Independent A Auditor

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O R I G I N A L P A P E R

The effect of a transparency report on auditor

independence: practitioners self-assessment

Christiane Pott Theodore J. Mock Christoph Watrin

Received: 14 May 2007 / Accepted: 25 March 2008 / Published online: 16 April 2008 Springer-Verlag 2008

Abstract The objective of this study is to investigate how practitioners assess

several aspects of a transparency report on auditor independence published by

auditing firms. This research was conducted using a survey approach with an

experimental component, where the research instrument was distributed to 92

experienced practitioners. Results indicate no significant perceived difference as to

whether the transparency report is mandatory or voluntary or whether the report is

audited or not. Also the transparency reports effectiveness is not assessed differ-ently by practicing auditors or accountants. Further descriptive analysis over the full

sample indicates the individually most important safeguards related to auditor

independence are perceived to be quality assurance, internal quality controls and

independence practice and compliance. However, the importance of fee information

and information on audited entities is assessed to be more important by accountants

compared to auditors due to different interests.

Keywords Transparency Auditor independence European Union

Report

Audit quality

Regulation

JEL Classification M42

C. Pott (&) C. Watrin

Institut fur Unternehmensrechnung und besteuerung, Westfalische Wilhelms-Universitat,

Universitatsstr. 14-16, 48143 Munster, Germany

e-mail: [email protected]

T. J. Mock

Rev Manage Sci (2008) 2:111127

DOI 10.1007/s11846-008-0017-y


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information. In comparison, we want to see how they assess the value of such

information in situations where publication is voluntarily. This should provide

insight into which information details audit firms might focus on in their

transparency report in order to provide audit quality signals to the market.

Furthermore, since our sample also includes practicing accountants, we provideadditional evidence on how audit client representatives assess the effectiveness of a

transparency report.

To address the widely discussed topic of who audits the auditors (e.g.,

European Federation of Accountants 2003; Institute of Chartered Accountants of

England and Wales 2003), we are also interested in how a transparency report is

assessed when the report is audited. Thus, we experimentally manipulate whether

the transparency report is audited by an independent assurance provider before it is

published. Again, the assessment of auditors and accountants might be different due

to their different roles in the financial markets.The paper proceeds as follows: Sect. 2 discusses the theory and develops the

research questions. Section 3 presents the research method; and in Sect. 4 the

results are discussed. We conclude with a brief discussion of implications,

limitations and future research in Sect. 5.

2 Theory and research questions

From a capital market perspective, transparent reporting is important for both theallocation and institutional efficiency of the capital market. Transparent information

can align informed auditors assessments of independence policies and procedures

to investors perceived assessments about the auditors independence. Investors

should have enough information about the audit firms practice, policies and

procedures in maintaining auditor independence to be able to evaluate these issues

precisely. Providing investors with reliable and reasonable information about the

auditor-agent of a public firm can have a positive effect on overall economic

performance by increasing investment opportunities in the global capital markets.

A growing body of evidence indicates that the development of financial markets

facilitates performance, but also depends on the level of corporate transparency.

Love (2003) studied the hypothesis that financial development affects growth by

decreasing information related imperfections in the capital markets. This research

indicates that a decrease in information asymmetry has a positive effect on

economic growth. Information asymmetry also exists between the audit firm and

other market participants. Information provided in a transparency report may thus

also have similar economic effects.

Furthermore, financial information has helped investors overcome moral hazard

and adverse selection problems as related to auditors (e.g., Rajan and Zingales

1998). In this respect transparent reporting would provide clients and potential

investors with comparable and detailed information on all audit firms and might

The effect of a transparency report on auditor independence 113


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interest in. In this respect the information provided might decrease perceptions

related to impaired auditor independence (e.g., Schneider et al. 2006).

