Tracking Auditing Firms’ Response to Negative News
Matt McGowan: This is Short Talks From the Hill, a research podcast of the University of Arkansas. My name is Matt McGowan. I’m a science writer here at the university. Today I’m talking to Liz Cowle. Cowle is an accounting doctoral candidate in the Sam M. Walton College of Business. Last year she and research partners Caleb Lawson and Steven Rowe, both assistant professors in the Department of Accounting, completed a major study of the so called Big 4 auditing firms. Here, we’re talking about Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers. Cowle presented their findings at the American Accounting Association’s mid-year meetings in January. After examining more than 4, 000 negative news articles about these firms, Cowle and her co-authors determined that the firms increased audit attention and improved audit quality when their work was covered by the media. Welcome Liz, and thank you for being here.
Liz Cowle: Hi Matt, thanks so much for having me. I’m really excited to chat with you today.
MM: So tell us about this study. What motivated you to do it and tell us what you found.
LC: Yeah, so this project is actually inspired by a previous paper that I had worked on with Stephen Rowe, and in that paper we received pretty significant media coverage over our findings, and we really started to notice this common theme in the coverage was that basically every article was really critical at the Big Four accounting firms. And when we started to look closer at these news stories on the Big Four, we saw that most stories actually cast the firms in a pretty negative light. And so we basically started wondering whether the audit firms were actually paying attention to this stuff and adjusting their behavior in response to these really negative news articles. So we started speaking with some practitioners at Big Four firms and learned that this is something that’s being constantly monitored, specifically by the firm’s national office, and that national offices are trying not only to manage these reputation hits, but also prevent the firms from appearing in this bad news in the future. And so there’s one audit partner who really put it to us, no audit firm wants to end up on the front page of the Wall Street Journal. But if you look at these articles about the firms, you can immediately see why they would want to avoid this coverage. And we started gathering data on this and, really we were looking for news coming from these leading business publications. So those outlets like the Wall Street Journal, New York Times, Accounting Today, in other words, outlets that have the potential to really impact a broad audience. And what we find is that since 2004 there have been over 4,000 negative news mentions of one or more of the Big Four firms. And our paper focuses on this idea of the news media really serving as what we call a watchdog over the activities of audit firms. And we argue that in this role as a watchdog, the media is actually able to provide some informal oversight that really seems to have an impact on auditor behavior. And so specifically we find auditors do respond to news coverage and what we show is that in the year following the news coverage, these firms put forth additional effort and that this effort is associated with actual improvements and audit outcomes. And so one of the most significant findings, we think, is that auditors charge up to 3 1/2 percent higher fees for every 5% increase in the amount of negative news about their firms, which is actually comparable to how auditors respond to inspection findings from the PCOB, which is the primary oversight body of audit firms. And we also find that this effect of increased attention is even stronger among clients that have issues similar to those being discussed in the news. And also that negative news coverage has pretty significant cost for audit firms in terms of audit firms’ ability to both attract and retain audit clients.
MM: Excellent. We should… I should mention here that you said PCAOB. We should mention that that is the Public Company Accounting Oversight Board, is that right?
LC: Yeah, so it was established during the early 2000s, in response to, you know, just a number of audit failures. What it really does is provide the most formal oversight of auditing firms. And it has a really effective disciplining mechanism in that it’s able to actually sanction audit firms when it finds deficiencies in their work that led them to conclude on the audit opinion. So a lot of the research out there has actually been focused on how auditors are responding to this really direct, formal oversight from the PCAOB. And what it’s doing is showing how auditors respond to this informal oversight from channels such as the news media.
MM: You kind of touched on this a little bit in your in the first answer, but can you elaborate on why these findings are important?
LC: Yeah, so we think that our findings are really important for a number of reasons. So, first there’s been a significant amount of research that looks at how auditors respond to more formal oversight or that from regulation and litigation, but there’s really not much out there on how informal oversight shapes auditor behavior. And so we’re the first study, at least to our knowledge, to highlight the importance of national news media as this affective and informal oversight body of auditing firms. We think another important finding from our study is that our findings really support these recent calls from the PCAOB to have audit firms actually hiring chief ethics officers that can help them manage these negative news articles that do cast the audit profession in a negative light. And we also answer calls from prior studies to help enhance our understanding of this monitoring role of the media, particularly in that it’s really providing this informal policing of audit firms. And then finally, our results also have these real world, actual implications for audit practice in that what we find really suggests that clients, investors and even regulators can actually use media coverage from these national news outlets as one way to actually anticipate changes in auditor behavior.
