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By Jason Bergner and Ling Lin

On December 4, 2013, the PCAOBconducted an open meeting toreconsider its proposal to require the disclosure of the engagement partner (and certain other participants) in the audit report, as part of its efforts to improve transparency. The PCAOB is carefully con- sidering the likely costs and benefits of this requirement before making a final decision (http://pcaobus.org/News/Speech/Pages/120 42013_Harris_Transparency.aspx). The authors present arguments for and against requiring audit partner disclosure and sum- marize the current practice and empirical findings in foreign jurisdictions, such as the EU and China. While the debate for the past five years has been an argument about the possible costs and benefits of a signature or disclosure requirement, the authors believe that the movement of the international community toward adopting common standards may eventually warrant a similar U.S. approach.

Debating the Issue The signature/disclosure requirement

has been an issue for almost a decade, first appearing on the PCAOB’s agenda in 2005 (Tammy Whitehouse, “Divided PCAOB Presses for Names in Audit Report,” December 4, 2013, Compliance Week, http://www.complianceweek.com/divided- pcaob-presses-for-names-in-audit-report/arti- cle/323604/). The current proposal to disclose of the engagement partner in the audit report stemmed, at least in part, from the 2008 Final Report of the Advisory Committee on the Auditing Profession (ACAP) (PCAOB Release 2011-007, “Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards and Form 2,” http://pcaobus.org/ Rules/Rulemaking/ Docket029/ PCAOB_ Release_2011-007 .pdf). That report con-

tained seven recommendations that the ACAP believed contained “room for improvement.” These recommendations were designed to be implemented in the short term and enhance the audit profession. The sixth of these recommendations was to “urge the PCAOB to undertake a stan- dard-setting initiative to consider mandating the engagement partner’s signature on the

auditor’s report” in order to increase trans- parency and accountability (Department of the Treasury, 2008, http:// www.treasury .gov/ about/ organizational-structure/ offices/ Documents/ final -report .pdf).

Accordingly, the PCAOB issued a concept release in July 2009 that would have required the lead engagement partner’s signature and the disclosure of other participants. This

Disclosure of the Engagement Partner in the Audit Report

An International Perspective on the PCAOB Proposal

A C C O U N T I N G & A U D I T I N G s t a n d a r d s s e t t i n g

original concept release resulted in 23 com- ment letters (Comment Letters for Docket 029, http://pcaobus.org/Rules/Rulemaking/Pages/ Docket029Comments.aspx). Respondents in favor of the release cited the following reasons: n Increased transparency will lead to increased accountability, which will in turn lead to higher audit quality. n It is common for executives to sign their names when acting on behalf of the entity (financing, purchasing, filing tax reports). n Interested parties can correspond directly with the signatory regarding par- ticular auditing questions, and track any relationship between signing partner and audit quality. n There is no justification for anonymity.

Respondents opposed to the release cited the following reasons: n The audit partner already has to sign off on files for reports to be issued and understands the strict sense of duty and the associated liability. n The existing accountability to the firm, SEC, and PCAOB is sufficient; the signa- ture requirement would not add incre- mental accountability. n The report is issued on the authority of the firm and not the individual; thus, the standard would mislead users into think- ing that the partner has the sole authority to issue the report. n There is the potential for increased lia- bility to the partners.

Some recent academic research supports the idea of the signature requirement leading to greater audit quality in the United Kingdom (J. Carcello and C. Li, “Costs and Benefits of Requiring an Engagement Partner Signature: Recent Experience in the United Kingdom,” Accounting Review, vol. 88, pp. 1511: 46, 2013), arguing that increased accountabil- ity theoretically should result in more conservative audit reports (J. Carcello and R. Santore, “Engagement Partner Signature Regulation: A Theoretical Analysis,” work- ing paper, University of Tennessee, 2010), and that auditors exhibit greater effort in an experiment where accountability is greater (T. DeZoort, P. Harrison, and M. Taylor, “Accountability and Auditors’ Materiality Judgments: The Effects of Differential Pressure S tr ength on Conservatism, Variability, and Effort,”

Accounting, Organizations, & Society, vol. 31, pp. 371–390, 2006).

Opponents, such as Ernst and Young (PCAOB 2013c) and KPMG (PCAOB 2013c), argued that audit partners (and their firms) are already accountable to a num- ber of bodies, including the rest of the firm, the PCAOB, and the SEC. Furthermore, opponents argued that requiring the part- ner’s public disclosure could have unin- tended negative consequences for the audit partner and mislead the public about the ultimate responsibility for the audit.