As argued by Black (2000) and Ball (2001), strong financial accounting regimes

focusing on the credibility and accountability of information are a prerequisite to the

very existence of vibrant securities markets. To address the need for greatertransparency as one major safeguard, the European Parliament and Council (2006)

require audit firms to publish a transparency report annually. Member states must

ensure that audit firms carrying out audits of public entities publish on their website

an annual transparency report that includes at least the following:

1. A description of the legal structure and ownership

2. If the audit firm belongs to a network of firms, a description of the network and

the legal and structural arrangements in the network

3. A statement on the governance structure of the audit firm

4. A description of the internal quality control system of the audit firm and a

statement by the administrative or management body on the effectiveness of its

function

5. An indication of when the last quality assurance review took place

6. A listing of public interest entities for which an audit has been carried out

during the last year by the audit firm

7. A statement about the audit firms independence practices, which also confirms

that an internal review of independence compliance has been conducted

8. A statement on the policy followed by the audit firm concerning continuous

education of auditors9. Financial information indicating the economic importance of the audit firm,

such as the total turnover divided into fees from the audit of annual and

consolidated accounts, and fees charged for other assurance services, tax

advisory services and other non-audit services (Article 40).

The required transparency report is seen differently throughout member states. For

instance, the German Chamber of Public Accountants (2004) is generally supportive

towards more transparency, but questions the level of detail required. Furthermore,

the German position points out that this report only addresses audit firms and not

individual auditors. They also argue that the date which indicates when the last

quality assurance review took place is not very important and suggest that it is more

important to know if the quality assurance review was successful.

More supportive of such transparency regulation is the government of the United

Kingdom. The United Kingdom delegation suggests that the report is an appropriate

compromise between all of the stakeholders interests and that there are also

important cost implications. Clearly, the benefits of greater transparency should

outweigh costs (United Kingdom Department of Trade and Industry 2005, p. 10).

However, prior research has shown that the benefits of increased accounting

regulation may exceed the costs (Gwilliam et al. 2005).

The European Federation of Accountants (2003, p. 17) believes that a

114 C. Pott et al.


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academic experts (Houghton and Trotman 2003). This document is publicly

available and offers sound and detailed information on KPMGs policies and

procedures and thus, serves as an oversight arrangement.

Similarly, one of the requirements of the revised Combined Code in the UK and its

related guidance is that audit committees should take on a more active role inoverseeing the external audit. An important part of this oversight relates to the

independence of the auditor. The Combined Code and the Smith Guidance specify

the matters to be taken into account in carrying this out. These include seeking from

the audit firm, on an annual basis, information about policies and processes for

maintaining independence and monitoring compliance with relevant requirements

(paragraph 4.22) (Institute of Chartered Accountants of England and Wales 2003).

This could be achieved by an audit of the audit firms policies and procedures in place

as stated in the transparency report. Thus, an audit of the audit firm would take place.

Lastly, since a transparency report is required to be published by audit firms,auditors are directly affected by this requirement. Accountants, who represent the

clients interest, are provided with the additional information of the transparency

report. Thus, whereas auditors have to bear the cost and time to provide a

transparency report, accountants receive additional insight into their auditor or other

audit firms. Moreover, since some safeguards of the transparency report are related

to very sensitive issues, e.g. client fee information, auditors might assess this

information in a more negative light. However, accountants might be quite

interested in information, which helps them to understand their own audit firm or

other audit firms business and independence activities. Prior research has shownthat better-informed clients lead to improved efficiencies in the audit process

(Chancy et al. 1997). These different interests of auditors and accountants might be

lead to differences as how individual safeguards are assessed.

Related to the above discussion and to prior research that suggests that greater

transparency helps to safeguard imperfections in markets and to address the

controversial discussion throughout member states, we investigate the following

overall research questions:

RQ1: Is a transparency report perceived to be more effective in improving auditor

independence (by practicing accountants versus practicing auditors) ifregulated or if voluntarily published?

RQ2: Is a transparency report perceived to be more effective in improving auditor

independence (by accountants vs. auditors) if audited or not audited?

RQ3: How do accountants vs. auditors assess the importance of individual

safeguards?

3 Method

3.1 Design



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is mandatory or voluntary and the second was whether the transparency report is

audited or not. Participants were assigned to one version randomly.

