptions of audit quality in the behavioural studies identified earlier

Audit firm attributes are characteristics of the audit firm Both the surrogate and behavioural studies have found audit firm attributes to be important in percep-tions of audit quality The surrogate studies identify audit firm attributes to include audit firm size, litigation experience, auditor reputation, auditor tenure, provision

of NAS, audit structure and industry experience to be associated with audit quality The behavioural studies identify audit firm attributes including quality control procedures, regulatory experience (Schroeder et al 1986), audit firm responsiveness to client needs and compliance with general audit standards (Carcello et al 1992), and firm industry experience and sceptical atti-tude of the firm (Warming-Rasmussen and Jensen 1998)

Research Method Adaptive conjoint analysis

This study gathers and analyses data using Sawtooth Software’s Adaptive Conjoint Analysis System (ACA) The ACA system, developed by Johnson (1987), is

a computer-administered, interactive conjoint method and combines the design of conjoint tasks, data collection and data analysis ACA uses a computerised questionnaire that consists of four sections, namely, importance, ratings, trade-off and calibration The importance section asks respondents to indicate which audit quality attributes they consider most important

In the ratings section, respondents provide a rating preference for different levels of the particular audit quality attribute In the trade-off section a series of customised paired comparison trade-off questions are presented to respondents in order to obtain the conjoint data so that utility values can be calculated In the calibration section a series of ‘calibration concepts’ are composed using those attributes determined to be most important This information is used to calibrate the utility values calculated in the earlier sections of

the questionnaire for use in further data analysis A

unique feature of ACA is that the procedure is both

‘adaptive’ and ‘dynamic’ in that the answers already

provided by respondents are used at each step to select

the next paired comparison question

Audit quality attributes

Collection of conjoint data using the ACA system

requires identification of the attributes and attribute

levels (descriptors) to be included in the survey

questionnaire Initially, five audit firm attributes were

identified from the literature as the main audit firm

attributes implicated in perceptions of audit quality

These were audit firm size, audit tenure, provision

of NAS, audit structure and industry experience Five

audit team attributes were selected: partner/manager

attention to audit; communication between audit team

and client management; partner knowledgeable about

client industry; very knowledgeable audit team; and

senior manager/manager knowledgeable about the client

industry These audit team attributes were the five

highest rated in the two most significant behavioural

studies of perceptions of audit quality (Schroeder et al

1986; Carcello et al 1992)

ACA survey questionnaire

The survey questionnaire was previewed for errors

using the ACA system tool that automatically checks

the completed survey for errors or warnings Four

faculty members of the Department of Accounting and

Finance at Macquarie University also reviewed the draft

questionnaire This process resulted in a number of

minor changes being made to the questionnaire, namely

the use of three levels for the audit firm size attribute

(Big N firms, mid-tier and local firms), and audit tenure

being specified as audit partner tenure with two levels

(five years or fewer and more than five years)

The reviewers also reported that they had difficulty

understanding and interpreting the term audit structure

Consulting the relevant literature (see, for example,

Cushing and Loebbecke 1986; Ashton and Willingham

1988; Dirsmith and Haskins 1991; Carcello et al

1995) revealed that audit structure methodologies are

not likely to be familiar to users of audit services

Consequently, this attribute was replaced with the

attribute ‘audit quality assurance review’ with two

levels (internal/external) The inclusion of this attribute

was motivated by debate surrounding the efficacy of

audit quality reviews and the subsequent formation,

in February 2006, of the Audit Quality Review Board

(AQRB).1 Furthermore, a number of empirical studies

have attempted to determine whether peer review is

effective in improving audit quality Examples of these

studies include Francis et al (1990), Wallace (1991), Deis and Giroux (1992), Krishnan and Schauer (2000) and Hilary and Lennox (2005) These requirements and the distinction between external and internal quality control reviews are likely to be known by users of audit services and provide further motivation for the inclusion of this attribute with two levels (internal/external)

The survey questionnaire was pilot tested by 19 faculty members of the Department of Accounting and Finance

at Macquarie University No difficulties in completing the questionnaire were reported The final audit firm and audit team attributes, their operational definitions and the attribute levels used in the ACA survey questionnaire are shown in Table 1 A copy of the ACA survey questionnaire used in this study is available on request

Data collection

The respondents chosen for this study are audit committee chairs/members and financial analysts/fund managers representing users of audit services As no readily accessible database of either respondent group

is available it was necessary to construct databases from publicly available information The audit committee chairs/members database was constructed from annual reports of companies listed on the Australian Securities

