Auditors' employment with clients and interaction with their former CPA firm.

It is not unusual for auditors to accept employment with audit clients upon leaving the audit firm. For example, Imhoff (1978) found that approximately 20 percent of the auditors in his sample accepted employment with a client firm. However, in recent years, the Independence Standards Board (ISB), the Securities and Exchange Commission (SEC), and the American Institute of Certified Public Accountants (AICPA) have expressed concerns about auditors' employment with their audit clients. Such concerns primarily relate to possible impairment of auditor independence. For example, the ISB noted that "a concern with partners or professional staff joining clients is that the remaining audit team members, because of their past relationship with the professional now in a position of importance with the client, may be reluctant to challenge the decisions or positions taken by the former partner or other professional" (1999: 13). Hence, this topic is of considerable interest not only to the accounting profession but als o to financial statement users as well as corporate managers.

The objective of this study is to provide empirical evidence about the perceptions of company executives and managers about their ability to resolve disagreements with their auditors who happen to be their former employers. While prior research has studied the perceptions of users and auditors (Imhoff, 1978; Parlin and Bartlett, 1994) on employment with audit clients, this is the first study that looks at clients' perceptions about their influence on auditors. Perceptions may be particularly useful in this context because (1) actual data about resolving disagreements with former colleagues are extremely difficult to obtain, and (2) perceptions can influence actions. We believe that this research is relevant to the general concern about auditors' employment with audit clients.

The next section examines the background and develops the research questions. This is followed by a description of method and results, and the article ends with summary and conclusions.

BACKGROUND AND RESEARCH QUESTIONS

Auditors' employment with their audit clients has been the focus of regulators for a number of years. Over 20 years ago, the Commission on Auditors' Responsibilities (1978) recommended that public accounting firms be prohibited from helping their former employees find employment with clients. In 1993, the AICPA recommended, as a step to enhance the confidence of the public in auditor independence, that the SEC and other regulators proscribe the hiring of the audit partner by the client for one year after the partner ceased to serve a client. The SEC (1994) noted its concern about auditors' employment with their former clients, but stated that it would be difficult, if not impossible, for the SEC to promulgate such rules. The SEC (1994) elaborated on independence problems that arise in the context of auditors going to work for their former clients, but suggested that the AICPA should address this issue.

The Independence Standards Board (ISB) came into existence in 1998 with the mission to establish independence standards applicable to audits of public entities in order to serve the public interest and to protect and promote investors' confidence in the securities markets (ISB, 1998). One of the issues on the ISB agenda was the employment of auditors with audit clients, after leaving an audit firm. The ISB expanded its focus beyond the audit partner, and examined issues associated with the hiring of members of the audit team by the client. The efforts of the ISB culminated with issuance of its Standard No. 3, Employment with Audit Clients, in July 2000 (ISB, 2000). This standard describes safeguards that firms should implement when their professionals join audit clients. The standard's requirements are effective for employment with audit client situations arising after December 31, 2000. This was the last standard issued by the ISB before it was dissolved on July 31, 2001.

The ISB (1999) noted that there are three concerns when professionals leave CPA firms to join audit clients. First, members of the audit team, who may have been friendly with or respectful of a former colleague when he or she was with the firm, would be reluctant to challenge the decisions of the former colleague and may not exhibit the appropriate skepticism or objectivity. (1) Second, when auditors resign to accept positions with audit clients, there may be questions about whether the individuals exercised appropriate level of skepticism during the audit process prior to their departure. Third, the former auditor may be familiar enough with the audit approach and testing strategy of the CPA firm so as to be able to circumvent its design.

In support of its concerns, the ISB stated that "contributing to the current concerns regarding audit professionals joining clients have been several, well publicized financial scandals where alumni of the audit firm held positions of responsibility at the client" (1999: 4). The ISB also noted that regulators from other countries have expressed similar concerns about the interaction between former professional employees and CPA firms. As stated by the ISB (1999), interest in this issue extends beyond the US. The European Contact Group (composed of representatives of the eight largest international networks of accounting firms) and the International Federation of Accountants also have noted concerns about auditors going to work for their former clients (ISB, 1999). In addition, the Public Oversight Board's Advisory Panel on Audit Effectiveness (POB, 2000) also has placed on record its concern about this issue.

Prior Research on Auditors' Employment with Clients

Imhoff (1978) surveyed auditors and financial statement users (e.g., bankers and financial analysts) to evaluate auditor independence when an auditor accepted employment with a client. He used hypothetical scenarios to obtain responses on a number of questions. The scenarios were varied to reflect the time elapsed between the audit engagement and accepting employment and whether the auditor held a supervisory position at the audit firm. He found that both groups' concern over auditor independence decreased as time elapsed between working on the audit engagement and accepting employment increased, or when the auditor worked in a non-supervisory position.

In an experimental study, Firth (1981) examined bankers' perceived lending decisions in the face of auditor-client relationships. Responses from over 1,200 bankers showed that bankers tended to grant smaller loans to a company whose financial director was previously a partner in the accounting firm compared to a situation when no alumni of the accounting firm was employed in the company. This illustrates the potential economic consequences of auditor employment with their clients.

Koh and Mahathevan (1993) examined middle managers' perceptions of auditor independence related to client employment. The results indicated that independence concerns increased as the time period between the last audit and accepting employment decreased. For subsequent audits, independence concerns were related to rank of the auditor when she left the firm and to her current position with the client organization.

In an experimental study, Parlin and Bartlett (1994) showed that auditors set a higher materiality threshold when the controller of the client company is a former colleague. This demonstrated that auditors' independence is impaired when dealing with clients who are former employees.

Research Questions

Financial statement users are concerned about auditor independence and they perceive auditors going to work for their clients as a threat to independence. Prior research shows that there are differences between the perceptions of auditors and users regarding the effect of such employment on independence (Imhoff, 1978). However, prior research has not looked at the perceptions of audit clients who are alumni of CPA firms. Audit clients who are CPA firm alumni would have better knowledge about this issue and perhaps personal experience in dealing with the auditors who are their former employers. CPA firm alumni are important constituents in this issue and their perceptions would be of interest to financial statement users and policy makers. Hence, as a first step, it is useful to examine whether audit firm alumni believe that they can resolve disagreements with their auditors if the auditors were their former employers.

Therefore, the first research question examined is:

RQI: Do the alumni of CPA firms believe they can resolve disagreements with their auditors more easily if the auditors were their former employers?

Factors Associated With Alumni Perceptions

There are many issues related to auditors' employment with clients and interaction with the former audit firm where empirical evidence may be useful before additional policy prescriptions are made. These issues include whether auditors' employment with clients affect perceptions of auditor independence, what factors impact those perceptions, and whether actions such as prohibiting this practice or having a "mandatory cooling-off period" would remedy the concerns about auditor independence. However, it may be extremely difficult to obtain archival data from audit engagements about such interactions and their impact on auditor independence. Studying perceptions are useful because perceptions can influence the actions of managers related to their negotiations with independent auditors.