3.2 Participants

Participants in the experiment were practicing accountants and auditors from the US

participating in a conference on current regulatory developments. In this conference

policy setters from the U.S. Securities and Exchange Commission (SEC) and the

Financial Accounting Standards Board (FASB) discussed latest regulatory devel-

opments. Participating in this conference is one means of maintaining required

continuing professional education (CPE) for practicing accountants and auditors.

Participants had an average of 21 years of professional experience in auditing and/

or accounting with a minimum of 5 years experience and thus they are a highly

experienced sample of preparers and auditors of financial statements.2

We obtain the assessment of non-European professionals, because we are

interested in how participants who were not expecting a transparency report to

become a mandatory requirement assessed the reports effectiveness. Within the

sample of professional participants we are taking the advantage of participants who

are relatively nave observers in terms of the transparency report and simultaneously

provide the professional expertise concerning what a transparency report means to

auditors and preparers.

The research was conducted as a survey with an underlying experimental design

and was distributed to all conference participants. Sixty-two questionnaires werecompleted at the conference and 29 were mailed in afterwards.3 As noted,

participants had an average of 21 years of professional experience in auditing and/or

accounting. Participants indicated their knowledge about auditor independence

regulation at a relatively high average of 5.45 on a scale of 0 to 6. Table 1 shows the

sample sizes by experimental treatments and by the participants current accounting

role (accountant vs. auditor). As is evident in the table, approximately the same

sample sizes occurred for each cell.

3.3 Procedure

Each participant received a copy of the research instrument as part of the conference

materials. An announcement requesting subjects to voluntarily participate in the

2 Biases can arise from a sample, which does not represent the participant population. Representativeness

expresses the degree to which sample data accurately and precisely represents a characteristic of a

populations parameter variations at a sampling point. If the sample is representative in some important

target variables, then we have increased confidence in the validity of the sample to represent the target

population. We conduct Chi-Square tests on the sample variables knowledge and experience, which

tests whether the frequency distribution of these target variables observed in the sample is consistent with

the particular theoretical distribution, since data on the whole population is missing. Results indicate anequal distribution for knowledge (v2 = 86.747) and experience (v2 = 40.615).3

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study was made by the conference director. Since there was no specific time

scheduled during the conference to complete the research materials, participants

were also provided with a self-addressed envelope in case they preferred to mailtheir response instead of completing the instrument during the conference. The

instrument contained the following materials.

First, there was an introduction to the current debate in Europe as to whether or

not a transparency report about audit firms own policies and procedures concerning

auditor independence should be required. They were informed that EU member

states have a broad range of opinions on whether the report should be mandatory or

voluntary. The discussion included concerns over the details required and cost

versus benefit implications.

This information was followed by a case study of a hypothetical audit firm R&P,LLP which was said to be located in the United Kingdom. The first experimental

manipulation (Regulation Approach) was implemented as follows. One group of

participants were told to assume that in the United Kingdom the regulations include

the mandatory publication of an annual transparency report on its own homepage to

document the policies and procedures that R&P carries out to maintain auditor

independence (mandatory). The other group was informed that in the United

Kingdom the professional guidance includes the voluntary publication of an annual

transparency report on its own homepage to document the policies and procedures

that R&P carries out to maintain auditor independence (voluntary).

Related to this experimental treatment, the main objective is to find the balance

between doing justice to the audit firms demand for self-regulation (Marten 1999;

Benau et al. 1999) and the need of enforcement for reliable transparent reporting.

Mandatory transparency reporting requires high quality signals to decrease

information asymmetries between audit firms and stakeholders (Helm et al.

2003). External reviews are discussed as being important to ensure high quality

transparency reports and enhanced public confidence in transparent quality controls

(Marten et al. 2003). Therefore, appropriate oversight, such as a detailed review

process might be necessary to ensure the effectiveness of auditor independence

policies and procedures (Houghton and Trotman 2003).The second experimental treatment (Oversight Arrangement) was manipulated

Table 1 Experimental treatments and cell sample sizes

Oversight arrangement

Audit No audit

Accountant Auditor Accountant Auditor

Regulation approach

Mandatory transparency report 11 12 10 12

Voluntary transparency report 8 14 12 12



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informed that after having audited the policies and procedures as described in the

transparency report, the two experts provided the following assurance: Based on

our audit, no significant issues have come to our attention that would cause us to

believe that R&Ps policies and procedures to maintain auditor independence is not

operating properly. The version (no audit) without an audit did not include any ofthe preceding information.

