Professors Anastasios Elemes, ESSEC Business School, and Jeff Zeyun Chen, Neeley School of Business, put the spotlight on auditing firms’ donations and their clients’ political connections to research the influence these might have on accounting practice.
Do Political Links Influence Big Four Accounting Practice? by CoBS Editor Pavan Jambai Narayanan Sedhu and Tom Gamble. Related research: Anastasios Elemes & Jeff Zeyun Chen (2020): Big 4 Office Political Connections and Client Restatements, European Accounting Review, DOI: 10.1080/09638180.2020.1856163.
Does the political connection of an audit firm or the client firm influence the professional relationship between them? To the layperson the answer might sound obvious. But does it really matter? The answer to this one is a categorical yes if we take into account the critical role of accounting firms in the world of business and finance and the possible implications that might arise as a result.
Profs. Anastasios Elemes & Jeff Zeyun Chen of ESSEC Business School and Neeley school of Business decided to do just that. They explore the political connections of the BIG 4 audit firms – EY, Deloitte, KPMG, and PwC – and by studying their data from 2003 and 2012 identify the impact of these connections on both the auditors’ practice and their clients’ behaviours.
An audit firm provides independent assurance of the credibility of financial reports and reviews the profit and loss statements to discover any potential theft or misdemeanor. The keyword here is the word independent – because that is ultimately the determining factor if the audit firm is creditworthy or not.
However, existing research on auditing firms suggests that they establish political connections at the national level to lobby regulators and legislators. Indeed, auditors use political connections to lobby for their own interests – for example, lobbying to influence accounting and auditing standard – as well as for the interests of their clients. Does that suggest that their independence is compromised?
Elemes and Chen’s findings indicate that in recent years, donations from the BIG 4 auditors’ political action committees (PACs) have risen significantly in number and amount. Not only. In addition to contributions made by these top-level committees, auditors’ employees are also targeting campaign money directly to members of the congressional committees who oversee the audit industry that include the Senate Committee on Banking, Housing, and Urban Affairs and the House of Representatives Committee on Financial Services.
…Of the game
Indeed, more than half of Big 4 companies’ offices were, at some point or another, politically connected in the considered five-year period. And it was found that political connections at the office level overlapped with the national level – 57% of politicians targeted (supported with donations) in a given year at the office level were also targeted at the national level via corporate headquarters.
While accounting firms’ political strategies vary across audit offices, these contributions and the overlap both peak in the years where there were intense regulatory activities that significantly affected the audit industry. For example, in the years 2005 and 2006 when the PCAOB (Public Company Accounting Oversight Board) imposed restrictions on auditors’ tax services and was deciding whether these restrictions should be expanded to include other non-audit services. Contributions from connected offices also spiked when Chris Todd – then Chairman of the Senate Committee on Banking, Housing, and Urban Affairs Committee – ran for president in 2007.
The effects of political connections on auditing quality
The fact that Big 4 audit firms have repeatedly and significantly contributed to the congressional members who oversee the audit industry is clear. But do these audit-client political connections have an influence on the quality of service and provided by the auditors and the independence required by an auditing firm to do its job correctly?
In order to explore these questions, Professors Elemes and Chen used earnings restatements – changing financial reports after a mistake has been discovered – to measure the audit quality offered by the audit firm. Traditional logic tends to point to a non-drop in quality, the argument being that because the creditworthiness of an audit firm is a key factor in forging long-term relationships and lobbying objectives, the quality of the auditing must be upheld.
A certain logic holds for the following too: Since politically connected auditors are more sensitive to litigation risk and reputation concerns, they will exert more effort to avoid errors for their politically connected clients. However, connected clients enjoy strong governmental support and are less likely to fail. Therefore, when connected clients decide to have less audit quality or contract for any reason, the politically connected auditors are willing to cater to the preference for flexibility. But when audit firms do allow managerial discretion in financial reporting, the incidence of errors may increase. So do these hold their own in the light of Elemes and Chen’s research?
Elbow grease or silver coins
The researchers find that auditors’ involvement in the political process indeed has implications for their audit quality, with clients of politically connected auditors being less likely to restate earnings. It turns out, however, that the findings reveal this negative relation to be weaker for politically connected clients.
Trawling through the data covering the restated years, Profs Elemes and Chen found that the audit firm is paid a much lower audit fee during the years that are subsequently restated when both auditors and clients are politically connected. The notion of flexibility too, became apparent – politically connected audit firms allowing a certain managerial discretion for connected clients, especially when the client desired a certain degree of leeway in reporting earnings.
The overall conclusion is that while auditors with political ties need to maintain high-quality audits to be reputed lobbying agents, this creditworthiness criterion is not applied for connected clients. It could also be said that connected auditors compromise their independence for their connected clients.
It seems that – to quote from the hit American drama series Billions – Elbow grease alone won’t solve what elbow grease and a few silver coins will. Will it continue to be the case for the audit industry? Profs Elemes and Chen’s research data ends in 2012 – due in part to the fact that due to the fact that there is a considerable time lag between the original financial statement release and a subsequent restatement. Though they doubt that auditors’ lobbying incentives and political activities are systematically different thereafter. Future research will tell.
- Link up with Anastasios Elemes and Jeff Zeyun Chen on LinkedIn
- Browse academic profiles and research: Anastasios Elemes and Jeff Zeyun Chen
- Read a related article: China: Accounting firm influence on client conduct
- Download this article and others in Global Voice magazine #19: Open for Responsible Business
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