Understanding Audit Quality:

Insights from Audit Partners and Investors

Brant E. Christensen
Mays Business School
Texas A&M University
bchristensen@mays.tamu.edu

Steven M. Glover
School of Accountancy
Brigham Young University
glover@byu.edu

Thomas C. Omer
School of Accountancy
University of Nebraska-Lincoln
thomas.omer@unl.edu

Marjorie K. Shelley
School of Accountancy
University of Nebraska-Lincoln
shelley@unl.edu

January 2014

Acknowledgements: We thank the six participating audit firms and the Center for Audit
Quality’s Research Advisory Board for helping to refine our study materials and for funding this
project. We also thank Tara Voskamp for assistance in identifying investor participants. We are
grateful for helpful comments from Jean Bedard, Kathleen Bentley, Liz Carson, Brian Fitzgerald,
Karla Johnstone, Andrew McMartin, Jeff McMullin, Jeff Pickerd, Nate Sharp, Kecia Smith,
Frances Tice, Ken Trotman, Chris Wolfe, and workshop participants at Texas A&M University,
Australian National University, the University of New South Wales, the 2013 Texas A&M FDS
Conference, the 2013 BYU Accounting Research Symposium, and the 2014 Audit Midyear
Meeting. Brant Christensen acknowledges funding from the Deloitte Foundation, Steven Glover
acknowledges funding from the Driggs Endowed Professorship, and Thomas Omer
acknowledges funding from the Delmar Lienemann Sr. Chair of Accounting at the University of
Nebraska-Lincoln. The views expressed in this article and its content are those of the authors and
not those of the Center for Audit Quality or the participating firms.
 Understanding Audit Quality: Insights from Audit Partners and Investors

Abstract: The PCAOB provides information regarding audit quality through the release of its
inspection reports, and the Board has recently discussed establishing audit quality indicators. To
provide more inclusive evidence on audit quality, we obtain and analyze auditors’ and investors’
views, definitions, and potential measures of audit quality. We find differing definitions of audit
quality between auditors (GAAS compliance) and investors (individual auditor competence), as
well as differing views on the relation between PCAOB inspections and audit firm quality. We
find agreement that auditor characteristics may be the most important determinants of audit
quality, and that restatements may be the best available signal of low audit quality. We relate
responses to a generally accepted audit quality framework and provide support for archival audit
research. Taken together, we provide evidence regarding the construct of audit quality in the
post-SOX environment, add substance to existing theoretical frameworks, and suggest avenues
for future research.

Keywords: Audit quality, audit quality indicators, PCAOB inspections, survey

Data Availability: Contact the authors.

 Understanding Audit Quality: Insights from Audit Partners and Investors

I. INTRODUCTION

Auditing standards require auditors to plan and perform audits to obtain reasonable

assurance about whether or not the financial statements are free of material misstatements and to

express an opinion about the accuracy of the financial statements (PCAOB 2010a).1 The degree

to which financial statement users can rely on an audit opinion depends on the quality of the

audit performed. Despite the importance of audit quality to the stability of the capital markets,

and the large body of research investigating the topic, regulators, investors, and researchers

continue to debate the definition, composition, and measurement of audit quality (Bedard et al.

2010; Defond and Zhang 2013; Francis 2011; Knechel et al. 2013).

Projects seeking to define, measure, and evaluate audit quality are on the agendas of the

International Auditing and Assurance Standards Board (IAASB 2013), the U.S. Department of

the Treasury (2008), the Public Company Accounting Oversight Board (PCAOB 2012a, 2013),

and the Center for Audit Quality (CAQ 2012, 2013a), as well as audit firms themselves (e.g.,

KPMG 2011). PCAOB board member Jeanette Franzel has listed the task of assessing and

tracking audit quality as the Board’s top priority (Franzel 2013). Given the increased interest in

audit quality, this study seeks to elicit insights on audit quality from both auditors and

investors—two key stakeholders in the financial reporting process that research has shown have

different expectations of the audit process.2

1
The PCAOB has defined “reasonable assurance” as “high” assurance (PCAOB 2004a).
2
We use the term “auditors or “audit professionals” throughout the paper to describe both partner and senior
manager participants; over 80 percent of our survey responses are from partners. Untabulated analysis indicates that
partners’ and senior managers’ responses are not statistically different (p > 0.10 in all comparisons). Further, we use
the term “investors” throughout the paper to describe our investor participants. While these participants are not
professional investors, their educational background and reported investing experience suggests they are
experienced and knowledgeable investors. See Section III for additional details.

1
 The PCAOB informs stakeholders in the audit process about the quality of audit

engagements through its release of Parts 1 and 2 of its inspection reports. Further, other PCAOB

releases provide instruction to audit committee members regarding matters to discuss with their

auditor (PCAOB 2012b). To provide additional information about the audit process and audit

quality, the PCAOB has also initiated its own project to define and measure audit quality

(PCAOB 2013). Because the PCAOB has initiated this discussion, it is likely to influence

expectations about audit quality; it is unclear, however, whether their efforts will align auditors’

and investors’ views on audit quality and thus narrow the “expectations gap” between auditors’

and investors’ expectations of the audit function (Church et al. 2008; Maijoor et al. 2002; Mock

et al. 2012). This study provides insights on the issue of audit quality using audit professionals’

and investors’ survey opinions and in-depth interviews to 1) inform the public debate on audit

quality, 2) provide evidence that contributes to the task of understanding and defining audit

quality, and 3) provide a benchmark for the extent of alignment between auditors’ and investors’

expectations about audit quality prior to potential efforts by standard setters and regulators to

establish a common definition and expectation for all parties involved.

We use a survey to obtain audit professionals’ and investors’ insights into audit quality

by asking participants to define and measure audit quality; evaluate the association of various

engagement-, team-, and entity-specific characteristics with audit quality; evaluate the

association between PCAOB inspection findings and the quality of the audit firm as a whole; and

identify publicly available signals of low audit quality. Previous studies have used surveys of

auditors, financial statement users, and preparers to rank various audit characteristics with

respect to their importance in determining audit quality (e.g., Carcello et al. 1992; Schroeder et

al. 1986). However, these surveys were conducted before the Sarbanes-Oxley Act of 2002 and

2
the creation of the PCAOB, which fundamentally changed the audit industry. This study

examines audit quality in the current regulatory and inspection environment. We find that audit

professionals define audit quality primarily in terms of compliance with professional auditing

standards, whereas investors rely more on the individual characteristics of the auditors and audit

teams that perform the audit. In terms of engagement-specific characteristics of audit quality, we

find that both audit professionals and investors perceive characteristics of the audit opinion,

outcomes from the review process, and the payment of reasonable audit fees as pertinent to

determining audit quality. When examining characteristics at the engagement team level, we find

almost unanimous agreement that individual auditor characteristics impact audit quality.

Additionally, we find evidence that input from parties outside the core engagement team such as

the national office and engagement review partners is an important attribute of audit quality. We

also find evidence that client-specific characteristics such as restatements, SEC enforcement

actions, and the frequency of audit committee meetings are significant attributes of audit quality.

Finally, we find evidence of an unintended interpretation of PCAOB inspection reports and that

auditors and investors view financial statement restatements as one of the strongest publicly

available signals of low audit quality.

This study provides evidence that supplements public discussion of the meaning of audit

quality in the post-Sarbanes-Oxley era and contributes to the theoretical frameworks that

describe audit quality (e.g., Francis 2011, Knechel et al. 2013). Our results provide evidence on

many of the audit quality indicators currently proposed by the PCAOB as well as suggest

additional disclosures that may prove useful in communicating audit quality. Further, our study

responds to the call in Francis (2011) for research that improves our understanding of the audit

3
process and the key inputs to that process. Finally, our study provides support for archival

proxies of audit quality discussed in DeFond and Zhang (2013).

The remainder of this paper is organized as follows. Section II discusses relevant

background literature, the survey instrument design, and the data collection process, and Section

III describes our survey participants. Sections IV through VIII discuss our audit quality findings

and Section IX concludes.

II. BACKGROUND LITERATURE AND DATA COLLECTION

Background Literature

Prior archival studies use a variety of proxies for audit quality, including client financial

statement restatements, audit fees, going concern opinions, lawsuits filed against auditors, client

bankruptcies, level of abnormal accruals, and SEC enforcement actions (e.g., Carcello and Nagy

2004; Francis et al. 1999; Francis and Michas 2012; Lambert et al. 2011; Lennox 1999; Palmrose

1998; Stanley and DeZoort 2007). The number of different proxies used to represent the

construct of audit quality indicates the diversity of views among researchers regarding what

constitutes a reliable measure of audit quality. We argue that surveys can serve an important role

in gaining understanding and insight into unobservable theoretical constructs, such as audit

quality, that prompt a diversity of representations in archival research (Dichev et al. 2013;

Nelson et al. 2002).

Auditors have been surveyed on earnings management (Nelson et al. 2002), the effect of

auditor behavior on audit quality (Herrbach 2001), the effect of budget time-pressure on audit

quality (Coram et al. 2003), in-person versus electronic review (Agoglia et al. 2010), audit

partner rotation (Daugherty et al. 2012), and auditor identification of fraud risks (Graham and

Bedard 2003). Previous studies have also used surveys of auditors, financial statement users, and

4
preparers to rank various audit characteristics (e.g., industry specialization, auditor

independence, provision of non-audit services, etc.) with respect to their importance in

determining audit quality (Carcello et al. 1992; Schroeder et al. 1986). Similarly, Duff (2004)

conducted a survey of U.K. auditors, finance directors, and fund managers to rank the

importance of characteristics identified in the audit quality literature as determinants of audit

quality. However, none of these studies solicited auditors’ opinions on audit quality beyond the

pre-determined characteristics presented in the survey. Further, previous surveys were conducted

before the Sarbanes-Oxley Act of 2002 and the creation of the PCAOB fundamentally changed

the audit industry in the U.S. As a consequence, research eliciting clarifying input about the

definition and determinants of audit quality in the current regulatory environment from the

perspectives of both auditors and investors is scarce.

Rather than treating audit quality as a single overarching construct, several recent

academic papers have provided theoretical frameworks outlining the components of audit

quality, (e.g., Bedard et al. 2010; DeFond and Zhang 2013; Francis 2011; Knechel et al. 2013).

These frameworks discuss dimensions of audit quality such as audit inputs (e.g., expertise), audit

processes (e.g., auditor judgments and work performed), outputs and opinions (e.g.,

restatements), and audit contexts (e.g., auditor tenure). In addition to these academic

frameworks, the CAQ, PCAOB, IAASB, and KPMG have proposed their own audit quality

frameworks referencing components similar to those listed above (CAQ 2013a; IAASB 2013;

KPMG 2011; PCAOB 2013). To help focus discussion of our results, we relate our findings

throughout the paper to a general audit quality framework described in Appendix A. Our choice

to discuss results in the context of this framework stems from its focus on inputs, processes,

outputs and opinion, and post-opinion dimensions of audit quality, which overlaps with the

5
majority of the dimensions included in the frameworks referenced above. In what follows, we

reference and discuss prior literature and recent reviews of the literature (e.g. DeFond and Zhang

2013; Knechel et al. 2013) as they relate to our findings.