After having read the introduction and the case study, participants were asked to

assess whether or not the policies and procedures described in the transparency

report provided an overall framework to improve the firms independence. The

question stated the following: The policies and procedures listed in the transpar-

ency report are usually thought of as being safeguards to auditor independence risk.

What is your viewpoint on how these policies and procedures provide an overall

framework to improve the firms independence? Participants were asked to assess

the effectiveness of the proposed transparency report on a 7 point Likert-scale,where 0 was labeled as not effective, 3 as moderately effective and 6 as very

effective.

At the end of the instrument, participants were asked to indicate on a seven point

scale which of the safeguards reported in the transparency report might be more

important than the others in order to maintain auditor independence. The question

was the following: How important is each of the individual safeguards as related to

each other? Participants were allowed to go back to the transparency report to re-

read the information listed in the transparency report, because the listed safeguards

were abbreviated as Governance Structure, Internal Quality Control, QualityAssurance, Audited Entities, Independence Practice and Compliance, Continuing

Professional Education and Fee Information.

Finally, we collected participants demographic information. We asked whether

they were currently practicing as an auditor or accountant, their experience in years

and for their knowledge of auditor independence regulation self-assessed on a 7

point Likert-scale where the scale ranged from little knowledge and moderate

knowledge to high knowledge. The scale was labeled with examples such as

casual investor as an example for little knowledge and CPA and audit

committee member for high knowledge.

4 Results

4.1 Research questions 1 and 2

Research question 1 asks whether a transparency report is perceived to be more

effective in improving auditor independence if regulated or if voluntarily published

(Regulation Approach). Whether a transparency report is perceived to be more

effective in improving auditor independence if audited or not audited by an expert

was asked in research question 2 (Oversight Arrangement). As part of research

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The descriptive statistics based on the question, where participants were asked to

indicate their viewpoint on how the information given in the transparency report

provided an overall framework to improve the firms independence are shown in

Table 2. A mandatory regulation approach of the transparency report is assessed as

being almost the same level of effectiveness as a voluntarily published transparencyreport (mean = 3.8 vs. 3.89, respectively). However, participants felt an oversight

arrangement in the form of an audit of the transparency report was more effective

(mean = 4.02) than if the transparency report was not audited (mean = 3.67).

The data were analyzed statistically in several stages. A Mann-Whitney U test

(also called the MannWhitneyWilcoxon test or the Wilcoxon rank-sum test) was

performed. This test is a non-parametric test for assessing whether two samples of

observations come from the same distribution. The null hypothesis is that the two

samples are drawn from a single population, and therefore that their probability

distributions are not significantly different. The test assumes the two samples areindependent. For the full sample analysis, we performed a KruskalWallis one-way

analysis of variance by ranks testing equality of population medians among groups.

To test whether any of the differences in Table 2 are significant, the results of a

MannWhitney U test and a KruskalWallis one-way analysis of variance of the

assessments of the effectiveness of a transparency report are presented in Table 3.

As indicated, there is no significant difference in the subjects assessments as to

whether or not the transparency report is more effective to maintain auditor

independence whether the transparency report is mandatory or voluntary (z =

-

1.622, P=

0.538). Results also indicate that the oversight arrangement is also notstatistically significant using conventional significance thresholds (z = -0.616,

P = 0.105). Lastly, whether the participant is practicing as an accountant or an

auditor did not results in a significant difference in how effective a transparency

report was assessed to be (z = -0.025, P = 0.98).