Exchange (ASX) selected at random from Aspect Annual Reports Online Database Information regarding

audit committee membership was obtained from the corporate governance section of the annual reports from which the names of audit committee chairs/members were obtained Contact details for each audit committee

chair/member were obtained from the Business Who’s Who of Australia Database, where available A total of

318 audit committee chairs/members were identified, with 158 representing the Top 500 firms listed on the ASX, and the remaining 160 representing non Top 500 firms

The financial analysts/fund managers database was constructed from information obtained from the

Australian Financial Services Directory (AFSD), which

provides web addresses for all financial analysts/fund managers listed in the AFSD Individual websites were accessed to obtain the names, position descriptions and contact details (mailing address, telephone number and email address) Only individuals whose position descriptions clearly identified them as working in financial analysis/funds management areas, or who could clearly be identified as having prior work experience in these areas, were selected for inclusion

in the database In order to obtain a similar sample size for financial analysts/fund managers, the names and contact details of 331 individuals were selected through this process

Table 1 Audit firm and audit team attributes, operational definitions and attribute levels used in the ACA questionnaire

2 Mid-tier firm

3 Local firm Audit partner tenure Duration of auditor–client relationship 1 ≤5 years

2.>5 years

Provision of non-audit services (NAS) Percentage of NAS fees to audit fees 1.<30% of audit fees

2 30–60% of audit fees

3.>60% of audit fees

Industry experience Industry specialisation 1 Specialist

2 Non-specialist Audit quality assurance review Audit quality control review 1 External quality control review

2 Internal quality control review Partner/manager attention to audit Activity level of partner/manager 1 High activity level

2 Moderate activity level

3 Low activity level Communication between audit team and Nature and frequency of communication 1 Formalised and regular

3 Ad hoc

Partner knowledgeable about client Years of experience in client industry 1 ≤3 years

3.>6 years

Senior manager/manager Years of experience in client industry 1 ≤3 years

3.>6 years

Very knowledgeable audit team Years of experience in accounting and auditing 1 ≤3 years

2 4–6 years

3.>6 years

Data collection was undertaken in two stages In

stage 1, 649 invitation letters and acceptance forms were

mailed to all 318 audit committee chairs/members and

331 financial analysts/fund managers After following

the multiple mailing procedure in line with Dillman’s

(2000) Tailored Design Method (TDM), 173 responses

agreeing to participate in the study were received from

audit committee chairs/members (96) and financial

analysts/fund managers (77) An overall response rate

of 28.8% to the invitation letter was achieved

Stage 2 commenced with each audit committee

chair/member and financial analyst/fund manager who

agreed to participate in the study being sent an

email thanking them and providing details of how

to access the survey questionnaire online Subsequent

emails/telephone calls were made to encourage

re-spondents to complete the questionnaire In total,

22 respondents withdrew from the study despite

initially agreeing to participate A further 66 did not

respond to repeated emails/telephone calls A total of

85 respondents attempted the questionnaire, of which

four were incomplete, resulting in an overall response

rate of 46.8% of respondents that initially agreed to

participate For audit committee chairs/members, 40.6%

responded; for financial analysts/fund managers 54.5%

responded Table 2 summarises the response rates for

stage 1 and 2 procedures

Results ACA average utility values

Prior to analysis, the utility data must be scaled and normalised so that utility values can be compared across respondents.2 Table 3 shows the average utility values The average utility values represent the desirability of

the attribute levels within each attribute.3

Relative importance scores

To enable comparison between attributes, the relative

im-portance score for each attribute across all respondents was calculated using the formula:

RI i=n (MaxU − MinU)i

i

(MaxU − MinU)

(1)

Where: RI i = the relative importance of the i th

attribute

Max U = the maximum utility of the i thattribute

Min U = the minimum utility of the i thattribute The relative importance scores for each attribute across all respondents are provided in Table 4 and are

Table 2 Response rates

Audit Committee Chairs/ Financial Analysts/Fund Members (% of total) Managers (% of total) Total Percent Stage 1 Procedures

Stage 2 Procedures

Table 3 Average utility values for all levels of all attributes

for all complete responses (N=81)