Research Questions and Survey Design

The PCAOB’s efforts to define audit quality may influence both auditors’ and investors’

views of audit quality, as well as the differences in their perceptions of audit quality that were

observed prior to SOX and the formation of the PCAOB (Church et al. 2008; Maijoor et al.

2002; Mock et al. 2012). Therefore, our study compares the responses of these two key

stakeholders in the current regulatory climate, extending the current literature on audit quality

and providing empirical support to the theoretical framework of audit quality. Auditors’ and

investors’ survey responses address the following four general research questions:

RQ 1) What is your definition of audit quality, and how would you measure it?

RQ 2) What engagement-, team-, and entity-characteristics impact audit quality?

RQ 3) What is the association between findings in PCAOB inspection reports and firm-

wide quality?

RQ 4) What publicly available information signals lower audit quality?

To address these research questions, auditors (investors) responded to 29 (23) queries

regarding audit quality.3 Senior members of the participating firms and the CAQ’s Research

Advisory Board provided feedback on survey design and valuable insights into different

perspectives on audit quality. The survey instrument was pilot tested by the participating firms

3
The length of our survey is equal to, or shorter than, other contemporaneous surveys (e.g., Dichev et al. 2013;
Nelson et al. 2002). We also note that the order of the questions presented to participants was not randomized. This
was done primarily because questions were presented in meaningful orders and topical groupings that were
generally confirmed using factor analysis. While order effects cannot be ruled out, participants’ responses to scale-
based questions are generally consistent with open-ended questions (e.g., lack of restatements is positively
associated with audit quality in question 6.2, and open-ended responses in Table 8 indicate that the presence of
restatements is an indicator of lower quality), thus indicating that the order of question presentation did not drive
results.

6
and subsequently revised. The final version of the survey was then distributed to the participating

firms.

Due to differences between audit professionals’ and investors’ professional experience,

understanding, and exposure to the terminology and concepts associated with financial statement

audits, some of the language in the survey was tailored to each group. To ensure that responses

from the participant groups could be meaningfully compared, care was taken to keep the

fundamental meaning of the revised questions the same between groups.4 We also did not ask

investors questions that were specific to the audit process itself (e.g., timeliness of audit

planning), whereas a question relating to the discovery of fraud was only posed to investors. The

investor version of the survey was distributed to a small pilot sample of investors for feedback

and revised accordingly before final distribution.

Data Collection

The CAQ’s Research Advisory Board coordinated with the six participating audit firms

(including all the Big 4 firms) to identify auditor participants. The only restriction we placed on

participants was that they have experience serving public company clients subject to PCAOB

inspection. Upon identification of potential auditor participants, the CAQ provided the survey to

the firms, with most firms using the web-based survey administered by Qualtrics.com; the

4
For example, investors were provided with a definition of the term “going concern” whereas auditors were not. We
also note there are minor differences in the wording between surveys for investors and auditors due to the fact that
the instrument for auditors was under continued revision by the CAQ during the period in which the investor survey
was being collected. Responses on questions with minor differences were compared to responses to questions
without wording changes within and across participant groups to determine whether the slight wording changes
altered the response patterns of participants. Results based on means, medians, and variances suggest that auditor
and investor response differences are smaller for the set of questions with minor wording differences than for the set
of questions without such differences. Thus, we are confident that any overall differences in responses to posed
questions are not the result of the minor wording differences observed. The wording of the questions in Tables 4, 5,
6, and 7 reflect the wording provided to auditors.

7
alternative administration was paper-based. Of the 109 auditor participants who started the

survey, we received usable responses from 93, for a completion rate of 85 percent.5

Investor participants were knowledgeable, nonprofessional investors. To restrict the

participant pool to individuals with a fundamental understanding of financial statements, we

required that all participants have a business degree. To increase the likelihood that participants

had the necessary financial capital to make investment decisions on their own behalf, we

required that participants be at least ten years beyond graduation. By setting these restrictions,

we identified a pool of participants with the knowledge, ability, and experience to make

reasonable decisions as investors. In coordination with a large U.S. university’s alumni

association, a randomly selected subset of alumni from the pool described above was sent an e-

mail invitation to participate in the web-based survey administered by Qualtrics.com. Of the 243

participants who initiated the survey, we obtained usable responses from 102, for a completion

rate of approximately 42 percent.6

Follow-Up Interviews

To add additional insight to the survey findings, we performed follow-up interviews with

six audit partners from the participating firms and five representative investors. Our interview

protocol consisted of seven questions designed to elicit participants’ reactions to our survey

results.7 The interview protocol was reviewed by the CAQ, after which phone interviews were

organized with the partners and investors. Including interviews allows interviewees to reflect on

5
Completion rate of individual firms ranged from a low of 70% (one firm) to 100% (three firms).
6
For both auditors and investors, we included any responses in which the participant had responded to at least half
of the survey questions. Of the 93 auditor responses used, 90 completed the entire survey (97%). Of the 102 investor
responses used, 98 completed the entire survey (96%).
7
These interviewees were from the same participating audit firms and investor pool as the participants in the survey,
but the interviewees did not complete the survey. Instead, they were provided with summary survey results and were
asked to reflect on their own experiences and to react to their colleagues’ responses.

8
individual situations, thus avoiding potential biases associated with survey evidence (e.g., Nelson

et al. 2002).8

III. PARTICIPANTS

Audit Professionals

Table 1 provides descriptive statistics for the auditor sample.9 Seventy-three partners and

17 senior managers completed the survey. On average, partners and senior managers had held

their current title for over 11 and 3 years, respectively and had total work experience in public

accounting for more than 23 and 11 years, respectively.

<insert Table 1 here>

Participants were asked to identify industries in which they considered themselves

experts. The two industries most frequently identified were Manufacturing and

Banking/Finance/Insurance (approximately 32 percent each). Our participant pool also reported

expertise in the Retail/Wholesale (22 percent) and Technology (22 percent) industries, with the

remaining industries reporting expertise levels under 20 percent. Based on the data in Table 1,

participants have experience performing audits in a wide range of industries, consistent with the

diversity in industry affiliations in a recent survey of CFOs (Dichev et al. 2013).

Investors

Table 2 provides descriptive statistics for the investor sample. Approximately 77 percent

of participants are between the ages of 41 and 60, an age range that is consistent with Dichev et

al. (2013). All participants have undergraduate business degrees and 48 percent have advanced

8
We note that individual quotes from auditors do not necessarily represent the opinions of the Center for Audit
Quality, its Research Advisory Board, or the participating audit firms.
9
Demographic information from audit professionals was limited to questions approved by the participating firms. In
the case of one firm, demographic information was provided only at an aggregate level.

9
degrees.10 Participants had worked an average of 24 years and were employed in a variety of

industries, with no single industry being selected by more than 15.8 percent of participants. 11

Based on participants’ business degrees, work experience, and responses during interviews, most

investor participants have likely experienced audits and the audit process in the context of their

current professional job responsibilities.

<insert Table 2 here>

Because education alone does not necessarily equate to investing experience, we asked a

series of questions about actual investing knowledge and experience. On average, our

participants read the business press approximately weekly and a high proportion of participants

currently invest in a retirement account such as a 401(k) or IRA (93.9 percent), individual mutual

funds (86.6 percent), and/or individual stocks (84.1 percent).12 Approximately 89 percent of

participants have used financial statement information to evaluate at least one company in the

past five years and 93 percent report a total portfolio value of at least $50,000. Taken together,

demographic data from Table 2 indicates that our investor participants are knowledgeable,

nonprofessional investors with reasonable investing experience.

10
According to Table 2, approximately 60 percent of our investor participants received an undergraduate degree in
accounting and thus it is possible that these participants are fundamentally the same as the auditor participants. In
untabulated analysis, we compare responses from investor participants with an undergraduate degree in accounting
with responses of participating auditors. In all cases except question 6.3, statistical inferences are identical to those
reported earlier using the full investor pool of participants. Based on this analysis, investors with an undergraduate
degree in accounting do not appear to unduly affect our results.
11
We note that investors were only asked to select one industry (the industry that best matches their current job)
while auditors were able to select multiple areas of expertise. The different phrasing of the question is due to the
inherent difference between professionals in industry versus public company auditors who may have expertise
across industries.
12
It is possible that investor responses differ based on actual investing experience. We use MANOVA to compare
all responses from investors who use individual stock as a primary investment tool versus those who do not;
responses are not significantly different (MANOVA F-statistic = 1.19, p = 0.29), indicating that the two investor
groups can be analyzed together. Further, when we compare all responses of auditors and only experienced
investors, we continue to find evidence of fundamental differences between auditors and investors (MANOVA F-
statistic = 10.22, p < 0.01).

10
 IV. DEFINITIONS AND MEASURES OF AUDIT QUALITY

The perceptions of audit quality can differ markedly between observers. In this study, we

asked participants to provide their definition(s) of audit quality and to assess the validity of audit

quality indicators suggested in prior research. Insights provided by audit professionals and

investors add context and substance to the proposed theoretical frameworks. As noted earlier, we

relate our findings to the general audit quality framework described in Appendix A.13

An open-ended question asked participants to provide up to four definitions of audit

quality, as well as how each definition could be practically measured. We received 181

individual responses. After reviewing the responses, the author team created 18 categories for

definitions of audit quality into which two Ph.D. students acting as independent raters

categorized all responses. The Cohen’s Kappa measure was 0.64, an agreement level that is

significantly different from zero (p < 0.001) and that indicates acceptable inter-rater agreement.14

Raters resolved all coding differences, and the results reported in Table 3 represent their

consensus.

Table 3, Panel A, provides audit professionals’ most frequently mentioned definitions of

audit quality. While there were numerous definitions provided, we focus on those that were most

frequent. Auditors’ most frequently mentioned definition of audit quality is an audit performed in

accordance with GAAS that obtains reasonable assurance that the financial statements are fairly

stated in all material respects.15 This definition relates to the inputs and processes portions of the

general audit quality framework, and is potentially measured by the results of internal and

13
In Appendix B we also provide a mapping of summary findings to PCAOB-proposed audit quality indicators.
14
According to Neuendorf (2002), a Kappa measure between 0.40 and 0.70 is acceptable, while above 0.80 is ideal.
15
Regarding the notion of reasonable versus absolute assurance, one partner responded: “[even] though the audit
standards state and everybody knows that the audit does not provide absolute assurance, when you have one audit
that did not have the right opinion, all of that is of virtually no help. At that point, that notion that the audit is not
designed to be perfect is of almost no help.”

11
external review and inspection, lack of future restatements, and individual auditor expertise.

Auditors’ next most frequently mentioned definition is an audit that provides financial statements

the public can rely on, a definition that relates to the outputs and opinion portion of the

framework. Suggested measures include lack of restatements and/or SEC action in subsequent

years. Finally, the third most frequently mentioned definition is a well-planned engagement that

addresses the significant risks of the company. That definition relates to the processes portion of

the framework, and suggested measures include the results of internal and external inspections.

Results indicate that audit professionals place substantial emphasis on factors related to the

inputs and processes portions of the general framework, over which they have the greatest

control, followed by the outputs and opinions portion, by which they are judged.