Interaction effects of two independent variables, e.g. regulation approach and

oversight arrangement (v2 = 3.678, P = 0.298), regulation approach and type of

participant (v2 = 0.385, P = 0.943) or oversight arrangement and type of

participant (v2

= 3.229, P = 0.358), do not indicate significant differences in the

perceived effectiveness of a transparency report. Also the joint effect of all three

Table 2 Assessments of the perceived effectiveness of the transparency report

Oversight arrangement Marginals

Audit No audit

Accountant Auditor Accountant Auditor

Regulation approach

Mandatory 3.82 (0.87) 4.00 (1.28) 3.9 (0.88) 3.5 (1.57) 3.8 (1.18)Voluntary 4.25 (0.71) 4.07 (1.49) 3.75 (0.97) 3.58 (1.56) 3.89 (1.27)



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independent variables, regulation approach by oversight arrangement by type of

participant, does not lead participants to assess the effectiveness of the transparency

report differently (v2

= 4.428, P = 0.729).

Overall, these results indicate that neither practicing auditors nor practicing

accountants see a significant difference in either whether a independence report is

voluntary or mandated or whether there is assurance on it or not. However, the

difference concerning the greater effectiveness of audited reports does approach

statistical significance.

4.2 Research question 3

Research question 3 asks how practitioners (practicing auditors and accountants)

assess the importance of individual safeguards. As noted, one post experimental

question asked participants to indicate the importance of each listed safeguard. The

importance of each safeguard was measured on a scale from 0 to 6, indicating that

the single safeguard is not important to very important. Descriptive statistics on

the overall assessment (N = 91) are shown in Table 4.

Over the full sample, the safeguard related to the audit firms independence

practice, which also confirms that an internal review of independence compliance

has been conducted, is rated to be the most important safeguard (mean = 4.84).

Slightly less important is the safeguard related to the internal quality control system

of the audit firm and a quality assurance safeguard (mean = 4.78). An indication of

when the last audit firms quality assurance review took place (mean = 4.59) is also

felt to be very important. A safeguard related to the policy followed by the audit

firm concerning continuous education of auditors (mean = 3.86) is assessed to be

important, as well as the safeguard related to the governance structure of the audit

firm (mean = 3.79).

Of moderate importance is a listing of public interest entities for which an audit

has been carried out during the last year by the audit firm (mean = 3.2). The least

Table 3 MannWhitney U and KruskalWallis one-way test of the assessment of the perceived effec-

tiveness of the transparency report

Source of variance z-statistic v2-statistic P value

Regulation approach -1.622 NA 0.538Oversight arrangement -0.616 NA 0.105

Type of participant -0.025 NA 0.98

Regulation approach 9 oversight arrangement NA 3.678 0.298

Regulation approach 9 type of participants NA 0.385 0.943

Type of participants 9 oversight arrangement NA 3.229 0.358

Regulation approach 9 oversight arrangement 9 type of participants NA 4.428 0.729

NA not applicable

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other assurance services, tax advisory services and other non-audit services

(mean = 2.78).

Comparing the assessments for practicing auditors versus practicing accountants,we find significant differences in four of the seven safeguards reported on in the

transparency report. Reporting on an audit firms governance structure is assessed as

being more important to practicing auditors than to practicing accountants

(mean = 4.10 vs. 3.41). Furthermore, information on an audit firms independence

practice is perceived to be more important by practicing auditors compared to

practicing accountants (mean = 5.16 vs. 4.44). However, practicing accountants

assess transparent reporting on audited entities and fee information to be moderately

more important (mean = 3.71 and 3.41 respectively) compared to auditors

(mean = 2.78 and 2.26 respectively).

4.3 Additional results related to knowledge and experience level differences

As part of the demographic questions, we also asked participants to indicate their

level of knowledge concerning auditor independence regulation. We did not have

any participants indicating a low knowledge level. Thus, we only report the

assessments of practitioners with moderate and high knowledge level on auditor

independence regulation. Concerning the effectiveness of a transparency report, we

do not find individual or interaction differences in whether a participant indicated a

moderate or high knowledge level (untabulated).We provide descriptive statistical details of the safeguards by knowledge level in

Table 4 Descriptive statistics: assessments concerning the perceived importance of safeguards

Safeguard Full sample

(N = 91)

Auditors

(N = 50)

Accountants

(N = 41)

Difference in

means CPA vs.