Following the receipt of the comment let- ters, the PCAOB took no further action; instead, it issued a proposal in 2011 that would have required the disclosure of the engagement partner’s name without requir- ing a signature (PCAOB Release 2011- 007). Of the 43 comment letters received, the arguments mirrored those of the 2009 concept release. Proponents often cited increased transparency and accountability, while opponents often cited accountability measures already in place. The PCAOB re- proposed the disclosure requirement in 2013, and stated that it believes that dis- closing an audit partner’s name, and not signature, would provide most of the same potential benefits while mitigating person- al liability concerns (Release 2013-009, “Improving the Transparency of Audits: P r opos ed A me ndme nts to PC AOB Auditing Standards to Provide Disclosure in the Auditor’s Report of Certain P ar ticipants in the Audit,” h t t p : / / p c a o b u s . o r g / R u l e s / R u l e m a k i n g / D o c k e t 0 2 9 / P C A O B % 2 0 R e l e a s e %20No%20%20 2013-009%20-%20 Transparency .pdf). It received another 67 comment letters in which proponents and opponents argued along the same lines of reasoning as the earlier proposals.

The International Scene The European Parliament passed the

Eighth Directive on Statutory Audits in 2006, which requires that engagement partners sign their names on audit reports. The member states of the European Union were required to adopt this standard by 2008, and they now follow the 2006 Statutory Audit Directive, instead of International Standard on Auditing (ISA) 700 (see Standing Advisory Group Meeting, Panel Discussion— Signing the Auditor’s Report, 2008, http://pcaobus.org/News/Events/Documents

/10222008_SAGMeeting/BP_Signing_Audit or_Report.pdf). Outside of the EU, Australia and China also require the auditor to sign the audit report. Although the experience of these countries cannot be a perfect predic- tor of what would happen in the United States, they can offer insights into the poten- tial effects of the PCAOB’s proposal.

In Sweden, researchers have studied investor reaction to the disclosure of spe- c ific pa rtne rs (W .R . Kne c he l, A. Vanstraelen, and M. Zerni, “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions,” working paper, University of Florida, 2013). The researchers examined audits of different companies across indus-

tries that were headed by the same part- ners. They found that the pattern of audit reporting, whether aggressive or conserva- tive, persisted over time and extended to other clients of the same partner. Their results show that not only do investors look for patterns of named audit partners as being primarily aggressive or conservative, but also these investors penalize the clients of firms with aggressive audit partners. As a result, these companies face higher borrowing costs than companies with conservative auditors.

In China, it also appears the individu- al partner disclosure has an effect. Researchers there have found that the

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effects that individual auditors have on audit quality are statistically and eco- nomically significant (F. Gul, D. Wu, and Z. Yang, “Do Individual A uditor s Affect Audit Quality? Evidence from Archival Data,” Accounting Review, vol. 88, pp. 1993–2023). They investigated approximately 800 individual auditors in China and found that auditors exhib- ited significant variability in audit quali- ty, distinct from effects at the firm level, office level, or client side; this was found with respect to both small and large audit firms. Furthermore, they found that the variation in quality could only partially be explained by educational level, expe- rience with a large firm, or other such factors. Their empirical test results lend support to the disclosure of the partner’s name to the market.

While these two international studies offer interesting results, it is important to note the uniqueness and limitations of the studies. The Chinese study used sev- eral proxies for audit quality, while the Swedish study focused on the context of the issuance of a going concern opinion. The use of a going concern opinion (employed by both studies) may not be representative of the greater concern about audit quality. In fact, the PCAOB has noted that they are more concerned about subtle ways in which auditor objec- tivity is compromised (Transcript of pub- lic meeting on auditor independence and audit firm rotation, http://pcaobus.org/ Rules/Rulemaking/Docket037/2012- 3-21_Transcript-Notice.pdf.). These stud- ies are based outside the United States and may not be representative of the con- sequences of adopting partner disclosure in this jurisdiction. As more countries adopt the partner disclosure standard (or some variant thereof) over time, the amount of data available for study will increase. Future studies may be able to use more subtle measures of audit qual- ity in markets that share more character- istics with the U.S. market.

Despite their limitations, disclosure advocates advance these international r e s u l t s i n t h e i r a r g u m e n t s f o r t h e PCAOB’s proposal. PCAOB Chairman James R. Doty, for instance, said that the capital markets know that not all audit quality is identical, and they are willing to pay more for reliable audits, in the

form of reduced financing costs for com- panies of which audit reports are more reliable (Statement on the reproposal, 2013, http://pcaobus.org/ News/ Speech/ Pages/ 12042013_Doty_ Transparency .aspx). Doty’s views, however, should not be taken to represent all of the board’s members.