<insert Table 3 here>

Table 3, Panel B provides the most frequently mentioned definitions of audit quality by

investors. The most frequently mentioned definition of audit quality is an audit performed by

well-trained, competent auditors (including specialists, where necessary), measured by auditor

experience, inspection results, and the size of the audit firm. This definition relates to the inputs

portion of the general framework. In response to this finding, one partner interviewee stated,

“[investors] and audit committee members want to know: Who is on the team? Do we have the

right team? Do they have the right experience? Don’t tell me about GAAS; tell me about the

team.” An investor interviewee echoed this view, stating that he had noticed “significant

variability” in the skill of individual auditors auditing his company. In contrast, however, an

audit partner expressed skepticism about this investor viewpoint, stating that “you can have the

right staffing levels, training and expertise, but I’m not convinced that automatically translates

into audit quality.” This partner went on to state that “[you] have to combine [those team

12
characteristics] with performing the audit in accordance with GAAS. Compliance with GAAS is

the minimum requirement, but then the quality of the audit can be improved upon by increasing

the quality of the staff through additional training, expertise, etc.” Several audit partner

interviewees expressed the opinion that the investors’ definition can be viewed as a subset of the

auditors’ definition because GAAS explicitly requires engagement teams to be adequately

staffed and trained.

Investors’ next most frequent definition of audit quality was an engagement that was

well-planned and addresses significant client risks. This definition relates to the processes

portion of the framework and is consistent with audit professionals’ third most frequent

definition of audit quality. Investors’ suggested measurements for this definition included client

industry complexity and auditing all material balances. Investors’ third most frequently

mentioned definition of audit quality was the need for independent, skeptical auditors, which

investors suggested could be measured by non-audit fees and auditor rotation. This definition

relates to the inputs portion of the framework. Thus, it appears that investors’, like audit

professionals’, definitions of audit quality focus on the inputs and processes sections of the

general framework.

Based on responses to our first research question, we conclude that both audit

professionals and investors heavily weight the inputs and processes sections of the general

framework; however, while some publicly observable measures of inputs and processes were

suggested, most relate to inputs and processes that are not currently observable to the investing

public. The limited number of observable measures of both inputs and processes provides

support for the disclosure of audit engagement team characteristics (Knechel et al. 2013). We

find two key differences between the two groups’ definitions and measures of audit quality: first,

13
investors explicitly reference the need for auditor independence, an issue consistent with

concerns recently voiced by regulators (Franzel 2012); second, audit professionals focus on the

outputs and opinion section of the framework to measure audit quality. This is not surprising

because these aspects are observable publicly and are used to judge the quality of audits,

particularly when it is determined subsequent to a clean audit opinion that the financial

statements contain a material misstatement.16

V. ATTRIBUTES OF AUDIT QUALITY

Tables 4, 5, and 6 report audit professionals’ and investors’ responses to questions about

how the quality of a specific audit engagement is impacted by various audit environment

characteristics. Based on consultations with audit professionals and on our understanding of the

audit function, the characteristics listed were sorted into three groups, each of which relates to a

different aspect of the audit: 1) the audit engagement, 2) resources available to the audit team,

and 3) the audited entity. Participants were asked to evaluate the extent to which a characteristic

impacts audit quality by marking their response on an 11-point Likert scale anchored by “Lower

Audit Quality” (1) and “Higher Audit Quality” (11) with a midpoint of “Not Related” (6).17 We

compare auditor and investor responses using ANOVA and compare each group’s mean

response to the midpoint using t-tests.18 We provide analyses of the validity of our question

16
While not in the top three definitions of audit quality, investors did list outputs (lack of restatements or SEC
actions) as a measure (signal) of audit quality, but less frequently than auditors.
17
As with any analysis using a Likert scale, there is the potential that some individual participants will
misunderstand the question and respond on the opposite end of the scale from the rest of the group. As shown in
subsequent tables, it appears that several individual participants did misunderstand certain questions; their responses
were reversed relative to the majority of participants. Upon review of the data, there did not appear to be an
identifiable group of participants who misinterpreted all questions; rather, the reversals appeared to be randomly
distributed across participants. Using factor analysis, we found that 95 percent of auditors and 96 percent of
investors treated the Likert scales in the same manner, providing evidence that the scales were not broadly
misinterpreted.
18
By necessity, each question is analyzed individually as each question is a different dependent variable. However,
the number of tests performed possibly raises concerns about spurious results. In an untabulated analysis, we use
MANOVA on all 18 questions from Tables 4, 5, and 6 in which auditors’ and investors’ responses are compared.
This analysis reports an F-statistic of 13.92 (p < 0.01), indicating that fundamental differences exist in responses

14
groupings using factor analysis. As detailed in Appendix C, this analysis of auditors’ (investors’)

responses provides nine (six) distinct key indicators of audit quality. Characteristics of the

Audit Engagement: Audit Firm Size

Question 1 in Table 4 (question 4.1) asks participants to indicate whether being audited

by a U.S. audit firm with a strong global network affects audit quality. Audit professionals

indicated that audit firms with a strong global network are associated with higher audit quality,

(mean score of 9.40 on the 11-point scale; different from midpoint at p < 0.01). Investors also

associated strong global networks with higher audit quality (mean score of 7.47; different from

midpoint at p < 0.01). However, investors perceive a significantly weaker association between

audit firm size and audit quality than audit professionals (p < 0.01). One partner suggested that

“by definition the firm would have to be large to perform a quality audit of a large organization

… because only a few firms can actually have the resources and ability to audit the largest

companies that are located in multiple jurisdictions.” One investor expressed a similar opinion,

stating that after verifying that a large audit firm audited a potential investment, no further

consideration was given to the auditor or audit quality in making an investment decision. Both

audit professionals’ and investors’ responses support academics’ use of audit firm size as a proxy

for audit quality (e.g., Francis et al. 1999; Kim et al. 2003) and provide one publicly observable

measure for an element from the inputs portion of the audit quality framework.

<insert Table 4 here>

between auditors and investors, providing evidence that differences identified in individual questions are not
spurious. Due to the skewness inherent in testing means between groups, we augment our analysis by testing median
responses for each question between auditors and investors. Inferences are robust to these alternative
(nonparametric) tests.

15
Characteristics of the Audit Engagement: The Audit Report

Questions 4.3-4.4 investigate the association between audit quality and audit opinion

accuracy in predicting a client’s future solvency. Responses to question 4.3 indicate that a large

percentage of both audit professionals and investors associate issuing an unqualified audit

opinion to a client that subsequently files for bankruptcy, a Type 2 error, with lower audit quality

(mean scores of 5.43 and 4.00; different from midpoint at p < 0.01), with investors’ responses

significantly stronger than audit professionals’ (p < 0.01). Question 4.4 addresses Type 1

misidentification errors, wherein a going concern paragraph is included and the client does not

file for bankruptcy in a subsequent period. On average, both audit professionals (mean score of

6.94; different from midpoint at p < 0.01) and investors (mean score of 7.08; different from

midpoint at p < 0.01) associate issuing a going concern paragraph with higher audit quality.

In summary, responses from questions 4.3 and 4.4 indicate that audit professionals and

investors view the failure to add a going concern paragraph followed by subsequent client

bankruptcy as an indicator of lower audit quality, whereas adding such a paragraph with no

subsequent client bankruptcy is viewed as an indicator of higher audit quality. These responses

relate to the outputs and opinion portion of the audit quality framework and provide some

support for using going concern opinions (or the lack thereof) as a proxy for audit quality

(Lennox 1999), while bearing in mind the low base rate of going concern opinions (Francis

2011). Prior research providing evidence that going concern reports are associated with negative

stock price reactions (Menon and Williams 2010) is consistent with investors’ relatively heavier

weight on the association between going concern issuance and audit quality. However, future

research may need to incorporate investors’ perception that audit quality is not impaired when a

firm issues a going concern warning that is not followed by client bankruptcy.

16
Characteristics of the Audit Engagement: Review and Inspection Results

The most direct evaluation of an audit engagement’s quality occurs during the rigorous,

iterative review process that all audits undergo. The process begins with real-time reviews during

the audit (PCAOB 2004b), continues with internal firm review performed by the engagement

review partner (PCAOB 2009) and possible additional internal quality control review, and

concludes with external reviews by peer firms and/or the PCAOB.19 Deficiencies identified

during the review process indicate a departure from standards and, hence, lower audit quality.

Questions 4.5 through 4.8 relate to the processes and post-opinion portions of the general

audit quality framework, and examine how participants view the association between the audit

review process and audit quality. In response to question 4.5, 79.5 percent of audit professionals

associate fewer real-time review deficiencies with higher audit quality (mean score of 8.33;

different from midpoint at p < 0.01), indicating that auditors acknowledge the importance of

rigorous real-time review. This association persists through the levels of review including

internal quality review (question 4.6), peer review (question 4.7), and PCAOB review (question

4.8). In all cases, more than 70 percent of audit professionals associated fewer deficiencies in the

review process with higher audit quality, but only in the case of PCAOB reviews did auditors

place greater weight on the association than investors (p < 0.05).20 One investor explained the

difference as follows: “clients are not named in inspection reports and thus [the information is]

potentially less useful to investors” in identifying engagement-specific audit quality. One partner

19
We note that review by the engagement review partner is also a part of “real-time” review, but will be addressed
along with other consultations from parties outside the core engagement team in Table 5.
20
In an untabulated within-subjects analysis, we compare the mean scores among the varying levels of review to
determine whether certain types of review are more strongly associated with audit quality than others. We find that
audit professionals indicate that real-time review (mean value 8.33) has the strongest association with audit quality,
although only statistically different from the more formal internal quality review, in which audit engagements are
selected for review by the firm’s national office (mean score 7.97; different at p = 0.04). Among investors, we find
that peer review has the strongest association with audit quality (mean score of 8.05) and that this association is
significantly stronger than either internal quality review (p < 0.01) or PCAOB review (p < 0.01).

17
interpreted this difference between auditors and investors as meaning that “investors aren’t as

concerned about the PCAOB inspection process as we the partners are,” while another partner

suggested that many PCAOB deficiencies relate to documentation only, and that “better audit

documentation is not necessarily consistent with what the investing public desires.”

Characteristics of the Audit Engagement: Timeliness of Procedures

Questions 4.9 and 4.10 investigate the association between the timely completion of audit

procedures and audit quality, thus addressing the processes portion of the audit quality

framework. Because the subject matter is specific to audit professionals, the questions were

posed to auditors only.

The PCAOB’s standard on audit planning (2010b) states that audit planning is not a

“discrete” event but rather a process that takes place from the completion of the prior year’s audit

through the completion of the current year’s audit (AS 9¶4). The majority of the planning

procedures, however, are performed before fieldwork commences and are adjusted as necessary.

Table 4 provides responses to question 4.9 and suggests that audit professionals view timely

completion of planning procedures as associated with higher audit quality (94.6 percent).

Provided that timely planning signals appropriately analyzed client risks and appropriately

selected audit procedures to address those risks, disclosure of such information, either by the

firms or by the PCAOB, may provide valuable information to investors about audit quality.

