On the nature of auditing: The audit partner effect : Research on the effect of individual audit partners on audit quality and the information dynamics of accounting data

This doctoral thesis is about whether auditing is ‘static and mechanic’ of nature or the opposite: ‘dynamic and organic’. If auditing is considered ‘static and mechanic’ of nature, this implies that standard audit solutions are available and can uniformly be applied by the audit partners. Moreover, it suggests that the level of audit quality can be guaranteed to a large extent by the audit firm’s control and governance structures. In such an environment, audit firm size and the actual audit quality delivered may be highly correlated and form a reliable measure for capital markets to assess audit quality (DeAngelo, 1981b). However, if auditing is considered to be ‘dynamic and organic’ of nature, this suggests that no standard audit solutions are available, and that the level of audit quality delivered depends on the capabilities, motivation and effort of the individual audit partners and their audit teams. In this study, two fundamental questions are examined. First, do differences in audit quality amongst audit partners matter? Second, are differences in audit quality influenced by strategic choices of audit partners to develop their own business cases? If the answer to both questions is affirmative, the nature of auditing is considered to be ‘dynamic and organic’. The benchmark for audit quality is in this study the level of usefulness of audited financial statements for economic decision-making. To ascertain the external validity of the results, the empirical research is performed on a dataset of 378 Dutch municipalities (period 1999-2005) and 743 European listed companies (period 1997-2005). The results presented below are consistent for both datasets. The answer to the first question is found by examining whether large audit firms – which are assumed to be a uniform group of high quality auditors– deliver a homogenous level of audit quality. The results show that statistically significant audit quality differences are observed amongst the large audit firms. These results imply that audit firm size is not a very reliable proxy for audit quality. To examine whether these differences in audit quality amongst large audit firms is due to differences in internal control and governance, I tested the degree of homogeneity of audit quality within large audit firms. The results suggest that 23% (Dutch municipalities) to 49% (European listed companies) of the audit partners deliver a level of audit quality which is of statistically significant difference compared to the audit firm’s average level of audit quality. These results do not support the assumption that large audit firms are very successful in governing their audit quality. On the contrary, I conclude that the average level of audit quality delivered by an audit firm is the bottom-up aggregation of audit quality delivered by individual audit partners. The second question deals with whether the audit partner’s business case affects the level of audit quality delivered. Audit partners are expected to develop an audit partner business case in order to survive the highly competitive audit markets, and to meet the audit firm’s profit and revenue targets. I assume three principal audit partner business cases, resulting in three audit partner archetypes, namely the liberal, conservative and the high quality audit partner. The liberal audit partner is expected to specialize in the auditing of financial statements with a relatively high risk profile and charges the highest audit fees in order to reduce the audit risk to an acceptable low level. Second, the high quality audit partner is expected to specialize in high quality audits that maximize the usefulness of financial statements. High quality audit partners are expected to charge relatively high audit fees in order to guarantee the high level of audit quality delivered. The third audit partner archetype is the conservative audit partner, who is expected to specialize in low budget auditing which can be achieved by minimizing risks in the financial statements in order to reduce the audit risk. Hence the audit partner is able to reduce audit effort and charge relatively low audit fees. However, I suppose that the extent of achieving the audit partner business case –and the corresponding extent of commercial success– depends on the audit partner’s technical and communication capabilities. The existence of the three audit partner archetypes and the corresponding business cases is supported by empirical evidence. Therefore, I conclude that the level of audit quality is systematically affected by the business case of an audit partner. Based on these results, I conclude that the nature of auditing is primarily ‘dynamic and organic’, indifferent to variables such as country, audit firm or the applied setting of Dutch municipalities and European listed companies. This study shows that the very nature of auditing is primarily dictated by ‘humaneness’; human capabilities and human behavior.