accountants

Chi-square testMean Standard

deviation

Mean Standard

deviation

Mean Standard

deviation

Independence practice and

compliance (IPC)

4.84 1.28 5.16 1.20 4.44 1.29 8.46***

Internal quality control

(IQC)

4.78 1.32 4.82 1.32 4.73 1.34 0.13

Quality assurance (QA) 4.59 1.26 4.64 1.43 4.54 1.05 1.03

Continuing professional

education (CPE)

3.86 1.49 3.92 1.63 3.78 1.31 0.46

Corporate governance

structure (CG)

3.79 1.65 4.10 1.69 3.41 1.53 4.40**

Audited entities (AE) 3.2 1.75 2.78 1.95 3.71 1.31 5.53**

Fee information (FI) 2.78 1.88 2.26 1.83 3.41 1.76 9.39***

Scale of 06 with 0 labeled as not important, 3 as moderately important, and 6 as very important

* Significant at 10%; ** significant at 5%; *** significant at 1%



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lower regulatory knowledge (mean = 4.97 compared to 4.27). The difference is

significant with P = 0.0375. Second, a lower knowledge level leads to assess

information about the audited entities and fees as being more important than higher

knowledge (mean = 3.94 compared to 3.01 and mean = 3.77 compared to 2.53,

respectively). Both pairs of means are significantly different with P = 0.0452 and

P=

0.008, respectively.Participants also indicated their professional experience in years. Additional

analysis on the experience level groups (e.g., two decades experience vs. four

decades experience; one decade experience vs. four decades experience) did

not indicate different assessments of the effectiveness of the transparency report

(untabulated).

Table 6 provides descriptive statistical details of safeguards by subjects

experience in years. We grouped the sample into experience in years up to nine

years (one decade), ten to 19 years (two decades), 20 to 29 years (three decades)

and 20 to 40 years (four decades). Panel A provides means and standard deviations

for the seven safeguards. Panel B shows results of a performed Fishers Least

Significance Difference Test.

Results indicate a significant difference between the assessments of the safeguard

Internal Quality Control (difference in mean -0.92, P\0.005). Subjects from 20

with up to 29 years work experience assessed this safeguard to be more important

than subjects with experience between ten to 19 years (mean = 4.30 compared to

5.22).

More significant differences in subjects assessment can be reported for the more

sensitive information such as details about audited entities and fee information. A

significant difference in assessment can be reported for one decade and two decades

experience compared to subjects having the most experience on details about the

Table 5 Descriptive statistics: assessments concerning the perceived importance of safeguards by

knowledge

Safeguard High knowledge

level (N = 83)

Moderate knowledge

level (N = 18)

KruskalWallis

chi-square test

Mean Standard

deviation

Mean Standard

deviation

v2

P value

IPC 4.97 1.28 4.27 1.36 4.3266 0.0375

IQC 4.80 1.31 4.66 1.37 0.1367 0.7116

QA 4.64 1.28 4.38 1.19 0.9987 0.3176

CPE 3.84 1.49 3.88 1.32 0.0217 0.8828

CG 3.79 1.74 3.77 1.21 0.0568 0.8117

AE 3.01 1.79 3.94 1.34 4.0097 0.0452

FI 2.53 1.88 3.77 1.51 7.0341 0.0080

Scale of 06 with 0 labeled as not important, 3 as moderately important, and 6 as very important

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Descriptivestatisticsdetailsofsafeguards

bysubjectsexperienceinyears

einyea

rs

Professional

N

Safeg

uards

IPC

IQC

QA

CPE

C

G

AE

FI

Mean

SD

Mean

SD

Me

an

SD

Mean

SD

M

ean

SD

Mean

SD

Mean

SD

meansa

ndstandarddeviation(SD)