Audit quality is also affected by the timeliness of audit fieldwork completion; 89.3

percent of audit professionals associate timely completion of audit fieldwork with higher audit

quality. One partner we interviewed specifically mentioned time pressure as an impediment to

audit quality, stating that “[when I speak of time pressure as an impediment to audit quality], I’m

talking about the findings or the need for information that comes right at the end…and there’s a

18
lot of pressure from management, and with some clients from the audit committee, in my

opinion, to go ahead and sign the audit opinion without getting that evidence.” The responses are

consistent with and supportive of prior research investigating the extent to which additional time

and budgetary pressure reduce audit quality, including Agoglia et al. (2010), Coram et al. (2004),

Houston (1999), Lambert et al. (2011), Lopez and Peters (2012), and McDaniel (1990).

Characteristics of the Audit Engagement: Other

Finally, question 4.12 investigates the association between audit fees and audit quality.

All else constant, auditors’ compensation must be sufficient to motivate audit effort and gather

sufficient audit evidence to justify the audit opinion (Messier et al. 2010; PCAOB 2010a;

Simunic 1980). Seventy-two percent of audit professionals indicate a positive association

between audit fees and audit quality, and their mean response is significantly higher than that of

investors (p < 0.05), of whom only 52.9 percent indicate a positive association between audit

fees and audit quality. While the payment of higher audit fees does not always ensure higher

audit quality, participants’ responses suggest that higher fees tend to be associated with higher

quality.

In summary, results documented in Table 4 indicate that audit firm size, accurate and

conservative audit opinions, fewer identified deficiencies, timely completion of audit planning

and fieldwork, and reasonable audit fees are indicators of higher audit quality. These indicators

relate to all four areas of the audit quality framework and reflect a general consensus by audit

professionals and investors on their expectations for audit quality and the factors that may

influence that quality.

19
Resources Available for the Audit Team: Engagement Team Qualifications

Table 5 provides responses to questions that examine the effect on audit quality of the

resources available to the audit engagement team. Questions 5.1 through 5.3 address individual

characteristics of the audit team, including adequate staffing, auditor training, and auditor

expertise. These characteristics relate most closely to the inputs portion of the audit quality

framework.

<insert Table 5 here>

In response to question 5.1, 100 percent of audit professionals and 91 percent of investors

associate adequate team staffing with high audit quality (mean responses of 10.02 and 8.80

different from midpoint at p < 0.01). Clearly, both groups indicate that adequate staffing is a

prerequisite to achieving a high-quality audit, a notion that partners and investors emphasized

during individual interviews and that supports prior research investigating adequate staffing of

audit teams (Bonner 1990; Griffin and Ricchiute 2011). Question 5.2 investigates the association

between audit quality and having well-trained auditors. Table 5 results indicate that 100 percent

of both audit professionals (mean score of 10.14) and investors (mean score of 9.66) associate

having well-trained auditors with higher audit quality. In a similar vein, question 5.3 investigates

the association between auditor expertise (e.g., industry-based or transaction-based) and audit

quality and finds that 100 percent of both audit professionals (mean score of 9.82) and investors

(mean score of 9.88) associate auditor expertise with higher levels of audit quality.

Questions 5.1 through 5.3 relate to individual characteristics of the audit engagement

team and its members. Both stakeholder groups overwhelmingly associate these individual

characteristics with high audit quality, thus also supporting findings from prior literature that

additional expertise leads to higher audit quality overall (e.g., Bedard 1989; Hammersley 2006;

20
Low 2004; Owhoso et al. 2002; Taylor 2000;Wright and Wright 1997). This finding is also

consistent with recent archival research that auditor training is positively associated with

accruals-based measures of audit quality, while staff and partner workload are negatively

associated with audit quality (Van Linden and Willekens 2013). Additionally, these findings are

consistent with accounting firms’ recent emphasis on key inputs to the audit process (CAQ 2012;

KPMG 2011). Interviews with investors generally echoed the views of the survey. One investor

stated that “audit quality is driven by the individuals”, while another stated that “industry-

specific expertise is the primary characteristic” that drives audit quality at the individual auditor

level.

Our results provide evidence that individual auditor characteristics are viewed as an

important determinant of audit quality and provide some support for disclosure of engagement

team characteristics. One partner indicated that these characteristics could be “reported without

embarrassing anybody,” while several partners we interviewed suggested that making such

disclosures comparable would be difficult because “each engagement really is unique…and

potentially has different staffing needs and requirements.” As an alternative, one partner

suggested that perhaps firms could disclose “a description of the process by which the

sufficiency of an engagement team is evaluated” by the firm itself, a suggestion that is consistent

with the firms’ willingness to disclose more information regarding their own internal quality

monitoring programs (PwC 2013). Another partner suggested that instead of disclosing

information about the entire engagement team, the disclosure could perhaps be limited to

characteristics related to the senior leadership of the audit engagement team (e.g., partners,

senior managers).21 Interviews with investors also suggested that while disclosure about the

21
Regarding team characteristics and audit quality, one partner stated that important potential impediments to audit
quality are “the personality and the personal characteristics of the audit partner and manager as to what is driving

21
entire team might not be helpful, disclosures focused on the partners and their experience and

expertise would be useful in determining audit quality.

What is clear from the discussion above is that while auditor characteristics are an

important determinant of audit quality, the currently-available public signals of auditor

characteristics are limited. While there does not appear to be broad support for disclosure of

individual characteristics about all members of the engagement team, responses appear to

indicate that disclosing some characteristics of the engagement team (e.g., staffing) as well as

characteristics of engagement team leaders (e.g., industry expertise) would be useful to investors.

Resources Available for the Audit Team: Consultations

Questions 5.4 through 5.7 evaluate whether consulting with individuals outside the day-

to-day operations of the audit team impacts audit quality. Input from sources such as engagement

review partners, national office partners, external experts, and internal audit firm specialists are

important to the processes portion of the audit quality framework. Because of the specialized

nature of these external advisors, we did not pose these questions to investors.

Audit standards require audits to be reviewed by an engagement review partner (ERP),

who has the necessary expertise to understand the client but is not directly responsible for, or

involved in, the day-to-day activities of the audit engagement (PCAOB 2009, AS 7 ¶2). We

asked audit professionals to indicate the extent to which the number of hours billed by an ERP is

associated with audit quality. Responses to question 5.4 indicate that 78.4 percent of audit

professionals associate involvement by the ERP with higher audit quality (mean score of 7.63;

different from midpoint at p < 0.01). Engagement teams may also contact the firm’s national

office for guidance during the audit on difficult technical auditing and accounting matters. When

them from a personal standpoint. I think both of these things can dramatically change the outcome of the audit
regardless of the quality of the engagement team inputs.”

22
asked about the association between the number of national office consultations and audit

quality, audit professionals on average suggest higher audit quality is associated with national

office consultations (mean score of 7.14, different from midpoint at p < 0.01).

Finally, questions 5.6 and 5.7 investigate the impact of involving external experts and

internal specialists, respectively, on audit quality. When asked about the association between

audit quality and the number of consultations with external experts, 59.1 percent of audit

professionals associate using external experts with higher audit quality. On the other hand, 82.9

percent of audit professionals associate consulting with internal firm specialists with higher audit

quality. The mean responses for the two questions, 6.77 and 7.68 respectively, are significantly

different (p < 0.01). Based on these responses, consulting with internal specialists is preferred to

consulting with experts outside of the firm. This finding may be due, in part, to the fact that

accounting firms are typically large enough to employ most types of specialists, reducing the

need to seek counsel from external specialists.

In summary, results presented in Table 5 indicate that both stakeholder groups associate

characteristics of the individual audit team such as staffing levels, training, and expertise with

higher audit quality. Additionally, audit professionals generally associate consulting with

individuals outside the core audit engagement team with higher audit quality, although

consulting within the firm is viewed more favorably than consulting outside of the firm. These

indicators of higher audit quality relate to both the inputs and the processes portions of the audit

quality framework but are not generally observable by investors, creating an information

asymmetry between audit professionals and investors. Although survey and interview results

indicate some suggestions for reducing this asymmetry via disclosure, future research that

investigates both the avenues for and adequacy of disclosures would prove useful.

23
Characteristics of the Audited Entity: Accruals

Table 6 presents responses to questions directed to determine if characteristics of the

audited entity itself are associated with higher or lower audit quality.

<insert Table 6 here>

Question 6.1 addresses the entity’s financial reporting quality as measured by accruals.

The level of discretionary accruals is often used as a proxy for earnings quality (see Dechow et

al. 2010 for a review), and lower discretionary accruals has been associated with higher audit

quality in prior research (Balsam et al. 2003; Francis et al. 1999; Francis and Yu 2009; Francis

and Michas 2012; Kim et al. 2003; Myers et al. 2003). Consistent with this literature, we find

that 54.8 percent of audit professionals indicate that conservative reserve balances are associated

with higher audit quality, whereas 37.6 percent indicate no association between reserve balances

and audit quality. Auditors’ responses indicate that higher audit quality is associated with more

conservative financial reporting (mean score of 6.89; different from midpoint at p < 0.01), and

investors respond similarly on average (mean score 6.62, different from midpoint at p < 0.01).

Thus, both stakeholder groups suggest that conservative reporting, which relates to the output

portion of the audit quality framework, indicates higher audit quality, providing some support for

prior research that uses accruals as a proxy for audit quality.

Characteristics of the Audited Entity: Subsequent Outcomes

Because of data limitations, many studies of audit quality focus on publicly observable

outcomes related to the audited entity. Questions 6.2 through 6.4 investigate three of these

outcomes: restatements, SEC enforcement actions, and fraud. Responses to these questions

provide evidence on the outputs and opinion portion of the audit quality framework.

24
 Question 6.2 addresses the association between audit quality and the lack of future

restatements, which have been used as a proxy for lower audit quality in prior research (Kinney

et al. 2004; Schmidt 2012; Stanley and DeZoort 2007). Responses to question 6.2 provide

support for this proxy with 75.3 percent of audit professionals, and 62.8 percent of investors,

indicating that the lack of future financial statement restatements indicates higher audit quality

(mean response of 7.87, different from midpoint at p < 0.01). However, the association is weaker

for investors (p = 0.03) than auditors. In follow-up interviews, partners agreed with these results,

stating that using restatement trends as an indicator of audit quality “is not 100 percent perfect,

but it’s a fairly good indicator as to whether or not audit quality is improving.”22

Question 6.3 examines the association between SEC enforcement actions (AAERs) and

audit quality. AAER’s have been used in prior research to proxy for extremely low audit quality

(Carcello and Nagy 2004; Lennox and Pittman 2010a). Responses indicate that, consistent with

their responses to question 6.2, 70.9 percent of auditors and 62.7 percent of investors report that

a lack of SEC enforcement actions indicates higher audit quality. In untabulated results, we also

find that for auditors, the association between SEC enforcement actions and audit quality is

significantly lower than the association between restatements and audit quality (p < 0.05), which

is surprising given the potentially more severe consequences of AAERs. Consistent with

commentary in DeFond and Zhang (2013), one partner attributed this difference to the infrequent

occurrence of AAERs: “Very few partners ever deal with an SEC enforcement action, but almost

everyone, at some time in their career, has dealt with a restatement or two.”

Finally, question 6.4, directed to investors, investigates the association between the lack

of future fraud identification and audit quality. Consistent with responses regarding restatements

and SEC enforcement actions, 62.8 percent of investors associate the lack of future fraud
22
We further discuss restatements as a signal of audit quality in Section VII.

