Research shows Big Four ‘too cosy’ with ex-audit CFOs
19 Feb 2018
When a CFO or other top executive of a company being audited was formerly employed by the accounting firm conducting the audit there is a risk from the ‘familiarity threat’ which can undermine audit independence and ‘breed coziness’, according to a report from the American Accounting Association which says the ‘revolving door’ might need to be closed
19 Feb 2018
Research by academics from Simon Fraser University's Beedie School of Business looked at whether restrictions on the employment of alumni put in place since the financial crisis have addressed the issue.
They tested the willingness of Big Four managers, in the US, to adopt a client’s position on a conjectural accounting matter. The findings show that 76% do so if the client’s CFO is a former colleague at their Big Four audit firm, while only 44% do so if the CFO is not.
The study was based on an experiment conducted via the internet with 140 managers of Big Four firms in offices throughout Canada and the US. The managers, who averaged about seven years of auditing experience, all received the same background information about a corporate client and its industry as well as a draft of the current year’s financial statement.
Some were told that until two years ago the client company’s CFO was a partner in their accounting firm, a colleague with whom they worked on engagements involving this very client and others; a second group was told that the CFO formerly attained partnership at another Big Four accounting firm; while the remainder received no information about the CFO’s prior employment history.
All participants were asked to assume the role of a continuing audit manager on the account and to look at the valuation of goodwill. The CFO in the case study maintained this should be unchanged from the previous year, but the researchers maintained the evidence was mixed.
In the first group of participants, who were told the CFO was a former colleague and engagement partner, 76% agreed with the CFO that goodwill was not impaired. Of those who were told the CFO was formerly with another Big Four firm, 48% agreed to no impairment, and in the third group, who received neither of those indications, only 39% agreed.
In sum, being told the CFO had formerly been a Big Four partner inclined participants to agreement on goodwill impairment but not nearly as much as the alumni effect did. And least likely of all to be swayed were participants whose CFO had neither alumnus status nor Big Four imprimatur.
The professors also tested the degree of confidence in their decisions among auditors who agreed with the CFO that goodwill should not be impaired. Those in the first and second groups reported, on average, about equal levels of confidence, with both being significantly higher than the average confidence in the third group.
This meant, researchers said: ‘the fact that the current auditors are more likely to concur with the client’s position when the client is a former audit partner of their firm can be interpreted as indicating reduced professional scepticism, but the results of the [confidence] test…suggest that source credibility also influences the auditors’ confidence in a CFO’s position.’
The research also found the alumni effect occurs even if it has been two years since the CFO left the audit firm, double the minimum span required in the US and Canada and the same as the minimum mandated in the UK and EU.
Michael Favere-Marchesi, one of the researchers who carried out the study, said: ‘Obviously, a one-year or two-year cooling-off period is not enough to avoid the alumni effect, particularly if it requires overcoming social bonds that colleagues often develop.
‘It may be that five or ten years would be enough. Alternatively, it may be that audits of companies where a CFO or other higher-up is a former engagement partner should be banned entirely, as some research on auditor independence has suggested.’
The study, The Alumni Effect and Professional Skepticism: An Experimental Investigation, is here.
Report by Pat Sweet