1decade

8

4.75

1.0

3

5.1

2

0.8

3

5

1.1

9

4.7

5

1.2

8

3

.75

1.4

8

4.2

5

1.0

3

4.6

2

1.0

6

2decades

33

4.69

1.2

1

4.3

0

1.4

8

4.5

1

1.2

2

3.6

3

1.3

6

3

.42

1.7

3

3.6

3

1.6

9

2.8

1

1.8

7

3decades

27

4.85

1.2

6

5.2

2

0.8

0

4.5

9

1.2

7

3.9

2

1.6

3

3

.92

1.6

1

3

1.7

3

2.3

3

1.8

6

4decades

23

5.04

1.5

2

4.8

2

1.5

2

4.5

6

1.3

7

3.7

8

1.5

0

4

.17

1.6

1

2.4

3

1.7

5

2.6

0

1.8

2

onofmeans

Safeguards

IPC

IQC

QA

CPE

CG

AE

FI

Fishers

leastsignificancedifferencetest

2

decades

0.0

5

0.82

0.4

8

1.1

1

0

.32

0.6

1

1.8

1*

3

decades

-0.1

0

-0.09

0.4

1

0.8

2

-0

.17

1.2

5

2.2

9*

4

decades

-0.2

9

0.29

0.4

3

0.9

6

-0

.42

1.8

2*

2.0

2*

3

decades

-0.1

5

-0.92

*

-0.0

8

-0.2

9

-0

.50

0.6

4

0.4

8

4

decades

-0.3

5

-0.52

-0.0

5

-0.1

5

-0

.75

1.2

0*

0.2

1

4

decades

-0.1

9

0.39

0.0

3

0.1

4

-0

.25

0.5

7

-0.2

8

6with

0labeledasnotimportant,3asmoderatelyimportant,and6

asveryimportant

antdiffe

renceinmeanscomputedwithFishersleastsignificancedifferencetest



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19 years assessed this information to be less but still moderately important

(mean = 3.63), the most experienced practitioners did not assess this information to

be very important (mean = 2.43).

Lastly, subjects in the one decade experience (up to nine years work experience)

felt fee information to be very important (mean = 4.62). This assessment issignificantly different from all other assessments (two decades mean = 2.81, three

decades mean = 2.33 and four decades mean = 2.6, P\0.005).

5 Discussion

Transparent information about an audit firms own policies and procedures to

maintain auditor independence (Woolf 2006) is potentially an important means of

reducing information asymmetry between audit firms, clients and investors. Toensure that the report disclosing each audit forms policies and procedures with

respect to auditor independence is published by all public auditing firms, such a

report will be mandatory in the European Union starting June 2008. The transparency

report is meant to serve as a signaling mechanism, which may be more effective

when oversight arrangements are put into place to ensure the reports quality.

Findings from our survey (RQ 1 and 2) indicate that the effectiveness of such a

report is perceived not to depend on whether or not the report is mandatory or

voluntary. Furthermore, the effectiveness of a report that documents the audit firms

independence practices and policies is not assessed to differ whether it is audited ornot. Both of the results are unchanged when we distinguish between practicing

auditors and practicing accountants. The results related to RQ 1 and 2 put the need

for having established a mandatory requirement in the European Union into

question. Based on our findings, there is no assessed difference in the quality of the

reports information whether the report is mandated or voluntary. One explanation

might be that the participants in our study believe that a transparency report is not

providing important details and thus, not an effective means of communicating

auditor independence.

The value of the publication of a transparency report has been anticipated by

European auditors even before the EU Directive was issued. In fact, two audit firms

have provided a transparency report annually since 2002 on their firms homepage

without being required to do so. These reports provide information on KPMGs

legal structure, ownership structure, decision making structure and leadership

structure (KPMG 2005). Based on these global corporate governance details,

KPMG then reports on audit quality mechanisms. Those include, again as now on

required in the EU, detailed information on internal quality control policies and

procedures, ethics and independence issues, clients and engagements including

supervision, review and consultation structures. Similar information is offered by

Grant Thorntons report of 2005 and 2006 (Thornton 2005, 2006).

Since both audit firms are now reporting for a third year, it is certainly possible

124 C. Pott et al.


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confidence in the audit firm, thus maintaining its reputation. The value put on this

transparent reporting may be a function of an audit firms performance. If

transparent information on an audit firm is withhold then potential investors of

clients or potential client are likely to conclude that the information might be bad

news (Ross 1979). Withholding transparent information increases market noisebecause the range of possible interpretations of the information. As a result, the

expected cost from loosing reputation and market shares may be so high that audit

firms are better served by providing a transparency report (Verrecchia 1983; Suijs

2005). Thus, the need for positive information of an audit firm may prevent

punishment by the market.