25
identification with higher audit quality. The fact that “only” 62 percent of investors view the lack

of future fraud indicates high audit quality is somewhat surprising considering investors’ high

expectations of auditors regarding fraud identification (Hogan et al. 2008; McEnroe and Martens

2001).

We acknowledge that the external indicators of audit quality discussed in questions 6.2-

6.4, which are among the most easily observable, are also subject to hindsight bias when

evaluating the performance of an auditor. One partner stated the following regarding this bias:

After Pearl Harbor, and after the attacks of 9/11, we do these investigations and we piece
together these things that, looking backward, we can connect these dots, this action or
inaction with that one and that one and that one and we can construct all of these things
that led up to this horrible event. And then we can look at the people who were involved
and say ‘my gosh, how could you possibly have not seen this coming?’ Now the problem
with that is that in the real world, we’re always in the beginning of that sequence of
events. Any one of those events by itself, the results are typically benign and yet it’s the
combination over time that eventually causes the problems.

Characteristics of the Audited Entity: Committee Meetings

The final two questions in Table 6 address the association between audit quality and the

number of audit committee and board of directors meetings held by the audited entity each year,

which, at least in the case of audit committee meetings, relates to the processes portion of the

audit quality framework. Question 6.5 asks participants to indicate the extent to which the

number of formally planned audit committee meetings per year is associated with audit quality.

Audit committees are receiving increasing attention from regulators, researchers, and the

financial press (PCAOB 2012b, 2012c; Weil 2012) and audit committee oversight is viewed as

an important component of the audit process. While 78 percent of audit professionals agree with

this view and indicate a positive association between the number of audit committee meetings

and audit quality, only 31.3 percent of investors have the same opinion and the difference in

26
mean responses is significant (auditor mean of 7.65 auditor, investor mean of 6.19; different at p

< 0.01).

Question 6.6 addresses the broader board of directors meetings and their association with

audit quality. In contrast to question 6.5, audit professionals indicate that the number of board of

directors meetings is not associated with audit quality (53.8 percent) while investors indicate

board of director meetings have a positive impact on audit quality (57.8 percent); the mean

responses are significantly different (p < 0.05). Responses to 6.5 and 6.6 indicate important

differences (or perhaps an expectations gap) between audit professionals’ and investors’ views

about the impact that audit committee and board meetings have on the processes portion of the

audit quality framework.

In summary, results documented in Table 6 indicate that financial statement outcomes

and governance structures are relevant in evaluating audit quality and relate to both the processes

and the outputs and opinion portions of the audit quality framework. Specifically, the number of

planned audit committee meetings, the lack of future restatements, and the lack of SEC

enforcement actions are among the governance structures and financial reporting outcomes that

audit professionals associate with high audit quality. Investors also indicate a positive association

between the lack of future restatements, fraud, or SEC enforcement actions and audit quality,

although to a lesser extent than auditors. Additionally, investors associate the number of board of

directors meetings with higher audit quality, whereas auditors do not. In general, the extent to

which these factors indicate audit quality is generally consistent between the two stakeholders

and provides substantial support for earlier research using these measures as indicators of audit

quality. However, we note that the difference of opinions regarding the importance of audit

committees is consistent with concerns raised at a recent CAQ symposium regarding the lack of

27
insights available to investors about the role the audit committee plays in the audit process (CAQ

2013b).

VI. PCAOB INSPECTIONS AND AUDIT FIRM QUALITY

The results from Tables 4, 5, and 6 relate to the quality of an individual audit

engagement. However, financial statement users and audit committees are also interested in audit

firm quality as a whole. After SOX, the PCAOB’s board and inspection staff has access to such

information that potentially provides indicators of audit firm quality. PCAOB communications

about regulatory oversight, inspection and enforcement processes and findings, and how these

communications relate to audit quality has been the focus of numerous research studies

(Abernathy et al. 2013; Carcello et al. 2011; Church and Shefchick 2012; Defond 2010; Ernst &

Young 2011; Fornelli 2012; Glover et al. 2009; Griffith et al. 2013; Lennox and Pittman 2010b).

In a release to Audit Committee members on the purpose of PCAOB inspection reports,

the PCAOB states that “the Board…cautions against judging the relative quality of firms’ audit

practices solely on the basis of the number of deficiencies described in the public portions of

inspection reports” (PCAOB 2012b, pg. 3). Thus, the PCAOB warns that the number of

deficiencies reported in their inspection reports should not be used as a statement of overall audit

firm quality. Several partners reiterated this stance in their interviews, with one stating that the

sample of engagements selected for inspection by the PCAOB “doesn’t start as a representative

sample, it doesn’t purport to be a representative sample, and we know it doesn’t end up as a

representative sample.” Another partner stated similarly that, “it’s very tempting to do a simple

deficiency count across Part 1 findings…and in the absence of other metrics it’s tempting to do

that. However, it’s potentially very misleading as a result of how the inspection process works

and how the engagements are selected.”

28
 <insert Table 7 here>

Table 7 responses indicate that in spite of the PCAOB’s warning, 64.5 percent of audit

professionals and 88.1 percent of investors view fewer deficiencies listed in PCAOB Part 1

inspection reports as indicating higher audit firm quality and thus higher audit quality. The mean

response for investors (7.90) was significantly higher (p < 0.01) than the mean response for

auditors (6.99), indicating that investors place greater weight on reported deficiencies than

intended by the PCAOB. Interviews generally confirmed that investors view PCOAB inspection

reports as a valid signal of audit firm quality. However, one investor voiced concern that in his

management role, he observed auditors “perform a quality audit and then add more work just out

of fear of the PCAOB. It’s more to ensure compliance than to increase quality.”

Several partners expressed concern about investors interpreting the number of PCAOB

deficiencies as an indicator of audit firm quality. One partner stated that, “I don’t believe that

fewer deficiencies are necessarily indicative of higher firm quality. … I think it’s a problem for

our profession that investors over-rely on something that might not be a great measure.” Another

partner agreed, stating “it’s an educational process trying to help users understand what the

reports actually mean. The [Board’s reports contain] that caveat, but at the end of the day the

investors take those numbers and look at them and have a different view regardless of what the

PCAOB might say.” In response to the 64.5 percent of partners who associate higher firm quality

with fewer PCAOB deficiencies, one partner stated “there’s now a direct connection between

personal inspection results and performance evaluations.”

Responses to these questions provide support for archival studies that use PCAOB

inspection reports to evaluate investor reactions to reported deficiencies (e.g., Bills et al. 2013).

29
However, it appears that relying on PCAOB inspection reports alone is of greater concern to

audit professionals than to investors.

VII. PUBLICLY AVAILABLE SIGNALS OF LOW AUDIT QUALITY

Due to audit engagement team and audit process data limitations, researchers, and

investors are frequently left to rely on other publicly available sources of information to

determine whether an audit was of high or low quality. When participants were asked to provide

up to four publicly available signals of low audit quality, we received 377 individual responses.

After reviewing the responses, the author team created 60 categories for signals of low audit

quality into which two Ph.D. students acting as independent raters categorized all responses. The

Cohen’s Kappa measure was 0.86, an agreement level that is significantly different from zero (p

< 0.001) and that indicates a significant amount of inter-rater agreement. The raters later resolved

all coding differences, and the results reported in Table 8 represent their consensus.

<insert Table 8 here>

In Table 8, Panel A, audit professionals overwhelmingly mention financial statement

restatements as the number one publicly available signal of low audit quality. This is consistent

with responses to question 6.2. In response to restatements as an indicator of low audit quality,

one partner agreed with the survey findings, saying “… even if it’s not the most frequent signal,

a subsequent restatement would be a strong signal of low audit quality.” In explaining his stance,

the partner referenced the concept of materiality. “I look at a restatement, and it’s obviously

material; if it weren’t material, it wouldn’t be restated. For us, a restatement is referred to as the

‘R’ word—we just don’t want them unless it’s absolutely necessary.” Another partner responded

to the findings by stating that “[the results] are dead on point and it gets back to what the purpose

of an audit is—to avoid having to restate something. The statements need to be right.” While

30
partners acknowledged that not all restatements are created equal or are due to low audit quality,

there was a general consensus that, as one partner stated, “if there’s a restatement, it’s probably

indicative that something could have been improved in the audit process that could have

identified the error.”

Prior research has indicated a decreasing market reaction to restatements over time

(Scholz 2008), suggesting perhaps that restatements are not meaningful indicators of low audit

quality. However, it is important to distinguish between financial reporting quality as perceived

by the market and the quality of the audit of those financial statements. Considering that auditors

are tasked with opining as to the material fairness of the financial statements, a subsequent

restatement would indicate that to some extent the audit was of lower quality irrespective of the

market’s reaction, which may be tempered due to reliance on other sources of information such

as analyst forecasts (Hail 2013). Taken together, auditor responses from question 6.2, open-

ended responses in Table 8, and comments from interview participants provide support for the

use of restatements as a proxy for audit quality and evidence that relates to the outputs and

opinion portion of the audit quality framework. The second and third most frequently mentioned

publicly available signals of low audit quality by auditors were SEC comment letters and

enforcement actions (ranking #2) and PCAOB reports of deficiencies (ranking #3), which relate

to the outputs and opinion and the post-opinion portions of the framework, respectively.

Other auditor-identified signals of low audit quality include frequent audit firm changes

(ranking #4); unusually low audit fees (ranking #7); and small and/or inexperienced audit firms

(ranking #10). These three signals are consistent with prior research findings that frequent

auditor changes can reduce audit quality (Ghosh and Moon 2005; Myers et al. 2003); that fee

pressure may reduce audit quality (Christensen et al. 2013a; Ettredge et al. 2012); and that

31
smaller firms may not have the resources to audit large companies. Commenting on frequent

audit firm turnover, one partner explained that “too frequent turnover could be an indication that

you’ve got somebody that’s difficult to deal with and is pushing the envelope, and a good quality

firm is not willing to go along with that.”

We present investor responses in Table 8, Panel B. Similar to auditors’ responses, the

number one publicly available signal of low audit quality is financial statement restatements,

providing further evidence relating to the outputs and opinion portion of the audit quality

framework. Investors also view frequent audit firm turnover as an indicator of low audit quality

(ranking #3), relating to the inputs portion of the framework. Investors often mentioned frequent

audit firm turnover in interviews and indicated that audit firm turnover was viewed by one

investor as “a significant red flag,” while another stated that “audit firm tenure of less than five

years is not enough for the firm to understand the client.”23 Similarly, several investors stated

that any concerns about a lack of independence due to long firm-specific tenure are overcome by

partner and staff rotation. Finally, investors also mention small audit firms or those with low

levels of industry expertise as indicators of lower audit quality (investor ranking #5). Investors

indicated that if an audit firm is too small, it can be ‘tricked’ by an unscrupulous client’s

complex accounting; in fact, several of the survey respondents specifically mentioned the Bernie

Madoff fraud, a situation involving a very small accounting firm. One investor stated that a

publicly available signal of higher audit quality is firm-level industry expertise. Specifically, the

investor stated “one can safely infer relatively higher audit quality when an industry-expert

audits a client within its area of expertise.” We note that while some signals from Table 8 may

23
We note that this timeframe is consistent with cutoffs used in archival literature for short- and long-term audit
firm tenure (e.g., Myers et al. 2003).

