Three essays on institutional conditions that enable audit quality

Audit partnerships have substantial agency costs, as partner effort and the residual risk from an audit are mostly unobservable, inviting shirking and free riding at the expense of audit quality. I study three institutional conditions in this dissertation that could improve audit quality. In Chapter Two, I research the consequences of introducing the Dutch audit partner clawback. Partners primarily reduce their compensation risk by de-risking and find little evidence of quality improvements. Confronted with clawbacks, partners accept fewer and less risky clients, initially audit longer, and issue more modified audit opinions. Meanwhile, partner income and audit fees increase, and clients switch to less competent auditors.
In Chapter Three, my Ph.D. supervisors and I investigate the auditor selection model. Auditors are selected and paid for by the organizations they audit. According to theory and recent findings, this auditor selection model incentivizes auditors to avoid reporting adverse audit outcomes to ensure client retention. We study local subsidiary audits under International Auditing Standards, where audit partners are either assigned to audit subsidiaries or self-selected by the subsidiaries’ management. Our findings suggest that assigned auditors may become too independent of auditees at the cost of client knowledge and their access to audit evidence.
Chapter Four, a collaborative effort with my Ph.D. supervisors, addresses the often discussed but little-researched relationship between audit firm culture and audit quality. We find a positive relation, especially for more complex audit settings. We conclude that other than clawbacks and assigning auditors, social controls could provide significant audit quality incentives.