Bertrand Malsch and Oriane Couchoux on audit committees and audit quality
Audit quality is a three-legged stool involving auditors, management, and audit committees, meaning that high quality audits can only be achieved through the collaboration of all three parties. Accordingly, various interrelated regulatory measures targeting concurrently the work of audit committees and auditors have been adopted over the last two decades to restore confidence in the audit function. In this contribution, we discuss the discrepancy observed between the ongoing cultural transformation of public accounting firms, under the pressure of independent audit regulators, and the cultural and regulatory stagnation of audit committees. We argue that this discrepancy jeopardizes the effort to improve the quality of audited financial information provided to market participants.
The path to partnership within firms has been frequently accused of being colonized by a reward structure mainly based on billable hours and profit. Critics claimed that aspiring partners were pushed to embody a commercially oriented image of professional success to the detriment of audit quality and public interest, which materialized in an adherence to the “customer is king” motto. The negative consequences of this culture have been largely acknowledged, with the understanding that high-quality audits could not be achieved without a significant change in the way auditors are trained and promoted. For instance, the Public Oversight Board in the U.S., in its early days, urged firms’ leaders to communicate “a positive constructive message” internally that would celebrate “taking difficult stands on earnings management issues” regardless of client preferences.
Almost two decades later, the assessment of culture and leadership tone has become a standard procedure in audit inspections. A handful of recent studies point to a positive cultural inflection at the top of the firms, with new types of quality-related controls and accountability mechanisms being implemented by firms at different levels (Johnson, Keune, and Winchel 2019; Westermann, Cohen, and Trompeter 2019). Regulators also seem to be witnessing this evolution. For instance, the director of the division of inspections at the PCAOB publicly acknowledged “a change in tone and culture at a number of firms” (PCAOB 2017). Our research in the Canadian regulatory space highlights a similar cultural shift triggered by a renewed emphasis on technical skills and quality in processes of evaluation and promotion. In other words, the ability of audit partners and aspiring partners to navigate inspections successfully and achieve high-quality audits is now supported, celebrated, and rewarded.
By contrast, the regulatory reforms that have assigned additional responsibilities to audit committee members and set specific requirement in terms of expertise and independence appear to have been less transformational. For instance, a shared belief among directors is still that “their primary role is to develop and support management” (Boivie et al. 2021, 3) rather than monitor them. Our recent interviews with audit committee members of publicly listed Canadian companies allowed us to identify four predominant and problematic opinions with respect to how they perceive and enact their monitoring role: 1) They do not believe they possess the financial and accounting expertise that matches the complexity of current financial reporting and audit processes and tend to rely, sometimes blindly, on management’s and auditors’ knowledge and conclusions; 2) They consider that the responsibility for high-quality audit rests primarily with management and auditors; 3) They view independent audit inspections as a regulatory issue that is mainly, if not exclusively, the concern of auditors and are quite skeptical about the overall impact of inspections on audit quality; 4) They are reluctant to support an increase in audit fees resulting from additional audit work arising from inspection requirements and recommendations.
These opinions reveal the existence of important barriers to the achievement of a sustainable culture of audit quality: 1) The collaborative efforts required to address complex and sensitive audit matters appear to be compromised. Audit partners are unlikely to establish meaningful communications with audit committee members if the latter do not feel concerned by inspection processes and disengage from the technical substance of auditing; 2) The lack of shared accountability between audit committee members and auditors generates frustration among audit teams, especially when the client is directly and partially responsible for some of the quality deficiencies identified in the inspection reports; 3) The flatness of audit fees sends a mixed message about the primacy of audit quality over commercial considerations, as auditors are asked to do more with less resources. Too much pressure on the profitability structure of the audit industry is not healthy.
To conclude, we maintain that the audit industry and the public cannot afford for the threelegged stool of audit quality to remain wobbly. We suggest three courses of action to help repair the stool. First, regulators need to provide much more specific guidelines about how audit committee members should perform their role and mobilize their expertise to fulfil their monitoring function. Second, independent audit inspections should adopt a broader view of the audit engagement by considering the role and responsibility of clients and audit committees when identifying audit deficiencies and designing solutions. Third, the ability of audit committees to deal with the increasing complexity of financial reporting and auditing standards needs to be reassessed. A more realistic view of what audit committees can actually understand and monitor might help avoid the side effect of the illusion of control and expertise.
References
Johnson, L. M., Keune, M. B., & Winchel, J. (2019). US auditors’ perceptions of the PCAOB inspection process: A behavioral examination. Contemporary Accounting Research, 36(3), 1540-1574. PCAOB. 2017. Building a Foundation for Audit Quality. Speech delivered at the AICPA Conference on Current SEC and PCAOB Developments, December 6. Available at: https://pcaobus.org/News/Speech/Pages/Munter-Building-A-Foundation-for-Audit- Quality.aspx (last accessed November 2, 2020). Westermann, K. D., Cohen, J., & Trompeter, G. (2019). PCAOB inspections: Public accounting firms on “trial”. Contemporary Accounting Research, 36(2), 694-731.