32
have limited relevance in international settings (e.g., restatements), several of the signals relating

to audit firm tenure, auditor expertise, and financial reporting quality are readily available.

VIII. SUPPLEMENTAL EVIDENCE ON AUDIT QUALITY

One area of audit quality given special emphasis by the PCAOB in recent years has been

auditors’ treatment of accounting estimates. Recent research indicates that auditors may be in the

difficult situation of opining on financial statements that contain material amounts of estimation

uncertainty (Cannon and Bedard 2013; Christensen et al. 2012, 2013b; Peecher et al. 2013; SEC

2011). Because of the impact this setting may have on audit quality, we asked participants to

evaluate the extent to which the size of the reasonable range and the number of estimates with

significant estimation uncertainty affect the auditor’s ability to achieve the desired level of

assurance for those estimates and the related financial statements. In untabulated analysis, both

auditors (75.0 percent) and investors (80.6 percent) indicate that high levels of estimation

uncertainty significantly affect auditors’ ability to provide the requisite level of assurance. The

mean response from both groups is significantly different from the midpoint (p < 0.01).

These responses indicate that audit professionals and investors acknowledge the difficulty

of auditing an account whose reasonable range of values exceeds audit materiality, providing

evidence regarding the processes portion of the audit quality framework. One partner we

interviewed agreed with the findings, stating that “there are multiple instances where [reducing

the reasonable range to within audit materiality] literally cannot be done. You can have minimal

changes in the inputs that result in a substantial difference.” Responses suggest that it is

problematic for auditors to provide high assurance for a reported point estimate when the

estimate is associated with an irreducible reasonable range of uncertainty that is beyond the

bounds of quantitative audit materiality. On the other hand, partners also recognize the practical

33
realities they face. Until and unless auditing standards change, auditors are prepared to continue

doing their best to provide the desired level of assurance. One partner stated that “in regard to

impacting the provision of assurance, there’s always a way to get there. If there isn’t, you

shouldn’t be issuing an opinion.”

IX. CONCLUSION

The definition, measurement, and composition of financial statement audit quality has

been a continued subject of interest and debate and has recently received additional focus by the

PCAOB (PCAOB 2013). Our paper responds to Francis’ (2011) call for more research on the

inputs to the audit process as well as further investigation of the archival proxies for audit quality

discussed in DeFond and Zhang (2013). In order to provide insights toward a more complete

view of audit quality, we survey both auditors and investors—two key stakeholders in financial

statement auditing whose differing views in the past have been described as an expectations gap

(Church et al. 2008; Maijoor et al. 2002; Mock et al. 2012). Rather than viewing audit quality as

a singular measure or construct, the literature provides theoretical frameworks suggesting that

audit quality is a multi-faceted construct (Bedard et al. 2010; Francis 2011; Knechel et al. 2013).

Our results and this concluding section are organized according to the simple audit quality

framework of: Audit Inputs, Processes, Outputs and Opinion, and Post-Opinion. Our results

provide possible definitions, factors, and signals associated with the different components in the

framework and provide a comprehensive overview of the construct of audit quality based on the

views of these key stakeholders.

We find that both stakeholders place considerable importance on the inputs to the audit

quality framework and that investors primarily define audit quality as an audit performed by

well-trained, competent individual auditors (e.g., who is on the team and whether the team has

34
the right experience and expertise). Further, both auditors and investors view individual auditor

characteristics as some of the strongest determinants of audit quality, suggesting that disclosure

of some auditor characteristics, particularly for the members of the engagement leadership team,

may be beneficial. Given the relative paucity of research regarding how individual auditor

characteristics and audit team composition relate to audit quality, survey results suggest that this

may be a fruitful area for future research. Considering the audit firm as a key input, we find that

both groups positively associate audit firm size with higher audit quality and that investors view

frequent audit firm change as an impediment to audit quality. Investors indicated that regular

partner rotation and staff turnover allay their fears of reduced independence that could come

from a longer tenure. Finally, we identify differences among these stakeholders regarding the

importance of the audit committee as an input to audit quality; while auditors associate greater

audit committee involvement with higher audit quality, investors make no such association and

focus instead on the involvement of the full board of directors.

The next step in the audit quality framework is the actual procedures or processes. Audit

professionals primarily define a high quality audit as one that complies with professional

auditing standards. Auditors also view the timely completion of audit planning and fieldwork as

important attributes of a high quality audit. Considering both groups’ secondary definitions of

audit quality focused on a properly-planned audit, responses indicate that disclosure of

information regarding the planning stage and its timely completion, either by the firms or by the

PCAOB, may provide valuable information to investors about audit quality. Future research can

investigate how the timely planning and completion of the audit affects audit quality. Although

engagement team members perform audit procedures, it is not uncommon to seek counsel from

individuals not associated with the day-to-day operations of the audit. Auditors’ survey

35
responses indicate that consultations with individuals external to the engagement team further

increase audit quality, although counsel from individuals within the firm (e.g., national office) is

viewed as superior to counsel from external experts. Given the potential need for expert advice to

assist in the audits of volatile estimates and fair value accounting, future research can investigate

the costs and benefits of the source of advice received from those outside of the engagement

team.

Due to data limitations, much of the existing literature focuses on the outputs and opinion

portion of the audit quality framework. Regarding this portion, both stakeholder groups view

financial statement restatements as the strongest publicly available indicator of low audit quality.

While participants agreed that not all restatements are created equal, evidence from scale-based

questions, open-ended responses, and follow-up interviews all support the use of restatements as

a signal of low audit quality. Responses also provide support for other observable indicators of

low audit quality such as SEC enforcement actions, aggressive accruals, and opaque financial

reporting. With regard to the audit opinion itself, both stakeholders, but especially investors,

associate offering an unqualified opinion to a client that subsequently declares bankruptcy with

lower audit quality. On the other hand, both groups associate adding a going concern paragraph

to a client’s audit report that does not declare bankruptcy with higher audit quality. Keeping in

mind the low base rate for going concern opinions, these results provide support for the use of

audit opinion characteristics as a proxy for audit quality.

Finally, we consider post-opinion activities such as PCAOB, peer, and internal

inspections. Both stakeholders associate fewer identified audit deficiencies throughout this

review process with higher audit quality. In spite of the PCAOB’s attempts to educate the public

as to the meaning of PCAOB inspection reports, both auditors and investors associate a lower

36
number of PCAOB deficiencies with higher engagement quality. In addition investors use this

number of deficiencies as an indicator of overall firm quality, indicating continuing confusion

about the intended use of PCAOB inspection reports by investors.

When evaluated together, our results present comprehensive insights into the definition

and measurement of audit quality based on the views of auditors and investors. Survey responses

provide clear definitions of perceived audit quality and, as outlined in Appendix B, provide

empirical evidence regarding many of the audit quality indicators currently being considered by

the PCAOB. Additionally, we provide nine (six) distinct constructs identified from auditors’

(investors’) responses that can lay the groundwork for a balanced scorecard approach to

evaluating audit quality. We believe these findings represent a significant step forward in

understanding the construct of audit quality in the post-Sarbanes-Oxley era and add substance to

the theoretical frameworks that describe audit quality in the current literature (e.g., Bedard et al.

2010; Knechel et al. 2013). Further, our study responds to the call in Francis (2011) for research

that improves our understanding of the key inputs to the audit quality process, provides support

for archival proxies of audit quality discussed in DeFond and Zhang (2013), and identifies

avenues for future research.

37
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 Appendix A
Mapping of Auditor and Investor Findings to Audit Quality Framework

AUDIT QUALITY
AUDITORS FRAMEWORK INVESTORS

Definition #1 Definitions #1, 3

Inputs
Signal #3
Factors #3, 4, 9
Factors #2, 4, 5

Definitions #1, 3

Processes Definition #2

Factors #5, 6

Definition #2
Outputs and Signals #1, 2

Signals #1, 2 Opinion Factors #1, 6

Factors #2, 7, 8

Signal #3
Factor #3
Post-Opinion
Factor #1

Summary findings are based on participants’ responses from Tables 3, 8, and Appendix Table 1. Definitions:
Auditors’ top three definitions of audit quality are: 1) an audit performed in accordance with GAAS; 2) an audit that
results in ex-post accurate financial statements; and 3) an audit that is well-planned. Investors’ top three definitions
of audit quality are: 1) an audit performed by well-trained individuals; 2) an audit that is well-planned; and 3) an
audit performed by independent, skeptical auditors. Signals: Auditors’ top three signals of low audit quality are: 1)
restatements; 2) SEC enforcement; and 3) PCAOB deficiencies. Investors’ top three signals of low audit quality are:
1) restatements; 2) poorly-written disclosures; and 3) frequent change in auditor. Factors: Auditor-identified factors
are 1) review/inspection results; 2) financial statement quality; 3) fees and governance; 4) auditor characteristics; 5)
timeliness of audit procedures; 6) consultations; 7) audit opinion; 8) accruals; and 9) large/conservative audit firm.
Investor-identified factors are 1) financial statement quality; 2) fees and governance; 3) review/inspection results; 4)
auditor characteristics; 5) large/conservative audit firm; and 6) audit opinion.

44
 Appendix B
Mapping of Auditor and Investor Findings to PCAOB Audit Quality Indicators
PCAOB Audit Quality Indicator
Average years of experience
Industry expertise and proficiency
Trainings hours per audit professional
Number of accounting and auditing consultations
Specialist hours as a percentage of overall engagement
hours
Partner, manager, engagement quality reviewer hours
relative to total audit effort
Processes
Number and nature of internal quality review findings
Number and nature of PCAOB inspection findings
Compensation to ensure adequate financial incentive
and resources
Outputs and Opinion
Frequency and market impact of financial statement
restatements for errors
Number of audit reports including a going concern
opinion which did not have a subsequent bankruptcy
Number of audit reports lacking a going concern
opinion which had a subsequent bankruptcy
Trends in the frequency, magnitude and results of
litigation against auditors
Frequency, nature and market impact of reported
frauds
Number and nature of internal quality review findings
Number and nature of PCAOB inspection findings
Trends in PCAOB and SEC Enforcement actions
PCAOB Audit Quality Indicators included in this table are based on the briefing paper for May, 2013 SAG meeting.
Survey Findings
Inputs
100 percent of auditors and investors associate appropriate
auditor expertise and experience with higher audit quality.
100 percent of auditors and investors associate well-trained
auditors with higher audit quality.
69.9 percent of auditors associate the number of consultations
with the national office with higher audit quality.
82.9 percent of auditors associate consultations with internal
specialists with higher audit quality.
78.4 percent of auditors associate the number of hours billed by
the EQRP with higher audit quality.
70.9 percent of auditors and 70.7 percent of investors associate
fewer deficiencies identified through internal quality review
with higher audit quality.
75.3 percent of auditors and 65.4 percent of investors associate
fewer inspection findings by the PCAOB with higher audit
quality.
72.0 percent of auditors and 52.9 percent of investors associate
the payment of reasonable audit fees with higher audit quality.
75.3 percent of auditors and 62.8 percent of investors associate
the lack of subsequent financial statement restatement with
higher audit quality.
39.8 percent of auditors and 53.0 percent of investors associate
this situation with higher audit quality.
44.4 percent of auditors and 69.6 percent of investors associate
this situation with lower audit quality.
30.2 percent of auditors and 49.0 percent of investors associate
the lack of subsequent litigation with higher audit quality.
62.8 percent of investors associate the lack of subsequent fraud
with higher audit quality.
See above.
See above.
70.9 percent of auditors and 62.7 percent of investors associate
the lack of subsequent SEC enforcement actions with higher
audit quality.
45
 Appendix C
Factor Analysis

To provide support for our grouping of survey questions reported in Tables 4, 5, and 6 we

use factor analysis to identify the underlying dimensions of audit quality examined in the survey.

