DO AUDITING STANDARD SETTERS RESPOND TO PUBLIC CONCERNS?
EXPLORING THE ECONOMIC CYCLE AND AUDITING STANDARD PRECISION IN
THE PRE-PCAOB ERA
By
Colleen Mary Boland

A DISSERTATION
Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of
Business Administration – Doctor of Philosophy
2014

ABSTRACT
DO AUDITING STANDARD SETTERS RESPOND TO PUBLIC CONCERNS?
EXPLORING THE ECONOMIC CYCLE AND AUDITING STANDARD PRECISION IN
THE PRE-PCAOB ERA
By
Colleen Mary Boland
Have private auditing standard setters been responsive to constituent concerns? I explore
the frequency of auditing standard issuance and the relative precision of auditing standards from
1939 through 2002, before the creation of the Public Company Accounting Oversight Board in
2002. My findings suggest that private standard setters have responded to a changing constituent
base, becoming more responsive over time to investor concerns. Auditing standard setters
increase the number of standards issued when investors are most at risk of loss, that is, during
economic contractions. In addition to increasing the number of auditing standards issued,
auditing standards may have precise features that make it easier to document compliance with
the standard. However, when I control for number of standards issued, I do not find evidence of a
relationship between standard precision and economic contractions. In addition, I find a negative
association between precision and regulatory enforcement actions. These results indicate that
enforcement is an important part of auditing standard setting and provide insight into an auditor’s
preferences for precise standards. These findings should be of interest to regulators who create
and enforce auditing standards, as well as preparers, auditors, and other stakeholders impacted by
auditing standards.

I dedicate this dissertation to my husband, Tom, my children, Kate and Sam, and my parents,
Tom and Gerrie.

iii

ACKNOWLEDGMENTS

I thank my dissertation chair, Chris Hogan, and committee members, Marilyn Johnson,
Isabel Wang and Lawrence Busch for their insights and encouragement throughout this study. In
addition, I am thankful for the support and encouragement of the faculty at Michigan State
University, especially Andrew Acito, Elizabeth Connors, Susan Convery, Sanjay Gupta, Fredric
Jacobs, John Jiang, Joan Luft, William McCarthy, Jack Meyer, Edward Outslay, Brian Pentland,
Kathy Petroni, Ranjani Krishnan, Karen Sedatole, V. Sambamurthy, Michael Shields, Gary
Solon, Cheri Speier-Pero, Dan Wangerin, Timothy Vogelsang and Jeffery Wooldridge.
I appreciate the comments and insights from Douglas Carmichael, Gary Previts, Bruce
Webb, Joni Young and the participants at the Michigan State University Brown Bag series, Ball
State University Colloquium, and workshops at Central Michigan University, Iowa State
University, University of Nebraska-Lincoln, and University of Wisconsin-Milwaukee. I am
grateful for financial support from the Department of Accounting and Information Systems at
Michigan State University.
I also thank my friends and colleagues Ge Bai, Matt DeAngelis, Andrew Imdieke, Beth
Kangas, Michelle Lau, Dara Marshall, Shannon Mulally, Miles Romney, Joe Schroeder, Amy
Swaney, Sue Tellier, Anne Thompson, and Kailong Wang for feedback and support on this
research.
Finally, I thank my husband for his support, in all the little and big ways, my parents for
their encouragement and my children for their inspiration and love.

iv

TABLE OF CONTENTS

LIST OF TABLES ........................................................................................................................ vii
LIST OF FIGURES ..................................................................................................................... viii
CHAPTER 1: INTRODUCTION ................................................................................................... 1
CHAPTER 2: BACKGROUND AND HYPOTHESES DEVELOPMENT .................................. 6
2.1. Models of Regulation and Standard Setting ........................................................................ 7
2.2. The Auditing Standard-Setting Process ............................................................................. 10
2.3. Hypothesis Development ................................................................................................... 13
2.3.1. Hypothesis 1: Political Pressure and Auditing Standards Issuance ............................ 13
2.3.2. Hypothesis 2: Political Pressure and Auditing Standards Precision ........................... 18
2.3.3. Hypothesis 3: Political Pressure and the Proportion of Precise of Auditing Standards
............................................................................................................................................... 20
CHAPTER 3: SAMPLE DESCRIPTION AND RESEARCH DESIGN ..................................... 21
3.1. Composition of ASB.......................................................................................................... 21
3.2. Test of Hypothesis 1: Political Pressure and Auditing Standards Issuance ....................... 25
3.2.1. Control Variables ........................................................................................................ 26
3.3. Test of Hypothesis 2: Political Pressure and Auditing Standards Precision...................... 29
3.4. Test of Hypothesis 3: Political Pressure and the Proportion of Precise of Auditing
Standards ................................................................................................................................... 30
3.4.1. Control Variables ........................................................................................................ 31
CHAPTER 4: EMPIRICAL RESULTS ....................................................................................... 33
4.1. Tests of Hypothesis 1 ......................................................................................................... 33
4.2. Tests of Hypothesis 2 ......................................................................................................... 35
4.3. Tests of Hypothesis 3 ......................................................................................................... 37
4.4. Robustness and Supplemental Analysis ............................................................................ 38
4.4.1. Hypothesis 1 ................................................................................................................ 38
4.4.2. Hypothesis 2 ................................................................................................................ 40
4.4.3. Hypothesis 3 ................................................................................................................ 41
4.4. Summary ............................................................................................................................ 41
CHAPTER 5: CONCLUSION ..................................................................................................... 42
APPENDICES .............................................................................................................................. 43
Appendix 1: List of Acronyms ................................................................................................. 44
Appendix 2: Variable Definitions ............................................................................................. 46
Appendix 3: Precise Features and Example Auditing Standards ............................................. 48
Appendix 4: Tables ................................................................................................................... 50

