News media provides important oversight of Big Four, study says
The national news media can function as a kind of oversight body for Big Four audit firms, according to a new academic study.
The Big Four have found themselves facing unwanted scrutiny as a result of a series of accounting scandals at client companies in the U.S. and other parts of the world. The study, which is expected to be presented at online meetings of the American Accounting Association in January, found that “clients, investors, and regulators can use coverage from national news outlets as one way to anticipate changes in auditors’ behavior. Specifically, we find that auditor attention and audit quality improve in the year following the revelation of negative audit news, which could be useful in clients’ auditor selection and retention decisions, investors’ investment decisions, and regulators’ selection of engagements for inspection.”
The study, co-authored by Elizabeth Cowle, Caleb Rawson and Stephen Rowe of the University of Arkansas, used the news-monitoring search engine Factiva to search for articles from 2004 to 2019 from news outlets including The Wall Street Journal, The New York Times, the Washington Post, the Chicago Tribune, Forbes, The Economist, Economic Times, Kiplinger, Accounting Today, Wired and CFO Magazine, along with the names of the Big Four — Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers, and abbreviations like EY and PwC.
The study found that when media coverage from these outlets includes issues specific to the audit opinion — including financial restatements, adverse internal control opinions, fraud — audit firms have responded by increasing the amount of attention they give to audits, along with increased fees, reporting delays and late filings. “We find that this is amplified among clients with issues similar to those discussed in the media coverage,” said the study. “In contrast, we find that when news coverage does not relate to audit reporting decisions, firms decrease fees and issue audit opinions sooner.”
The researchers also interviewed some auditors for the study. “No [audit] firm wants to end up on the front page of The Wall Street Journal,” said one anonymous Big Four audit partner.
Not only the firm that’s the subject of an article is affected by the negative news coverage. Additional analysis by the researchers found that audit firms respond to high levels of news coverage at their peer firms. That suggested to the researchers that firms try to preemptively manage their reputation even when they’re not under direct media scrutiny, and negative news has significant costs for the firms’ client growth and retention.
“Collectively, our evidence suggests that the news media functions as an effective informal oversight mechanism of auditing firms by driving increased auditor attention and improved audit quality,” said the study.
The paper also raises concerns about the vanishing number of media jobs in newsrooms across the country. The AAA noted that newsroom employment in the U.S. dropped by 23 percent from 2008 to 2019 according to Pew Research, and the U.S. Bureau of Labor Statistics projects an 11 percent decline in reporters, correspondents and broadcast news analysts over the next 10 years. When newsrooms permanently shed jobs, it is not just harmful to journalists, it’s also dangerous for members of the greater business community who often rely on oversight from national news outlets to make, and monitor, their investment decisions, according to the AAA. The research offers evidence that the national news media serves another vital role to companies, investors and regulators: policing audit firms.
The findings suggest “the news media functions as an effective informal oversight mechanism of auditing firms by driving increased auditor attention and improved audit quality.”
The researchers found that a 5 percent increase in the amount of negative news coverage equates to roughly a 3.5 percent increase in audit fees for clients of that auditor, which is comparable to auditor response to inspection findings from the official oversight body, the Public Company Accounting Oversight Board. Their findings suggest coverage from the news media ultimately offers numerous benefits to the business community and “could be useful in clients’ auditor selection and retention decisions, investors’ investment decisions, and regulators’ selection of engagements for inspection.”
“What our study suggests is that cutting business journalist jobs is akin to cutting jobs from the PCAOB, or the SEC, which should be of extreme concern to investors, clients and regulators,” said one of the researchers, Professor Rowe.
He believes the study’s findings shouldn’t surprise many auditors. “In the informal conversations we have had with practitioners, we’ve often found there are already directives in place to monitor and respond to news coverage from a national office perspective,” Rowe said in a statement. “What we do is provide confirmation that this type of news coverage has significant effects on auditor reputation, which is already a concern for many in the audit profession. What’s perhaps even more concerning is that such negative news coverage could have second- or third-order effects in affecting the ability of the profession to continue to attract top talent.”
The study also found negative news bears significant costs for audit firms as far as client retention and growth. Clients are less likely to engage audit firms that have received high amounts of negative news coverage and they’re more likely to switch away from audit firms that have received high negative news coverage. Audit firms experience overall lower client growth in the period after negative news coverage.
“The decline of business journalism, coupled with proposed legislation to weaken formal auditor oversight, should be of serious concern not only to the business press but to the greater business community which relies on them to police the audit market,” Rowe said in a statement. “To anyone who believes in the value of oversight, this should be concerning.”
The paper will be among hundreds of scholarly studies presented at the AAA’s auditing and financial accounting and reporting midyear meetings, along with the Hawai’i Accounting Research Conference, which are expected to attract over a thousand scholars and practitioners in January. The conferences will be held online due to the ongoing coronavirus pandemic.