Internal Control, Financial Reporting, and Corporate Governance of Smaller Firms

Authors

Tian Tian, Florida International UniversityFollow

Document Type

Dissertation

Degree

Doctor of Philosophy (PhD)

Major/Program

Business Administration

First Advisor's Name

Abhijit Barua

First Advisor's Committee Title

co-committee chair

Second Advisor's Name

Kannan Raghunandan

Second Advisor's Committee Title

co-committee chair

Third Advisor's Name

Silver Chung

Third Advisor's Committee Title

committee member

Fourth Advisor's Name

Maria Vulcheva

Fourth Advisor's Committee Title

committee member

Fifth Advisor's Name

Qiang Kang

Fifth Advisor's Committee Title

committee member

Keywords

internal control, financial reporting, corporate governance

Date of Defense

6-27-2022

Abstract

Prior studies have provided mixed evidence of the benefits of integrated audits (i.e., financial statement (FS) audits integrated with audits of internal control over financial reporting (ICFR)) relative to FS-only audits. In section one, I conduct a comprehensive study to understand the implications of integrated audit for FS audit quality with a sample of small firms comprised of small- and non-accelerated filers. Unlike large firms, small firms face less complexity in control environments, and there are other alternative mechanisms that operate (i.e., mandatory FS audit and management certified ICFR effectiveness) to enhance the firms’ internal control quality. Therefore, it is not apparent whether an integrated audit offers incremental value to small firms. I examine integrated audits’ effects on FS audit quality using not only widely used accruals quality measures but also measures based on auditor communication and investors’ perception. My empirical results show that integrated audits are superior to FS-only audits, which is inconsistent with the results provided in a recent study (Bhaskar, Schroeder, and Shepardson, 2019). As a robustness check, I match small- with non-accelerated filers based on year, industry, and size. With a matched control sample, I continue to find that integrated audits are associated with better accruals quality, receive more going concern audit opinions, and a lower cost of debt capital. The findings in this section provide input to the ongoing debate among policymakers, regulators, and academic researchers on the benefits of an ICFR audit for FS audit quality.

In section two, I examine integrated audits’ effects on FS audit quality after ICFR audit quality is controlled. To measure ICFR audit quality, I use Ge et al.’s (2017) prediction model and identification method to separate the firm-years with high-quality ICFR audits from those with low-quality ICFR audits. Then, I examine the association between ICFR audit quality and FS audit quality for a sample of small-accelerated filers, as well as compare the FS audit quality between small-accelerated filers with high-quality ICFR audits and non-accelerated filers. My empirical results show that: (1) for small-accelerated filers, there is a positive association between ICFR and FS audit quality when the latter is measured by the likelihood of receiving going concern audit opinions, and (2) compared to non-accelerated filers, small-accelerated filers with high-quality ICFR audits are more likely to have high-quality FS audits measured by the cost of debt capital. The findings in this section support my conjecture that integrated audits provide better audit outcomes than FS-only audits when ICFR audits are performed effectively. Further, it contributes to the ongoing debate about ICFR audits’ benefits and costs by showing that their quality determines the quality of FS audits.

In section three, I investigate the effects on small-accelerated filers of under-or over-assessment of control risks attributable to low-quality ICFR audits on auditor-client contracting decisions measured by audit fees, the likelihood of receiving going concern audit opinions, and the likelihood of auditor turnover. One of the ICFR audit’s objectives is to evaluate the risk that the existing internal control system is not likely to prevent misstatements in financial reports. Thus, if firms’ control risk is underestimated, the FS audit process is less likely to detect inherent weaknesses and irregularities in the financial reporting system and less likely to prevent misreporting, which may increase audit engagement risks and therefore affect the auditor-client contracting decisions. In contrast, if firms’ control risk is overestimated, the FS auditor is likely to conduct more substantive tests than necessary, which leads to over-audit that may have adverse effects on the audit-client relationship and therefore affect auditor-client contracting decisions. My empirical evidence shows that under- or over-assessment of control risks is associated with higher audit fees and more frequent auditor changes attributable to resignation. The results are consistent with my conjecture that under- or over-assessment of control risks attributable to low-quality ICFR audits increases audit engagement risks; thus, auditors choose to increase their audit effort, charge a risk premium, and resign from working with high-risk clients. This section provides evidence of the effect of control risks’ under or over-assessment on audit engagement risk and auditor-client contracting decisions, and contributes to the literature on ICFR audit quality.

Identifier

FIDC010106

Recommended Citation

Tian, Tian, "Internal Control, Financial Reporting, and Corporate Governance of Smaller Firms" (2022). FIU Electronic Theses and Dissertations. 4681.
https://digitalcommons.fiu.edu/etd/4681