Research on disclosure of audit partner names

Another regulatory reform is to disclose audit partner names in either audit reports or a special form. Lead engagement partners’ names are required to be disclosed publicly in Form AP (auditor reporting of certain audit participants) in the U.S.

The PCAOB former Chairman Janies R. Doty believes that auditing is a profession built on reputation, and one important way investors can assess the quality of an audit is to know who conducted that audit. Form AP will provide that important information to investors.

Disclosing partner identification may enhance the transparency and accountability of engagement partners. Transparency is improved because the identification disclosureestablishes the link between the reputation of engaging partners and realized audit outcomes. With that information, investors may learn and access the abilities of audit partners and thereby make capital investment decisions efficiently. In the presence of investors’ assessment, audit partners are incentivized to build their reputation, thereby improving the quality and accountability of audit services.

According to three theory papers, Lee and Levine (2016), Basu and Shekhar (2019), and Deng et al. (2019), disclosing partner names is not all beneficial. Lee and Levine (2016) consider the trade-off between individual partners’ incentives to provide high-quality audits and the partnerships’ incentives to reduce good internal controls. Basu and Shekhar (2019) show that while the higher reputation incentives can improve audit quality, partners have a lower incentive to monitor other partners when names are disclosed. Deng et al. (2019) build a two-period matching model and demonstrate that audit partner identification can reduce audit value if we consider the disclosure effect on the labor market for audit talent. In their model, there are two audit partners and two clients. One partner is better able to detect material misstatements than the other. One client is complex and the other is simple. The best match would be where the higher-ability partner audits the complex client and the lower-ability partner audits the simple client. When partners’ names are not disclosed to the public, the best match will occur and overall audit quality for these two engagements are high. Audit quality is lower if the high-ability auditor engages the simple client and the low-ability auditor engages the complex client. When their names are disclosed, the labor market will be able to learn which partner is of higher ability than the other. The partners who successfully audited the complex client will have better job opportunities in the second period. In a decentralized assignment in which partners directly bid for clients, they find that the disclosure gives rise to lowballing (the audit fee is lower than its cost) in the first period, because partners aggressively lower the audit fees to maximize their career advancement. In a centralized assignment in which an audit firm assigns partners to clients, with the disclosure, audit firms may distort partner assignment at the expense of lower audit quality in order to dampen partners’ career advancement. Their analysis highlights a possible unintended consequences of partner identification policy by considering the labor market.

Empirical research on the impact of such a disclosure on audit quality provides mixed evidence in the U.S. Abbott et al. (2018) document a reduction in the propensity to issue a going concern modification in the disclosure regime. Burke et al. (2018) find that the disclosure requirement has a positive association with audit quality and audit fees and a negative association with audit delay. Cunningham et al. (2019) does not find consistent evidence of a change in audit quality or fees following mandatory partner identification. Gipper et al. (2018) find that low-quality audits give rise to early engagement partner rotations and have career consequences for partners.

Moreover, there are experimental studies examining the potential effects of disclosing critical audit matters (CAMs) on auditor legal exposure and investor decisions. Christensen et al. (2014) find that investors who receive a CAM paragraph are more likely to change their investment decision than are investors who receive a standard audit report (an

information effect) or investors who receive the same CAM paragraph information in management’s footnotes (a source credibility effect). They also find that the effect of a CAM paragraph is reduced when it is followed by a paragraph offering resolution of the critical audit matter. Gimbar et al. (2016) assert that jurors perceive precise accounting standards to constrain auditors’ control over financial reporting outcomes, resulting in a lower propensity for negligence verdicts when the accounting treatment conforms to the precise standard. They find that the use of either imprecise standards or critical audit matters reduces the extent to which jurors perceive this constraint to exist, leading to increased auditor liability. Kachelmeier et al. (2019) provide experimental evidence suggesting that CAM disclosures in the auditor’s report involving areas of high measurement uncertainty forewarn users of misstatement risk (the risk that the financial statements contain material misstatements). They support the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM-related material misstatements.