Because of differences reported between auditors’ and investors’ responses, and because not all

questions were posed to both groups, we run the factor analysis separately by participant group.

We perform the analysis using a principal component extraction method with varimax rotation to

identify orthogonal constructs with eigenvalues greater than 1.24 Results are reported in

Appendix Table 1.

Appendix Table 1
Panel A: Auditors
Factor Factor Name Eigenvalue Question #s (Factor Loadings)
1 Review/Inspection Results 3.1 4.5 (.79); 4.6 (.80); 4.7(.92); 4.8 (.81)
2 Financial Statement Quality 2.3 6.2 (.90); 6.3 (.90)
3 Fees and Governance 2.1 4.12 (.51); 5.8 (.44); 6.5 (.71); 6.6 (.79)
4 Auditor Characteristics 2.0 5.1 (.62); 5.2 (.86); 5.3 (.69)
5 Timeliness of Audit 1.9 4.9 (.89); 4.10 (.75); 5.4 (.48)
Procedures
6 Consultations 1.8 4.11 (-.48); 5.5 (.65); 5.6 (.88); 5.7 (.60)
7 Audit Opinion 1.6 4.2 (.65); 4.3 (.75)
8 Accruals 1.5 6.1 (.86)
9 Large/Conservative Audit 1.3 4.1 (-.52); 4.4 (.72)
Firm

Panel B: Investors
Factor Factor Name Eigenvalue Question #s (Factor Loadings)
1 Financial Statement Quality 2.7 4.11 (.52); 6.1 (.52); 6.2 (.68); 6.3 (.67); 6.4
(.89)
2 Fees and Governance 2.4 4.12 (.58); 5.8 (.48); 6.5 (.85); 6.6 (.81)
3 Review/Inspection Results 2.4 4.6 (.73); 4.7(.87); 4.8 (.86)
4 Auditor Characteristics 2.2 5.1 (.51); 5.2 (.90); 5.3 (.85)
5 Large/Conservative Audit 1.9 4.1 (.45); 4.2 (.62); 4.4 (.83)
Firm
6 Audit Opinion 1.2 4.3 (.89)

24
For a robustness check, we also perform the analysis using maximum likelihood extraction. This method also
identified 9 factors for auditors and 6 for investors.

46
 As reported in Appendix Table 1, Panel A, nine distinct factors result from the 25

questions posed to auditors and reported in Tables 4, 5, and 6.25 Results generally support our

assigned groups: Factors 1, 2, 4, 7, and 8 are composed of questions consistent with our grouping

and analysis. However, there are differences, specifically factors 3, 5, 6, and 9 provide slightly

different question groups. Factor 3 combines questions 4.12 and 5.8, relating to audit fees and

engagement profitability, with questions 6.5 and 6.6, which address board governance. Given the

involvement of boards in the audit fee decision, factor 3 reflects a meaningful combination of

questions. Factor 5 combines questions 4.9 and 4.10, relating to the timeliness of audit

procedures, with question 5.4, which examines the impact of engagement review partner hours.

Given the important role of the engagement review partner in the planning and completion stages

of the audit, factor 5 also appears to reflect a meaningful combination of questions and addresses

the processes portion of the framework. Factor 6 combines questions 5.5, 5.6, and 5.7, relating to

consultations with individuals outside the core engagement team, with question 4.11, which

examines the lack of eventual lawsuits against the auditor. When we consider the role of

consultations with those outside the day-to-day operations of the engagement team in assisting

the team with more complicated transactions, the combination of consultations with a lawsuit-

related question appears to be appropriate. Finally, factor 9 combines question 4.1, relating to the

size of the audit firm, with question 4.4, which examines the impact of issuing a going concern

paragraph to a client that remains solvent. This combination does not appear as meaningful as the

other factors. However, this analysis supports our grouping of questions to reflect various aspects

of the audit engagement and audit quality.

25
These 9 factors explain 71 percent of the variance; only 4 of 25 questions had cross-loading greater than .35, in
which case we assigned the question based on its strongest factor loading.

47
 As reported in Appendix Table 1, Panel B, six distinct factors result from the 19

questions posed to investors (Tables 4, 5, and 6).26 Consistent with auditor responses, results

generally support our assigned groups; Factors 3, 4, 5, and 6 are composed of questions

consistent with our groupings. The differences related to factors 1 and 2. Factor 1 combines

questions 6.1, 6.2, 6.3, and 6.4, related to financial statement outcomes, with question 4.11,

related to a lack of litigation against the auditor. This combination of questions appears logical

considering all questions relate to the outputs and opinion portion of the framework. Identical to

Factor 3 in from the auditor questions, Factor 2 from the investor questions combines 4.12 and

5.8, relating to fees and profitability, with questions 6.5 and 6.6, which address board

governance.

Taken together, the nine auditor-identified and six investor-identified factors provide a

concise summary of our analysis and provide a framework for a potential ‘balanced scorecard’

approach to evaluating audit quality (Franzel 2013) and describe audit quality as a multi-faceted

construct consistent with existing theoretical audit quality frameworks (Bedard et al. 2010;

Francis 2011; Knechel et al. 2013). While the factors identified in our analysis may not represent

all facets of audit quality, they provide support for prior research investigating the effects of

audit quality, suggest avenues for additional investigation, and contribute to the ongoing public

discussion of audit quality.

26
These 6 factors explain 68 percent of the variance; only 3 of 19 questions had cross-loadings greater than .35, in
which case we assigned the question based on its strongest factor loading.

48
 Table 1
Demographics—Audit Professionals

Title and Tenure

Partner: 73
Senior Manager: 17

Years in current position:

Partners: 11.1 years
Senior Managers: 3.3 years
Years in public accounting:
Partners: 23.4 years
Senior Managers: 11.3 years

Client Portfolio
Percent Publicly Traded: 67%

Industry Expertise
Retail/Wholesale: 22.2%
Mining/Construction: 5.5%
Manufacturing: 32.2%
Transportation/Energy: 17.7%
Communications/Media: 8.8%
Tech (Software/Biotech): 22.2%
Banking/Finance/Insurance: 32.2%
Service/Consulting: 11.1%
Healthcare/Pharmaceutical: 5.5%
Other: 8.8%

Education
Highest degree obtained
Bachelor’s degree: 80.0%
M.B.A: 13.8%
Non-M.B.A. Master’s degree: 6.2%

Some percentages add to more than 100% because participants could select more than one option. Percentages are
based on the participants who completed the entire survey.

49
 Table 2
Demographics—Investors

General Investment Patterns

Age Read Business Press: mean response: 7.01
<30 years old: 0% (from scale of 1-Never
31-40 years old: 15.2% to 11-Daily)
41-50 years old: 36.7%
51-60 years old: 40.5% Reference to the audit report when making investment
61-70 years old: 6.3% decisions:
>70 years old: 1.3% Always: 18.5%
Gender Most of the time: 22.2%
Male: 65.4% Sometimes: 24.7%
Female: 34.6% Rarely: 22.2%
Never: 12.4%
Education
Bachelor’s in Accounting: 59.7% Current/Future Investment Activity
Bachelor’s in Finance: 21.9% Current Retirement Account: 93.9%
Bachelor’s in Management: 2.4% Current Mutual Funds: 86.6%
Master’s in Accounting: 13.4% Current Stock: 84.1%
Master’s in Finance: 10.9% Current Bonds: 23.2%
Master’s in Other: 4.8%
MBA Finance: 6.1% Primary Investment Vehicles
MBA Other: 8.5% Mutual funds: 85.4%
PhD: 4.8% Individual stocks: 52.4%
Corporate bonds: 20.7%
Employment Cash deposits: 29.2%
Work Experience: 23.8 years Money market funds: 41.5%
Years at Current Job: 9.98 years Derivatives: 12.2%
U.S. Treasury bonds: 10.9%
Industry Other: 20.7%
Retail/Wholesale: 2.4%
Mining/Construction: 7.3% Financial Statement Evaluation
Manufacturing: 4.8% The number of companies evaluated using financial
Transportation/Energy: 12.2% information in the past five years
Communications/Media: 1.2% 0 companies evaluated: 11.1%
Tech (Software/Biotech): 1.2% 1-5 companies evaluated: 33.3%
Banking/Finance/Insurance: 10.9% 6+ companies evaluated: 55.6%
Service/Consulting: 13.4%
Public Accounting: 12.2% Portfolio Value
Healthcare/Pharmaceutical: 2.4% Value less than $50,000: 6.7%
Education: 9.7% Value greater than $50,000: 93.3%
Retired: 6.5%
Unemployed: 0%
Other: 15.8%

Some percentages add to more than 100% because participants could select more than one option. Percentages are based on
the participants who completed the entire survey.

50
 Table 3
Definitions and Measures of Audit Quality
Panel A: Audit Professional Responses

Auditor Number of Investor

Rank References Auditor Top 5 Definitions Measures Rank
Audit performed in accordance with professional
standard (GAAS), including rigorous Results of internal/external
documentation, that obtains reasonable assurance inspection; lack of
that financial statements are not materially restatements; auditor
1 31 misstated expertise 4
An audit that results in financial statements Restatements, SEC action in
consisting of accurate, reliable information that subsequent years; auditor’s
the investing public can rely upon as evidenced correct identification of
2 25 by hindsight risks 4
Results of internal/external
A well-planned engagement that addresses the inspections; properly
3 15 significant risks of the company supervised audit 2
Number of Part 1 PCAOB
The lack of errors identified in subsequent comments; results from
4 14 review other inspections 13
Having well-trained, competent auditors Auditor experience;
(including specialists, where necessary) perform inspection results; number
5 13 at a high-level of audit hours spent 1

Panel B: Investor Responses

Investor Number of Auditor

Rank References Investor Top 5 Definitions Measures Rank
Having well-trained, competent auditors Auditor experience;
(including specialists, where necessary) perform inspection results; size of
1 18 at a high-level audit firm 5
Complexity of client’s
A well-planned engagement that addresses the industry; all material
2 8 significant risks of the company balances in scope 3
Non-audit fees; auditor
3 6 Performed by independent, skeptical auditors rotation 6
Audit performed in accordance with professional
standard (GAAS), including rigorous
documentation, that obtains reasonable assurance Auditor expertise; staff
that financial statements are not materially training; results from
T4 4 misstated external inspections 1
An audit that results in financial statements
consisting of accurate, reliable information that
the investing public can rely upon as evidenced Subsequent SEC actions and
T4 4 by hindsight restatements 2

