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Weekly UpdatesThe peer review program is one way to reassure the public and regulators that the accounting profession is serious about maintaining and enhancing the quality of audit services (Francis et al., 1990). In 1988, the membership of the American Institute of Certified Public Accountants (AICPA) made the periodic quality review of public accounting firms a mandated requirement. Firms that are members of the AICPA's Division for CPA Firms satisfy this requirement through peer review, a program which provides "an effective means of assuring the public that a firm has performed its accounting and audit engagements at a satisfactory level of professional achievement" (Public Oversight Board, 1989: 6). Evidence that the peer review program is effective would address concerns expressed at the hearings of the Dingell Subcommittee of the House Energy and Commerce Committee on Oversight and Investigation regarding the quality of audit work and the effectiveness of the profession's self-regulatory programs (Shad, 1985). Suc h evidence would support the position that the peer review program contributes to the improvement of audit quality which, in turn, would enhance public confidence in the reliability of audited financial statements (File et al., 1992). [1]
The objective of this study is to examine the effectiveness of the peer review program in improving audit quality as perceived by groups of key constituents. For this purpose, this study focuses on perceptual measures of effectiveness of the peer review program in performing its functions/processes and achieving its goals. The effectiveness of the audit process is critical to the issue of self-versus public regulation. The results of our study suggest that peer review appears to improve audit practices and the self-regulation of auditors. Hence, managers of audit client firms should require that their auditors undergo a regular peer review and that new auditors must provide summary results of their most recent peer review. In the following two sections, we discuss the peer review program and the constituencies' effectiveness perspective, followed by research questions and hypotheses. In the subsequent three sections, we describe the research methodology, present the analyses and interpretation of findings, a nd discuss the implications and limitations of the study.
Managerial Considerations
The strategic planning of a business is influenced by the long-term objectives of its stockholders, which is generally maximizing stock value. Consequently, strategic plans should consider all those factors which affect the value of the stock. For instance, management should consider consumer tastes and preferences, technological developments, sources of financing, investment opportunities, and social, regulatory, and cultural factors in planning and operational decisions. Insuring that plan objectives have been met is the purpose of strategic control (Preble, 1992). For purposes of implementing plans and achieving goals, firms design and use internal controls to improve the relevance and reliability of information for internal decision making (Kinney, 2000). Specifically, internal controls could provide reasonable assurance regarding the achievement of business objectives in the following areas: effectiveness and efficiency of operations, reliability of financial reporting, and compliance with laws and regulations (Committee of Sponsoring Organizations (COSO) of the Treadway Commission, 1994).
Managers periodically provide information about the results of their planning and operational efforts to the stockholders in the form of financial statements. However, managers have a vested interest under the agency contract (e.g., Davis et al., 1997) to obtain the highest quality assurance about the financial statements in order to convince the investment community that their financial representations are credible and reliable. Hence, they acquire the best external auditors they can afford. The peer review program of the accounting profession gives managers confidence in hiring auditors who would do quality audit work. The accounting profession, through its peer review program, attempts to ensure that accounting firms follow applicable audit standards and plan to detect material fraud and misstatements in management representations expressed in the form of financial statements. Periodic peer review, therefore, may enhance the confidence in the accounting profession that the quality of work performed by a p eer reviewed firm undergoes peer scrutiny and that the process provides for a disciplining mechanism for firms not adhering to minimum standards of performance (Fogarty, 1996). The General Accounting Office requires that firms under their jurisdiction undergo a periodic peer review. Similar requirements exist for firms listing with the NASDAQ.
Peer Review Program
In 1977, facing congressional investigations and potential governmental regulation, the accounting profession responded by establishing the AICPA's Division for CPA Firms consisting of two sections--the Private Companies Practice Section (PCPS) and the SEC Practice Section (SECPS). The CPA firms who are members of these sections are reviewed at least once every three years. Until 1995, those firms which were not a member of either of these sections were required to go through a quality review under the Quality Review Program. In 1994, the AICPA approved the combination of the PCPS Peer Review Program with the non-PCPS Quality Review Program, which became effective as of April 1995. The new, combined program is called the AICPA Peer Review Program (see El- sea and Stewart, 1995).