From the perspective of the regulator, the advantages of letting the market decide

which information should be provided to interested parties include first, more

flexible responses when a change in information is demanded because there is no

need to activate a legislative apparatus and second, less cost and time intenseimplementation.

This study also provided evidence as to the relative importance of the safeguards

required in the EU mandated report (RQ 3). The information on when the last

quality assurance of the audit firm took place is assessed as being very important by

practitioners. This finding contradicts concerns of the German Chamber of Public

Accountants (2004). The value of this information is high since it may imply a

successfully performed quality assurance. This is a signal of quality that can be used

as a basis for decision making. Also, investors of existing clients are interested in

the reliability of the audit firm that is auditing the company they have invested intoor they are planning to invest into. As expected, the most important safeguard is the

audit firms independence practice, which also confirms that an internal review of

independence compliance has been conducted. Related to the discussion of how

audit firms can deal with independence issues, their own policies and procedures are

felt as being very important.

However, some safeguards importance is assessed differently by auditors and

accountants. Information on an audit firms governance structure and independence

practice is perceived to be more important by auditors compared to accountants.

Accountants assess transparent reporting on audited entities and fee information to

be more important compared to auditors. The fact that fee information was assessed

by auditors as being rather not important may be due to the type of participants who,

although representing stakeholders, are auditors, who are provided with fee

information or do not need to be informed of fee information. Similar, KPMG and

Grant Thornton also do not provide detailed information on fees and audited

entities. This indicates that disclosures of fee information as well as the firms

audited entities are considered to be very sensitive details. In addition, since there is

a critical discussion occurring on as to whether particularly non-audit fees are not

reasonable high, audit firms might be afraid of harming their business reputation.

Also, given that independence issues are more effective as assessed by auditors due

to their work activities in audit engagements; this group of participants feels an



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regulators propose requirements based only on their own assessments of what are

perceived to be important safeguards. Decisions may be supported by information

about theoretically sound measures. However, such measures are not well defined in

a world with imperfect and incomplete markets (Ballwieser 2004, p. 72).

Our study has obtained practitioner impressions about the newly issuedtransparency report requirement in the European Union. Clearly, audit firms are

opposed to the idea of mandatory requirements to publish a transparency report.

However, being audited by an expert might promote auditor independence.

Interestingly, with less knowledge about auditor independence regulation, we find

fee information and information about the audited entities to be perceived as being

more important safeguards to auditor independence. This is also supported by the

finding that professionals with up to nine years experience assess fee information as

very important compared to all other experience levels.

Overall our findings indicate that regulators should carefully weigh costs andbenefits of new requirements before implementation. Our study indicates that

although a transparency report might offer valuable information for investors or

audited companies, the profession itself is somewhat pessimistic regarding a

positive effect from more transparent information.

A related issue concerns the degree to which personal characteristics of the

participants not captured in this study might have affected the results. For example,

auditors may be more sensitive to fee information than accountants. Furthermore,

our findings are based on the assumption that our U.S. participants are relatively

unaware of the introduction of a transparency report in the EU. However, given thataudit firms often work internationally, auditor participants might have known about

the proposed transparency report from in-house communication and this might have

affected their assessments.

Future research should provide evidence on how other stakeholders assess the

transparency report. Transparent reporting might be seen differently by different

types of stakeholders due to different interests. Comparing findings related to audit

firms providing transparent reporting and to types of audit report users might give

valuable insight into different perceptions related to the audit report. Also, given

that Member States have to adopt the EU transparency report requirements as a

minimum, further research should compare individual Member States transparency

report requirements and investigate the association between transparency report

differences and their perceived effectiveness. A related issue concerns the degree to

which personal characteristics of the participants not captured in this study might

have affected the results. For example, auditors and accountants may be more

sensitive to fee information than investors.

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