MM: I was fascinated by your finding that the negative attention had an impact on peer firms. In other words, if there happened to be negative stories about, say, Ernst & Young, this had an impact on Deloitte. Can you tell us a little bit more about how that worked?
LC: Yeah, so that’s a really interesting point. So we do observe an effect when media attention is focused on these peer firms. So for example, as you mentioned, if Ernst & Young receives a really high amount of news coverage this year, what our findings suggest is that the other Big Four firms, so PWC, Deloitte and KPMG, respond to this coverage and actually divert additional attention to their audit clients in the year following the negative news coverage of the peer firm. And what we find is that this effect is even stronger for clients of these firms that have issues similar to those highlighted in the media, so either weaknesses in their internal controls or restatements of their prior period financial statements. And what this finding really is consistent with is auditors focusing attention on clients with the highest risk of generating future negative news coverage. And really what this suggests is that firms are actually trying to preemptively manage their reputations by diverting additional resources to actually avoiding issues that led to another firm being spotlighted in the media. And we think this finding is super important and pretty neat, because it suggests the media has an indirect disciplining mechanism on these other firms, even when they’re not directly the subject of the media coverage.
MM: Inspired by their own findings, Cowle built a new study, a sort of side project. She wanted to know more about the effect of fewer journalists. It’s been no secret that print media have been on the decline for many years. According to the Pew Research Center, newsroom employment in the United States dropped by 23% from 2008 to 2019. The Bureau of Labor Statistics projects an 11% decline in reporters, correspondents and broadcast news analysts over the next 10 years. Sadly, the economic impact of the coronavirus pandemic has only accelerated this trend. In designing the new study, Cowle said, she was also trying to think about reasons why non-accounting professors should care about their findings. Okay, so here we know about the sad state of the of the journalism profession, and many people worry about this because of the press’s traditional role as the fourth estate or the so-called watchdog of government proceedings and officials. Your concern, as an accounting scholar, is a little different. Can you tell us what you found in this new study?
LC: Yeah, so, right, as you mentioned, kind of the state of journalism has really been on the decline for a while now, and most recently with this coronavirus pandemic, we have actually, unfortunately seen thousands of business journalists who have been displaced, as more and more newsrooms are being shuttered. And so when newsrooms are currently shutting these jobs, we think it’s not just harmful to the journalists losing their jobs, but it’s actually also really dangerous for members of the greater business community who actually often rely on this oversight from national news outlets to make and monitor their own investment decisions. So related to this, what our study really provides, we think, is the first large-scale evidence that the national news media does serve another vital role to companies, investors and regulators, and that it does police audit firms, and while some may say, common sense should suggest that auditors have these incentives to avoid association with negative news events that could be publicized, there’s actually really limited evidence related to how market participants actually view this type of news. And so as I mentioned earlier as part of the study, we show that auditor response to news coverage is actually comparable to their response following inspection findings from the PCAOB. So to kind of tie our study back to this idea of why the broader business community should really be concerned by the decline in journalism that you touched on. What our study suggests is that cutting business journalist jobs is actually akin to cutting jobs from the PCAOB or even SEC, which really should be of concern to investors, clients and regulators. And you know, earlier this year there was actually some proposed legislation to eliminate the PCAOB as a stand-alone body and actually consolidate within the SEC. And I think that when you consider the decline of business journalism that we’ve seen over the past few decades, and couple that with this proposed legislation to actually weaken formal auditor oversight, this can cause some real problems. And so I think these issues should be of serious concern not only to the business press but also the greater business community, which does rely on the news media to actually police the audit market. And really to anyone who believes in the value of oversight, I would say that what we’re seeing with these declines and trends in news reporter jobs should be really, really concerning.
MM: Liz, thank you so much for your time. I really appreciate it and we look forward to more of your research in the future.
LC: Thanks so much, Matt.
MM: Music for Short Talks From the Hill was written and performed by local musician Ben Harris. For more information and additional podcasts, visit Arkansas Research. That’s arkansasresearch.uark.edu, the home of science and research news at the University of Arkansas.