This study examines the perceived effectiveness of the peer review program of the SECPS. The members of the SECPS audit 87 percent of U.S. public companies which produce 99 percent of the total sales volume of all U.S. public companies (SEC Practice Section, 1989). The requirements of the SECPS affect more than 127,000 practitioners at 1,300 accounting firms that audit more than 15,600 SEC clients (Public Oversight Board, 1997). The SECPS imposes membership requirements and administers the peer review program to ensure that SEC registrants are audited by accounting firms who adhere to the quality control elements stipulated in Statement of Quality Control Standards No. 1 (American Institute of Certified Public Accountants, 1979).
The Public Oversight Board (POB) oversees the activities of the SECPS and assures the effectiveness of the peer review program, ensuring that the review is conducted according to professional standards (Shad, 1985). In summary the peer review program emphasizes controls that are program-based (Higgins, 1994). It is a method of control that determines if the elements of the quality control standards have been successfully implemented.
During the 1977-1997 period, the SECPS conducted 4,021 peer reviews, of which 322 firms received qualified/modified opinions and 50 firms were given adverse opinions. In addition, a total of 769 corrective actions were imposed by the Peer Review Committee over the same period of time. Using the 1997 Annual Report of the SEC Practice Section, Table 1 shows that the two largest number of corrective measures required during the 1977-97 period of reviewed firms include an "independent review of the firm's monitoring program" (44.3%), followed by the requirement of "oversight by peer reviewers or by PRC members to ascertain progress made in implementing corrective actions" (26.3%). The issue which this study addresses is the perceived effectiveness of the peer review program of the SECPS in improving the quality of audit work.
Effectiveness Assessment
The purpose of the peer review program is to assess whether the CPA firm under review has developed appropriate policies and procedures for the elements of quality control and follows them in their practice (Arens and Loebbecke, 1997). Peer review also ensures that a firm is complying with professional standards (Dennis, 1997). There is little agreement on how to assess the peer review program of the accounting profession (Mautz, 1984). Past efforts have focused on the mechanics and output of the peer review process (Evers and Pearson, 1989), on reviewer-reviewee characteristics (Wallace, 1991), on preparer's perceptions (McCabe et al., 1993), and on procedural fairness (Ehlen and Welker, 1996), rather than on the effectiveness of the goals and the overall peer review program. Much of the difficulty in assessing the effectiveness of the program in improving audit quality is the elusiveness of the concept of effectiveness itself. This is due, in part, to problems of identifying measures of "effectiveness" as well as agreeing on who should define them (Sutton and Lampe, 1991). In this study, we adopt the perspective that effectiveness is a multi-faceted and subjective concept; it ". . . is often a perception and not necessarily a computable reality" (Albrecht et al., 1988:3).
The peer review program is a system linking organizations rather than individuals. As such, the peer review program is a system that is more open to external influences than a traditional organization. A system, such as the peer review program, maybe considered to be effective if the system's processes and results are perceived to achieve or exceed a set of multiple goals and processes while satisfying relevant constraints (Pennings and Goodman, 1977). Assessing system effectiveness in this way involves choosing: 1) the criteria or standards of effectiveness and 2) whose perspective should be used in making the assessment (Cameron, 1986).
Although there are several different views (e.g., Cameron, 1979; Fogarty, 1996) relating to organizational and system effectiveness, the constituencies view seems most appropriate in situations where constituents affect or are affected by a system (Cameron, 1986; Mitchell et al, 1997). According to the constituencies perspective, the criteria for measuring system effectiveness include both perceived goals and the means for achieving them, including the system's effect on its constituents. Traditional views of effectiveness assume that only insiders can/should assess a system's effectiveness. The constituencies view suggests that all constituents, both internal and external, who have a stake in the system should judge its effectiveness.
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