Average Attribute Utility

Audit firm size Big N auditor 52.86

Mid-tier firm 8.64

Audit partner tenure 5 years or less 21.54

More than 5 years −21.54

Provision of NAS <30% of audit fees 38.59

30–60% of audit fees −2.22

>60% of audit fees −36.37

Audit firm industry Specialist 50.61

experience Non-specialist −50.61

Audit quality assurance External quality assurance 14.96

Internal quality assurance −14.96

review Partner/manager attention High activity level 58.24

to audit Moderate activity level −1.94

Low activity level −56.3

Communication between Formalised and regular 33.86

audit team and client Informal and regular 15.73

Partner knowledgeable 3 years’ experience −52 26

about client industry 4–6 years’ experience 9.72

>6 years’ experience 42 55

Senior manager/manager 3 years’ experience −56.09

knowledgeable – client 4–6 years’ experience 11.66

industry >6 years’ experience 44.44

Very knowledgeable 3 years’ experience −57.26

audit team 4–6 years’ experience 14.52

>6 years’ experience 42.74

a Utility values are interval data scaled to an arbitrary additive

constant within each attribute using the ‘Zero-Centred Diffs’

method.

shown in histogram graphic form in Figure 1 Relative

importance scores measure how much influence an

attribute has on a person’s choices An attribute with

a high importance score is more influential because the

difference between the average utility values at the ‘best

level’ and the ‘worst level’ for such an attribute is high

Since the relative importance scores of the 10 attributes total 100, if the attributes were equally preferred by respondents, the importance score of each attribute would be 10.4

Table 4 and Figure 1 indicate that the most important attribute for respondents is ‘Audit firm size’ (relative importance score 13.63) The average utility values (Table 3) indicate that the preferred levels for all respondents are, firstly, ‘Big N auditor’ average utility value 52.86) and then ‘Mid-tier firm’ (average utility value 8.64), since the average utility values for both levels are positive

Other attributes considered important by respondents (relative importance scores greater than 10) in order

of relative importance are ‘Partner/manager attention

to audit’ (relative importance score 12.72), ‘Senior manager/manager knowledgeable – client industry’ (relative importance score 11.04), ‘Very knowledgeable audit team’ (relative importance score 10.65), ‘Commu-nication between audit team and client management’ (relative importance score 10.62), ‘Audit firm industry experience’ (relative importance score 10.51) and

‘Partner knowledgeable about client industry’ (relative importance score 10.34) The least important attributes for respondents are ‘Audit quality-assurance review’,

‘Audit partner tenure’ and ‘Provision of non-audit services’ (relative importance scores less than 10)

Within each attribute the level preferred by

respon-dents is provided by the average utility values (Table 3) For the attribute ‘Partner/manager attention to audit’, respondent preference is for a ‘high activity level’ (aver-age utility value 58.24) Respondents prefer a minimum level of knowledge of at least four years for the attributes

‘Partner knowledgeable about client industry’, ‘Senior manager/manager knowledgeable – client industry’, and

‘Very knowledgeable audit team’, since the average utility values for levels ‘4–6 years’ experience’ (average utility values 9.72, 11.66 and 14.52, respectively) and

‘More than 6 years’ experience’ (average utility values 42.55, 44.44 and 42.74, respectively) are positive for all attributes Respondents prefer regular communication

Table 4 Attribute relative importance scores for all

complete responses (N = 81)

Relative Importance

Audit firm industry experience 10.51

Audit quality assurance review 5.15

Partner/manager attention to audit 12.72

Communication between audit team

and client management

10.62

Partner knowledgeable about client

industry

10.34

Senior manager/manager

knowledgeable – client industry

11.04

Very knowledgeable audit team 10.65

with client management, whether formal or informal

(average utility values of 33.86 and 15.73, respectively)

for the attribute ‘Communication between audit team

and client management’ For the attribute ‘Audit firm

industry experience’, the level ‘specialist’ (average utility

value 50.61) is preferred by respondents

Discussion

The study found that, in general terms, users of audit

services consider audit team attributes to be relatively

more important than audit firm attributes in their

perceptions of audit quality All five audit team attributes

were found to be relatively more important since their

relative importance scores were greater than 10 Only two audit firm attributes had relative importance scores greater than 10 These two attributes were audit firm size and audit firm industry experience The results for each

of the 10 attributes are discussed in descending order of relative importance

Audit firm size

This attribute was ranked as the most important attribute In terms of attribute levels, respondents indicated a preference for Big N and mid-tier audit firms compared to local firms This result is not surprising since audit firm size has been demonstrated to be an important factor in perceptions of audit quality in prior literature (see, for example, DeAngelo 1981; Francis 2004), with audit firm size serving as a proxy for audit quality, based on the assumption that larger audit firms are more competent and independent than smaller firms, resulting in audits of a higher quality

Partner/manager attention to audit

Respondents ranked this attribute second in terms

of relative importance This ranking emphasises the perception by respondents of the importance of the audit partner/manager in providing a high level of audit quality The attribute level with the highest average utility value was ‘high activity level’ This result supports findings of studies such as Knechel (2000), who observes that, since auditing is inherently a judgement and

15.00 10.00

5.00 0.00

Audit firm size.