Participants were asked to provide their definition of audit quality and how they would measure that definition. Responses were coded
by independent raters with a Cohen’s Kappa of 0.64, an acceptable level of agreement that is significantly different than random
chance at p <0.01 (Neuendorf 2002). Raters resolved all differences. Rankings above are based on the number of times each definition
was given.
51
 Table 4
Examining the Attributes of Audit Quality: Characteristics of the Audit Engagement

For each statement below, how is the audit quality of a specific engagement impacted by…:
Auditors Investors ANOVA
…higher …no …lower …higher …no …lower Auditor
audit association audit audit association audit mean vs.
quality with audit quality Average quality with audit quality Average Investor
Question Attribute (7-11) quality (6) (1-5) scorea (7-11) quality (6) (1-5) scorea meanb
Category: Audit Firm Size
…the entity being audited by a U.S.
9.40*** 7.47*** p < 0.01
audit firm with a strong global 94.6% 5.4% 0% 67.6% 22.5% 9.8%
N=92 N=102 F = 64.46
4.1 network?
Category: The Audit Report
…the audited entity receiving an 6.82*** 7.28*** p = 0.06
30.1% 69.9% 0% 50.0% 43.2% 6.8%
4.2 unqualified opinion? N=93 N=102 F = 3.56
…issuing a clean audit opinion if the
5.43*** 4.00*** p < 0.01
audited entity files for bankruptcy 12.2% 43.3% 44.4% 6.9% 23.5% 69.6%
N=92 N=102 F = 24.84
4.3 within the subsequent 12 months?
…adding a going concern paragraph
to the audit opinion when the audited 6.94*** 7.08*** p = 0.60
39.8% 59.1% 1.1% 53.0% 34.3% 12.7%
entity does not file for bankruptcy N=93 N= 102 F = 0.27
4.4 within the subsequent 12 months?
Category: Review and Inspection Results
…fewer audit deficiencies identified
8.33***
during real-time internal quality 79.5% 19.4% 1.1%
N=93
4.5 review?
…the internal quality reviewers
7.97*** 7.48*** p = 0.06
identifying fewer deficiencies for the 70.9% 26.9% 2.2% 70.7% 16.6% 12.7%
N=93 N=102 F = 3.55
4.6 engagement?
…the peer-review firm identifying
8.12*** 8.05*** p = 0.79
fewer deficiencies for the 75.3% 21.5% 3.2% 78.2% 12.9% 8.9%
N=93 N=101 F = 0.07
4.7 engagement?
…the PCAOB inspectors generating
8.15*** 7.52*** p = 0.02
fewer matter sheets for the 75.3% 24.7% 0.0% 65.4% 21.8% 12.8%
N=93 N=101 F = 5.15
4.8 engagement?

52
 Table 4 <Continued>

Category: Timeliness of Procedures

Auditors Investors ANOVA
8.74***
…the timeliness of completing audit 94.6% 5.4% 0.0%
N=92
4.9 planning procedures?
8.85***
…the timeliness of completing audit 89.3% 7.5% 3.2% N=93
4.10 fieldwork?
Category: Other
…the lack of eventual lawsuits filed
6.60*** 6.86*** p = 0.33
due to the work performed to support 30.2% 63.4% 6.4% 49.0% 39.0% 12.0%
N=93 N=100 F = 0.93
4.11 an audit opinion?
…the payment of reasonable audit 7.78*** 7.17*** p = 0.04
72.0% 22.6% 5.4% 52.9% 36.3% 10.8%
4.12 fees to the auditor? N=93 N=102 F = 4.26

a
Mean values are tested against the scale’s midpoint of 6. ***, ** and * indicate the mean is statistically different from the midpoint at p < 0.01, p < 0.05 and p < 0.10
respectively.
b
Results from a one-way ANOVA comparing the mean values of each question across Auditors and Investors. In situations where the question was not asked to both groups, the
appropriate boxes are blacked out.

53
 Table 5
Examining the Attributes of Audit Quality: Resources Available for the Audit Team
For each statement below, how is the audit quality of a specific engagement impacted by…:
Auditors Investors ANOVA
…higher …no …lower …higher …no …lower Auditor
audit association audit audit association audit mean vs.
quality (7- with audit quality Average quality with audit quality Average Investor
Question Attribute 11) quality (6) (1-5) scorea (7-11) quality (6) (1-5) scorea meanb
Category: Engagement Team Qualifications
p < 0.01
10.02*** 8.80***
. . . the sufficiency of 100.0% 0.0% 0.0% 91.2% 6.9% 1.9% F=
N=93 N=102
5.1 engagement team staffing? 38.03
…having well-trained p < 0.01
10.14*** 9.66***
auditors on the engagement 100.0% 0.0% 0.0% 100.0% 0.0% 0.0% F=
N=93 N=102
5.2 team? 10.72
…having auditors on the
engagement team with the
appropriate expertise (e.g., 9.82*** 9.88*** p = 0.67
100.0% 0.0% 0.0% 100.0% 0.0% 0.0%
industry expertise, experience N=93 N=102 F = 0.18
in specific transactions,
5.3 forensics, etc.)?
Category: Consultations and Other
…the number of hours billed
7.63***
by engagement review 78.4% 19.4% 2.2%
N=93
5.4 partners?
…the number of consultations 7.14***
69.9% 25.8% 4.3%
5.5 with the national office? N=93
…the number of consultations 6.77***
59.1% 35.5% 5.4%
5.6 with external experts? N=93
…the number of consultations 7.68***
82.9% 16.1% 1.0%
5.7 with internal specialists? N=93
…achieving expected levels 6.23 5.88 p = 0.12
25.0% 65.2% 9.8% 20.6% 53.9% 25.5%
5.8 of engagement profitability? N=92 N=102 F = 2.40
a
Mean values are tested against the scale’s midpoint of 6. ***, ** and * indicate the mean is statistically different from the midpoint at p < 0.01, p < 0.05 and p < 0.10
respectively.
b
Results from a one-way ANOVA comparing the mean values of each question across Auditors and Investors. In situations where the question was not asked to both groups, the
appropriate boxes are blacked out.
54
 Table 6
Examining the Attributes of Audit Quality: Characteristics of the Audited Entity
For each statement below, how is the audit quality of a specific engagement impacted by…:
Auditors Investors ANOVA
…higher …no …lower …higher …no …lower Auditor
audit association audit audit association audit mean vs.
quality with audit quality Average quality with audit quality Average Investor
Question Attribute (7-11) quality (6) (1-5) scorea (7-11) quality (6) (1-5) scorea meanb
Category: Accruals
…the audited entity’s historical
conservatism reflected in 6.89*** 6.62*** p = 0.19
54.8% 37.6% 7.5% 39.6% 51.5% 8.9%
recording reserves (compared to N=93 N=101 F = 1.69
6.1 industry peers)?
Category: Subsequent Outcomes
…the lack of financial statement
7.87*** 7.32*** p = 0.03
restatements by the audited entity 75.3% 23.7% 1.0% 62.8% 29.4% 7.8%
N=93 N=102 F = 5.00
6.2 related to the period in question?
…the lack of SEC enforcement
actions against the audited entity
7.66*** 7.26*** p = 0.16
for reporting or disclosure 70.9% 26.9% 2.2% 62.7% 26.5% 10.8%
N=93 N=102 F = 2.00
deficiencies related to the period
6.3 in question?
…the lack of subsequent
discovery of significant 7.30***
accounting fraud and/or 62.8% 25.5% 11.7% N=102
misrepresentation in the audited
6.4 financial statements?
Category: Committee Meetings
…the number of formally
7.65*** 6.19 p < 0.01
planned audit committee 78.2% 18.5% 3.3% 31.3% 56.9% 11.8%
N=92 N=102 F = 40.60
6.5 meetings per year?
…the number of formally
6.58*** 7.11*** p = 0.02
planned board of directors 40.8% 53.8% 5.4% 57.8% 35.3% 6.9%
N=93 N=102 F = 5.50
6.6 meetings per year?
a
Mean values are tested against the scale’s midpoint of 6. ***, ** and * indicate the mean is statistically different from the midpoint at p < 0.01, p < 0.05 and p < 0.10
respectively.
b
Results from a one-way ANOVA comparing the mean values of each question across Auditors and Investors. In situations where the question was not asked to both groups, the
appropriate boxes are blacked out.
55
 Table 7
Examining the Association between PCAOB Reports and Firm-Wide Audit Quality

To what extent is the quality of an audit firm as a whole impacted by…

Auditors Investors ANOVA
…higher …no …lower …higher …no …lower Auditor
audit association audit audit association audit mean vs.
quality with audit quality Average quality with audit quality Average Investor
(7-11) quality (6) (1-5) scorea (7-11) quality (6) (1-5) scorea meanb
...having fewer total Part One
comments in PCAOB inspection 64.5% 29.0% 6.5% 6.99*** 88.1% 10.9% 1.0% 7.90*** p < 0.01
reports? N=93 N=101 F = 19.22
a
Mean values are tested against the scale’s midpoint of 6. ***, ** and * indicate the mean is statistically different from the midpoint at p < 0.01, p < 0.05 and p < 0.10
respectively.
b
Results from a one-way ANOVA comparing the mean values of each question across Auditors and Investors. In situations where the question was not asked to both groups, the
appropriate boxes are blacked out.

56
 Table 8
Publicly Available Signals of Low Audit Quality

Panel A: Audit Professional Responses

Auditor Number of Investor
Rank References Auditor Top 10 Rank
1 47 Restatements 1
2 19 SEC comment letters and enforcement actions 25
3 18 PCAOB reports of deficiencies 20
T4 10 Negative news about the company’s finances 6
Financial Statement policies/ earnings trends inconsistent with
T4 10 industry and other benchmarks 4
T4 10 Frequent change in auditor 3
T7 9 Poorly written, confusing, or inadequate disclosures 2
T7 9 Unusually low audit fees 10
T7 9 Lawsuits against the audit firm 8
T10 5 Negative analyst reports that raise questions about performance 32
T10 5 Small audit firm/ low levels of industry experience 5
T10 5 Identification of material weaknesses 25

Panel B: Investor Responses

Investor Number of Auditor
Rank References Investor Top 10 Rank
1 16 Restatements 1
2 14 Poorly written, confusing, or inadequate disclosures 7
3 13 Frequent change in auditor 4
Financial Statement policies/ earnings trends inconsistent with
4 12 industry and other benchmarks 4
5 11 Small audit firm/ low levels of industry experience 10
6 8 Negative news about the company’s finances 4
7 7 No turnover of auditor 48
T8 6 Lawsuits against the audit firm 7
T8 6 Material write-offs/ accounting for intangibles 13
T10 5 Unusually low audit fees 7
T10 5 Bankruptcy of client with clean audit opinion 13
T10 5 Client liquidity concerns 26
T10 5 Turnover of client executives 17

Participants were asked to provide publicly available signals of low audit quality. Responses were coded by independent raters with a
Cohen’s Kappa of 0.86, an acceptable level of agreement that is significantly different than random chance at p <0.01 (Neuendorf
2002). Raters resolved all differences. Rankings above are based on the number of times each definition was given.

57