Over half of US businesses facing financial problems go ‘opinion shopping’ for auditors to try to override unfavourable going concern opinions at the expense of auditor independence and investor interests, a US study has found
The American Accounting Association has published academic research on the use of opinion shopping, whereby companies seek an independent assessment of their business from a third party auditor, when they are facing financial problems, with some putting pressure on their auditors to produce a favourable opinion on their numbers.
The researchers analysed data from over 3,500 distressed public companies in the US over a nine-year period, focusing on companies which had reported either negative net income or negative operating cashflow in a given year, and the impact on auditor independence and corporate pressure on audit firms to produce positive reports of business viability.
Whether or not companies engaged in opinion shopping was determined through analysis of a complex array of factors that included firms’ financial profiles (for example, the amounts of their assets, debt, return on assets, and operating cashflow); whether firms’ prior-year audit resulted in a clean opinion or a going concern opinion ; and sizes of auditors’ practices and whether they used Big Four firms.
The results showed that 57% of the companies in the sample shopped opinions, among which only 16% received going concern opinions, compared to the 28% among non-opinion shoppers.
The researchers point out that going concern opinions express substantial doubt about a company’s ability to continue as a going concern in the near future, which is why companies are eager to avoid this judgment.
The study shows that of the 142 businesses that filed for bankruptcy, 45% of the opinion shoppers had received clean opinions, compared to only 19% of the non-shoppers. In other words, there were significantly fewer red flags for investors with respect to the former group of companies.
The study also found other evidence of auditing lapses as a result of opinion shopping, for example, in the incidence of financial misstatements, which was significantly higher among companies that engaged in opinion shopping than among those that did not.
The disparity was attributable to opinion shoppers that switched auditors rather than those that retained incumbents. Opinion-shoppers that did not switch auditors proved no more likely to restate finances than non-shoppers.
The researchers said this difference between the two groups of opinion shoppers occurred because successor auditors are incentivised to keep their new clients until they recover start-up costs and are thus more susceptible to client pressure.
The report said: ‘In addition, if auditors are concerned about reputation damages borne by early termination of audit contract, the successor auditors subsequent to switching opinion shopping could be more vulnerable to the threats of dismissal.
‘In contrast, incumbent auditors under non-switching opinion-shopping can be more resistant to client pressure, as they have recovered the start-up costs partly or fully from previous audit services.’
The study found that clients that switch can be particularly aggressive in exerting influence, since ‘changing auditors is costly to clients because they should bear auditor searching costs and a share of the incoming auditor’s start-up costs. Clients’ willingness to incur such costs may signal that their opinion shopping incentives are relatively strong. This may result in more adverse effects on audit quality.’
Professor Jong-Hag Choi of Seoul National University, one of the lead researchers, said: ‘Regulators and sophisticated investors can identify companies that switch auditors after opinion shopping, something that should be of value given the increased likelihood of misstatements among such firms. As for less sophisticated investors, they can benefit by simply exercising an extra measure of caution in assessing any company that changes auditors after receiving a going concern opinion.’
The research also investigated whether the US Sarbanes-Oxley Act of 2002, which created the Public Company Accounting Oversight Board (PCAOB) to provide national oversight of corporate auditing, has reduced the use of opinion shopping. Collecting data from before and after the establishment of the PCAOB in 2003, they found that opinion shopping sharply declined in the period 2004-2006 but subsequently returned to its pre-PCAOB level.
The research concluded there was a 'need to develop mechanisms that curb clients’ opportunistic auditor switches, such as regulatory intervention in the choice of a successor auditor or other mechanisms that discipline excessive client pressure. Our findings also provide important implications for investors and audit committees by suggesting that both audit opinion credibility and financial reporting quality can be hampered by auditor switching through opinion shopping.’
The joint research project was conducted by professors Jong-Hag Choi of Seoul National University, Heesun Chung of Sejong University, Catherine Heyjung Sonu of Korea Open National University, and Yoonseok Zang of Singapore Management University.
The review, Opinion-shopping to avoid a going concern audit opinion and subsequent audit quality, is in the May issue of Auditing: A Journal of Practice and Theory, published by the American Accounting Association.