Partner/manager attention to audit

Senior manager/manager knowledgeable -client

industry Very knowledgeable audit tea m

Communication between audit team and client

management Audit firm industry experience Partner knowledgeable about client industry

Provision of non-audit services Audit partner tenure Audit quality assurance review

Figure 1 The relative importance of attributes for all respondents

decision-making process, audit quality is particularly

contingent upon both the judgement and

decision-making qualities of the members of the audit team and

the audit partner

Senior manager/manager knowledgeable – client

industry

Respondents ranked this attribute third most important

in their perception of audit quality Greater average

utility values were assigned to the levels ‘4–6 years’

experience’ and ‘More than 6 years’ experience’

compared to the level ‘3 years’ experience’, thereby

rating more experience as more important in perceptions

of audit quality The importance accorded to this

attribute is, again, likely explained by recognition that the

audit manager is closely connected with the individual

audit procedures and practices that affect audit quality

Audit managers are responsible for the conduct of the

audit and the supervision and review of the work of the

audit team Consequently, audit managers are pivotal in

ensuring that the audit is conducted to a high standard

Very knowledgeable audit team

Respondents ranked this attribute fourth most

im-portant They assigned higher average utility values

to the levels ‘4–6 years’ experience’ and ‘More than

6 years’ experience’ than to the level ‘3 years’ experience’,

thereby indicating more experience as more important

in perceptions of audit quality This finding supports the

results of Zerni (2008), who argues that audit quality

is related to the characteristics of the audit engagement

staff; that is, to audit team characteristics, which include

factors such as the technical competence, knowledge and

experience of the audit team

Communication between audit team and client

management

This attribute was ranked fifth in terms of relative

importance Respondents assigned the highest average

utility value to the level ‘Formalised and regular’

communication and higher average utility values to the

level ‘Informal and regular’ compared to ‘ad hoc’, further

emphasising the importance of regular communication,

whether formal or informal, as opposed to ad hoc

communication

Audit firm industry experience

Respondents ranked this attribute sixth in terms of

relative importance, indicating that audit firm industry

experience is considered less important than other attributes in perceptions of audit quality Within the attribute respondents assigned the greatest average utility value to the audit firm being an industry specialist Prior studies (see, for example, Hogan and Jeter 1999; Deis and Giroux 1992; Solomon et al 1999) support

a link between audit firm industry experience and audit quality These studies argue that because industry specialists have more experience, have financial savings (economies of scale) and a higher concentration of clients, they will make better judgements and therefore provide audits of higher quality Further, studies by Craswell et al (1995), Knechel et al (2007) and Lowensohn et al (2007) suggest that participants in the audit market perceive differences in audit quality due to factors such as industry specialisation While the result in this study supports prior research in finding that respondents assigned the greatest utility to the ‘specialist’ attribute level, it also extends earlier research by finding that industry experience is relatively less important than other attributes in assessing audit quality

Partner knowledgeable about client industry

Respondents ranked this attribute seventh in terms of relative importance, indicating that it was somewhat less important in perceptions of audit quality The attribute levels with the highest/lowest average utility values were

‘More than 6 years’ experience’ and ‘3 years’ experience’, respectively These findings indicate that users of audit services, while not considering partner knowledge about the client industry to be particularly important in their assessments of audit quality, nevertheless prefer a more experienced partner compared to a less experienced one

