The Impact of Disclosing Engagement Partner Identity: No Clear Answer
By Dan Goelzer
In 2015, the Public Company Accounting Oversight Board adopted a rule requiring accounting firms to make a filing disclosing the name of the engagement partner responsible for each public company audit. Audit reports are signed in the name of the accounting firm issuing the opinion, and, prior to the new rule, the identity of the engagement partner had generally not been on the public record. The PCAOB’s partner name disclosure requirement has now been in effect for over two years, and researchers are beginning to sift through the data. So far it is not clear whether investors are benefiting from knowing who headed their company’s audit or whether auditors are doing anything different.
The PCAOB proceeding that led to the new disclosure requirement was contentious. Initially, the Board proposed that engagement partners sign audit opinions in their own name, as is the practice in some other countries. The Board, along with some investor advocates, argued that a signature would enhance the signer’s sense of personal accountability and thereby improve audit quality. They also pointed out that, under the Sarbanes-Oxley Act, CEOs and CFOs are required to personally certify the accuracy of SEC financial filings and that the same should be expected of auditors.
The accounting profession responded that there were already strong legal and practical incentives for engagement partners to perform their work properly. Auditors objected that a signature requirement was likely to increase the partner’s exposure to litigation — meritorious or otherwise — and could make partners reluctant to accept high risk assignments. The large accounting firms also stressed that auditing is a team effort and that firms are required to have quality control systems designed to ensure that the level and nature of audit effort does not vary based on the identity of the partner leading the engagement.
In the end, the PCAOB compromised. It dropped the signature requirement, but adopted name disclosure in a new public filing, Form AP. The Board justified partner identification as a step that would provide useful information to investors: “Investors will be able to take into account not just the firm issuing the auditor’s report but also the specific partner in charge of the audit and his or her history as an engagement partner on issuer audits. * * * While this information may not be useful in every instance or meaningful to every investor, the Board believes that, overall, it will contribute to the mix of information available to investors.”
Engagement partner disclosure on Form AP began in January 2017. Whatever its other effects, the new filing has been a boon for academic research. Studies are now beginning to appear that seek to gauge the benefits to investors of this new data point and the impact on auditing. At least so far, the results seem to be somewhere between underwhelming and inconclusive.
A paper prepared by four researchers at the University of Alabama’s Culverhouse School of Accountancy examines the utility of Form AP disclosures by studying securities market reactions to partner name disclosure. In Do Investors Care Who Did the Audit? Early Evidence on the Informativeness of Form AP (available on SSRN), Marcus Doxey, James Lawson, Thomas Lopez, and Quinn Swanquist find “no significant investor response” to disclosure of the identity of engagement partners. There is, however, an exception: If the partner has previously been associated with a restatement, there is a measurable increase in securities market trading activity in the audit client’s shares, but no clear price impact.
The study looked at three types of disclosure that might be expected to have market effects: (1) partner switches in the second year of Form AP, (2) partner switches where the incoming partner has industry experience, and (3) partners associated with restatements by other clients. The authors state that, “While we find no evidence that Form AP informs market participants in the first two cases, for partners associated with restatements at other clients (restatement partners), we find significant abnormal trading volume around the Form AP release.” However, the “directional price reaction” is not statistically significant. The authors suggest several possible explanations, but the bottom line seems to be that a Form AP disclosing a partner with a previous restatement “prompts investor trading but does not, on average, affect market value.”
Securities market impacts aside, perhaps publicly identifying the engagement partner improves audit quality, as the PCAOB envisioned when it considered a signature requirement. Two studies of this possibility seem to point in different directions.
In What’s in a Name? Initial Evidence of U.S. Partner Identification Using Difference-in Differences Analysis, 94 The Accounting Review 139–163 (September 2019), Lauren M. Cunningham, Chan Li, Sarah E. Stein, and Nicole S. Wright investigated whether partner name disclosure affects audit quality. Their research finds only limited evidence of any impact.
“Audit quality” is an amorphous concept. Therefore, researchers use observable financial reporting characteristics, such as discretionary accruals, misstatements, and incorrect opinions on the effectiveness of internal control, as proxies for audit quality. By these measures, the What’s in a Name? authors state that they were “unable to detect a significant change in audit quality” attributable to partner name disclosure. There was, however, an apparent audit quality improvement in a few specific areas. For example, while audit quality, as measured by discretionary accruals, did not improve on average, “it did improve for specific types of engagements with weak internal controls and higher risk of litigation.”
Jenna J. Burke, Rani Hoitash, and Udi Hoitash come to a somewhat different conclusion in Audit Partner Identification and Characteristics: Evidence from U.S. Form AP Filings, 38 Auditing: A Journal of Practice & Theory 71–94 (August 2019). Using discretionary accruals as their proxy for audit quality, these researchers find that audit quality improved following partner name disclosure, but only for Big Four firms. “These results suggest that the enhanced accountability and legal, regulatory, and reputational risk concerns imposed by public identification motivate partners to increase audit quality. * * * [D]espite arguments against the disclosure requirement, reputational concerns appear to be salient for Big 4 audit partners.” They also find that, for both Big Four and other firms, “audit delay” decreased (as measured by how far in advance of the SEC filing deadline the audit report is dated). However, quality improvements and speedier audit completion came at the price of an increase in audit fees. The authors suggest that higher fees are the result of audit teams expending greater effort following the disclosure requirement.
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Engagement partner name disclosure has been in effect for less than three years, and the research on its impact is still preliminary. As a data base of information concerning engagement partners accumulates, the effect on both investor decision-making and audit quality should become clearer. For now, however, while there are some intriguing early signs, the debate over the benefits of this new disclosure remains unresolved.