For example, Jay Hanson, also a board member, has “strong reservations about the proposal,” stating “that my concerns about this aspect of the reproposal are significant, because, based on what we know, I believe the potential costs associated with requir- ing this disclosure in the audit report may f a r o u t w e i g h t h e m o r e l i m i t e d benefits” (Statement on the reproposal, http://pcaobus.org/News/Speech/Pages/120 42013_Hanson_Transparency.aspx, 2013). Hanson has called into question the potential associated costs of implement- ing the partner disclosure standard. He and others are concerned about increased costs for firms under the proposed require- ment, with specific mention of potential increased personal liability and unneces- sary audit procedures performed as part of “defensive audits” (Comment letters for Docket 029).

The Costs of Enhancing Audit Quality Even those who protest against the pro-

posal state their support of more transpar- ent audits and higher audit quality. The debate about the current proposal boils down to two questions: 1) Would the pro- posal enhance audit quality? and 2) Would the increased costs (assuming there are any) justify the requirement?

The benefit of the disclosure requirement rests primarily on increased accountability. At its core, it is a social instrument aimed at mitigating unconscious biases. When a decision maker’s identity is undisclosed to viewers of the information (i.e., financial statement users), the decisions being made may be biased toward those with whom the decision maker has strong social ties. Requiring the lead engagement partner’s name to appear on the publicly disclosed audit report would identify that partner, and identifiability has been shown in social psychology experiments to mitigate uncon- scious biases (M. Dobbs and W.D. Crano, “Outgroup Accountability in the Minimal Group Paradigm: Implications for Aversive Discrimination and Social Identity Theory,”

Personality and Social Psychology Bulletin, vol. 27, pp. 355–364, 2001).

Although this proposal describes accountability in a general sense, it is really aimed at identifiability, which is one of four subtypes of accountability (P. E. Tetlock, “Accountability and Complexity of Thought,” Journal of Personality and Social Psychology, vol. 45, pp. 74–83, 1983). As its name would suggest, identi- fiability is aimed at making the decision maker identifiable to others (i.e., financial statement users). The theory suggests that people will make decisions in a more unbi- ased (i.e., independent) manner when they know in advance that they will be identifiable to others.

While the psychology research shows that identifiability decreases bias, the weakness of these studies is that they are performed in a vacuum; that is, no other accountability measures exist. In the audit context, however, there are already many other accountability measures in place. Thus, the argument is whether the partner disclosure requirement will add any incremental benefit to measures already in place. Despite the accountabil- ity already provided through a firm’s system of quality control, there are dif- ferences in terms of audit quality at the office level (J. Francis, “What Do We Know about Audit Quality?,” British Accounting Review vol. 36, pp. 345–368, 2004). The logic that follows suggests that there might also be differences at the part- ner level.

Because users already know the office that signs off on the financial statements, there might be little more to be learned by pushing down to the individual partner level. The research cited in non-U.S. coun- tries from earlier in the article suggests that going down to the individual auditor level would bring incremental benefits. The authors believe that, as the history of an engagement partner develops, financial statement users will learn more about the audit experience, industry specialty, and eventually the reputation of each engage- ment partner. They will incorporate this information when judging audit quality and react to patterns of aggressiveness and conservatism accordingly. In the long run, the authors believe that the disclosure of an engagement partner’s name will bene- fit financial statement users at large.

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However, such benefits come with costs. Tying engagement partners’ repu- tations to the audits they oversee would encourage them to require more evidence to support the audit opinion. Therefore, audit fees will likely increase due to longer hours spent by the audit team. Furthermore, the accounting profession, including all of the Big Four, voiced their concerns that litigation against the engagement partner would be encouraged by the disclosure requirement (Comment Letters for Docket 029). If their concerns were to be found accurate, highly qual- ified individuals might become reluc- tant to take on the role of engagement partner in the absence of increased compensation. As a consequence, audit fees would likely increase.

What may ultimately move the dis- closure requirement from proposal to real- ity is not a clear resolution of the cost-benefit argument, but rather con- vergence with international standards. The International Auditing and Assurance Standards Board has released a proposal requiring the disclosure of the engage- ment partner’s name. If adopted, it would align the requirements for the interna- tional community to require disclosure with those of the EU, China, and others; this could move the United States toward adoption of such a standard. As PCAOB Board member Lewis H. Ferguson noted, “If that is adopted, as it is likely to be, that will become binding on the many countries around the world that will fol- low those standards. If we don't move in this way, the United States will be an out- lier. I don't think we should be an outli- er on an issue like this” (Oral statement on the reproposal, http:// pcaobus.org/ N e w s / S p e e c h / P a g e s / 1 2 0 4 2 0 1 3 _ Ferguson_oral.aspx, 2013). q

Jason Bergner, PhD, is an assistant professor in the college of business at the University of Nevada, Reno. Ling Lin, DBA, is an assistant professor of accounting in the department of accounting and finance at the Charlton College of Business, University of M a s s a c h u s e t t s D a r t m o u t h , N o r t h Dartmouth, Mass. The authors would like to thank Krishnagopal Menon, edi- tor, for his helpful comments.

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