An explanation for this finding is that the role of the audit partner in the conduct of the audit is somewhat different from that of the audit manager and audit team While the audit partner has overall responsibility for the audit engagement, it is the responsibility of the audit manager to coordinate and supervise the execution of the audit program, and the responsibility of the audit team

to undertake the audit procedures Users of audit services appear to be aware that while the audit partner bears the responsibility for the audit, it is the other members of the audit team and their connection to individual audit procedures and practices that play a more significant role

in achieving an audit of high quality

Provision of non-audit services

Respondents ranked this attribute eighth in relative importance, indicating that they did not consider this attribute to be particularly important in their perceptions of audit quality However they assigned

the greatest average utility value to the level ‘Less than

30% of audit fees’ The result regarding the average

utility value is not surprising given the significant and

ongoing attention that has been given to the issue of

NAS provision by audit firms in both the academic and

professional literature and by regulators and legislators

in recent years In particular, the provision of NAS has

been the subject of considerable scrutiny and recent

legislative and regulatory change in Australia (CLERP 9)

and elsewhere (e.g., SOX in the US) By indicating a

preference for limiting the provision of NAS by audit

firms, respondents appear to support recent legislative

and regulatory efforts on this issue

Audit partner tenure

Respondents ranked this attribute ninth in relative

importance in their perceptions of audit quality,

indicating that they did not consider audit partner tenure

to be very important However, respondents assigned

the highest average utility vales to the level ‘5 years or

less’ The result regarding the average utility value is

most likely due to audit partner tenure having received

significant attention by regulators and the auditing

profession Specifically, CLERP 9, Australian Securities

and Investments Commission’s Policy Statement PS 187

Auditor Rotation, and standards set by the Accounting

Professional and Ethical Standards Board mandate lead

audit and audit review partner rotation every five

years The intent of these regulatory and professional

mandates is to restore public confidence in the auditing

process and in the quality of that process Nevertheless,

it is interesting to note that respondents consider

this attribute to be relatively less important in their

perceptions of audit quality

Audit quality assurance review

In terms of relative importance respondents ranked this

attribute the lowest for all attributes (tenth) Within

the attribute respondents assigned the greatest average

utility value to the level ‘External quality assurance

review’ Recent attention has been given to the issue

of audit quality review For example, the Audit Quality

Review Board (AQRB) was established in 2006 with the

stated objective of undertaking independent, transparent

monitoring of the quality of assurance services in order

to enhance audit quality The intent of this initiative

is aimed at restoring public confidence in the auditing

process and in the quality of that process Given this

intent, it is interesting to find that respondents consider

this attribute to be relatively less important in their

perceptions of audit quality

Implications

To date, there is limited empirical evidence of the attributes that affect perceptions of audit quality and limited evidence regarding the relative importance of those attributes for users of audit services The findings from this study are important because it is these percep-tions that determine the credibility of the audit report and are associated with confidence in the integrity of the financial reporting system This confidence is important

to capital market participants and plays a prominent role

in the effective allocation of economic resources (Coffee 2001; Monroe and Tan 1997; Wallman 1996)

The findings of this study have implications at an international level As previously indicated, corporate collapses and audit failures and the ensuing investiga-tions have resulted in significant changes to regulatory arrangements in an effort to enhance the reliability and credibility of financial statements (e.g., CLERP 9

in Australia, SOX in the US and the Combined Code

in the UK) More recently the GFC has seen policy makers again focus attention on the importance of

an effective audit function as a key component in

effective capital markets Examples include the Audit Quality in Australia – A Strategic Review (2010) by the

Treasury in Australia, the final report of the Advisory Committee on the Auditing Profession in the US and

the release in the UK of The Audit Quality Framework

(2008)

These reports have identified key drivers (indicators) central to achieving high audit quality and, in particular, have recognised the importance of the culture within au-dit firms and auau-dit partner and staff skills (i.e., auau-dit team attributes) as important drivers of audit quality The International Forum of Independent Audit Regulators (IFIAR) has also endorsed these drivers of audit quality These developments have further encouraged regulators and policy makers at an international level to focus

on these drivers of audit quality The findings of this study that users of audit services consider audit team attributes to be relatively more important than audit firm attributes in their perceptions of audit quality, will assist regulators and policy makers internationally to address any real or perceived threats to these drivers of audit quality

The findings also have implications for regulators, the accounting profession and audit firms The findings have implications for regulatory and professional bodies, which, in seeking to improve audit quality, have focused

on audit firm factors such as audit tenure (both firm and partner), the provision of NAS and audit quality assurance reviews This focus, however, has been

determined more by a priori arguments and normative

assertions than by empirical evidence (Schelluch and Thorpe 1995) The findings of this study provide direct

evidence that, relative to audit team attributes, the

only audit firm attributes relatively more important

in perceptions of audit quality are audit firm size and

audit firm industry experience The findings of the

study are therefore useful in assisting regulatory and

professional bodies in formulating policy based on

direct empirical evidence of the relative importance of

attributes perceived to affect audit quality by users of

audit services

The finding that, in general terms, audit team

attributes are relatively more important than audit

firm attributes is also relevant to audit firms in

communicating and promoting themselves with clients

and potential clients Despite the greater importance

accorded to audit team attributes, generally speaking,

users of audit services must rely on attributes they can

observe, particularly audit firm attributes (specifically

audit firm size) Nevertheless, the opportunity exists

for audit firms to make available through their

com-munications and promotions with clients, particularly

prospective clients, information about their audit team

and its characteristics Making audit team characteristics,

particularly those characteristics that have been found in

this study to be relatively more important in perceptions

of audit quality, more publicly visible and available to

clients may be a more effective means of demonstrating

and signalling audit quality than promoting audit firm

characteristics

This opportunity may be of particular importance to

mid-tier and local audit firms, who may differentiate

themselves and demonstrate audit quality through

emphasising audit team attributes such as the level

of partner involvement in the audit and their audit

teams’ knowledge both generally and in specific client

industries This may enable non-Big N audit firms to

signal to potential purchasers the quality of their services

and obtain fee premiums not previously available to

them

The findings also have implications for the literature in

terms of understanding the nature of audit quality First,

consistent with prior research, the study finds that audit

quality is perceived as a multi-dimensional construct

This was demonstrated by the relative importance

assigned by respondents to both sets of audit quality

attributes and the trade-offs they made within and

between these sets Second, the finding that audit team

attributes are perceived as relatively more important in

perceptions of audit quality than audit firm attributes is

consistent with the findings of Schroeder et al (1986),

Carcello et al (1992), Herrbach (2001) and Knechel

et al (2007) but inconsistent with the findings of

Warming-Rasmussen and Jensen (1998), who found

audit firm factors to be more important The

current study lends weight to the greater

per-ceived importance of audit team factors and

sup-ports the suggestion that the results of

Warming-Rasmussen and Jensen (1998) may have been culturally driven

Alan Kilgore, Renee Radich and Graeme Harrison are in the Department of Accounting and Corporate Governance

at Macquarie University.

Notes

1 The AQRB’s function is to review the systems, processes and controls applied by audit firms to ensure that they meet the independence and quality standards required in audits of listed entities.

2 The ACA system rescales utility data using a normalisation method termed ‘Zero-Centred Diffs’ so that each respondent has equal impact when computing average utility values for all respondents.

3 Horng (2005) indicates that due to the arbitrary origin within each attribute, the utility values of levels between attributes (e.g.,

‘Audit-partner tenure of 5 years or less’ versus ‘External quality assurance review’) cannot be directly compared Horng (2005) also points out that since utility values are interval data, they do not support ratio operations Therefore, when comparing utility values within the same attribute, a level with a utility value of

30 is not twice as desirable as a level with a utility value of 15 However, the directionality of attribute-level utility values does reveal the overall preferences of respondents for levels within an attribute For example, for the attribute ‘Audit firm size’ it can be concluded that, on average, respondents prefer a ‘Big N auditor’ (average utility value 52.86 in Table 3) to either a ‘Mid-tier firm’ (average utility value 8.64) or ‘Local firm’ (average utility value

−61.50)

4 Horng (2005) points out that, unlike average utility values, relative importance scores are ratio data, have a meaningful zero point and are relative to the other attributes Therefore, an attribute with a relative importance score of 20 is twice as important as one with a relative importance score of 10 The relative importance scores reported in Table 4 can be interpreted in the following way Using the attributes ‘Audit firm size’ and ‘Audit partner tenure’

as an example, the ‘Audit firm size’ attribute (relative importance score 13.63) is seen as being more than twice as important as the

‘Audit partner tenure’ attribute (relative importance score 6.39).

References

Advisory Committee on the Auditing Profession 2008, Final Report, Department of the Treasury, Washington Available at http://ustreas.gov

Ashton, R.H and Willingham, J.J 1988, ‘Using and Evaluating

Audit Decision Aids’, Auditing Symposium IX (University of

Kansas): Proceedings of the 1988 Touche Ross/University of Kansas Symposium on Auditing Problems School of Business,

University of Kansas, Kansas

Aspect Annual Reports Online Accessible at:

http:/www.aspectfinancial.com.au/af/home?xtm-licensee = annualreportsonline

Australian Financial Services Directory Accessible at: http://www.afsd.com.au/directory.htm

Australian Securities and Investments Commission 2007,

‘Policy Statement 187 Auditor Rotation’, Australian Securities

and Investments Commission, Sydney