v

REFERENCES ............................................................................................................................. 61

vi

LIST OF TABLES

Table 1

Descriptive Statistics

51

Table 2

Accounting Scandals

53

Table 3

Poisson Regression of Frequency of Auditing Standards

54

Table 4

Poisson Regression of Frequency of Precise Auditing Standards

55

Table 5

OLS Regression of Proportion of Precise Auditing Standards

56

Table 6

Poisson Regression of Frequency of Auditing Standards
Supplementary Analysis – Business Cycle Proxies

57

Table 7

Poisson Regression of Frequency of Precise Auditing Standards
Supplementary Analysis – Business Cycle Proxies

58

Table 8

Poisson Regression of Frequency of Precise Auditing Standards
Supplementary Analysis – Precise Features

59

Table 9

OLS Regression of Proportion of Precise Auditing Standards
Supplementary Analysis

60

vii

LIST OF FIGURES

Figure 1

ASB Constituents

12

Figure 2

Business Cycle and Auditing Standards

14

Figure 3

Number of Auditing Standards Issued Each Year

22

Figure 4

Number of Accounting Standards Issued Each Year

23

Figure 5

Number of Precise Auditing Standards Issued Each Year

24

Figure 6

Precise Auditing Standards as a Percent of Total Auditing Standards Issued

24

Figure 7

AAERs Issued

25

Figure 8

GDP and the Business Cycle

39

viii

CHAPTER 1: INTRODUCTION
“The (Auditing Standards B)oard [ASB] shall be alert to new opportunities for auditors to
serve the public, both by the assumption of new responsibilities and by improved ways of
meeting old ones, and shall as expeditiously as possible develop standards and procedures
that will enable the auditor to assume those responsibilities.”(Carmichael 1982)

Have auditing standard setters been responsive in serving the public? The financial
accounting literature documents that accounting standard setters issue accounting standards in
response to public and regulatory concerns (Kothari et al. 2010; Gipper et al. 2013). However,
with the notable exception of analytical work by Ye and Simunic (2013), there is little research
on the determinants of auditing standard setting. In this paper, I consider the responsiveness of
self-regulated auditing standard setters to investor demand for audit quality. Specifically, I
evaluate the association of the frequency and precision of auditing standards to transitions in the
business cycle.
Bertomeu and Magee (2011) describe how demand for financial reporting quality varies
across the business cycle. They assume that investors exert political pressure to improve
financial reporting as business cycles fluctuate from expansion to contraction. Investors demand
better information to identify good and bad investment opportunities. To obtain better
information, investors demand an increase in financial reporting and audit quality. Regulators are
generally sensitive to their constituents and issue regulations designed to improve financial
reporting quality. Standards theory in both economics and sociology suggest standard setters
issue standards to signal better (audit) quality (Nelson 1970; Power 1997; Busch 2011).
However, as it is difficult for the public to evaluate a standard’s quality, the public measures
responsiveness by the frequency of the standards issuance (Nelson 1970; Byington and Sutton
1991). Therefore, standard setters signal responsiveness by issuing standards (Nelson 1970;
1

Byington and Sutton 1991; Causholli et al. 2010).
Auditing standards are basically “certification” standards that communicate to outsiders
that a firm’s results have met certain requirements. Certification standards are used to monitor
agency relationships. In the case of auditing, these are the standards auditors’ reference to certify
management has applied accounting principles reasonably. Agency costs, and the demand for
monitoring, are procyclical (Bertomeu and Magee 2011; Westermann 2014), with demand
increasing as economic expansion transitions into recession. Using sociological theory of
certification standards, Power (1997) and Busch (2011) predict that when auditors are subject to
more scrutiny, standard setters will issue more precise standards. Auditors and their work are
more closely examined during economic contractions when the demand for monitoring increases
(Bertomeu and Magee 2011).
I examine all auditing standards issued by the Auditing Standards Board (ASB) between
1939 and 2002, when the ASB was responsible for creating auditing standards for all audits in
the United States.1,2 To test the responsiveness of the ASB, I consider both the frequency of
issuance and precision of auditing standards. In Hypothesis 1, I apply Bertomeu and Magee’s
(2011) predictions to the auditing profession. That is, I examine whether the ASB responds to
investor concerns by issuing more auditing standards after an economic downturn. I find there is
an increase in the number of auditing standards issued after the business cycle transitions into
recession in response to investor demand for higher financial reporting and audit quality. I
control for and find an increase in the number of auditing standards issued in response to high
profile accounting scandals, as standard setters provide guidance designed to protect investors
1

As described in Chapter 2, the ASB was preceded by the Committee on Auditing Procedures and The Audit
Standards Executive Committee. This study identifies these legacy committees and the ASB as ASB.
2
The Public Company Oversight Board (PCAOB) was created by the Sarbanes-Oxley Act of 2002 (Pub. L. 107204) to oversee the audits of public companies. The PCAOB creates the auditing standards applicable in the audits
of public companies and inspects the auditors of public companies for compliance.

2

from future fraud3 or possibly to protect the profession from liability.4
In Hypothesis 2, I posit that precise standards are issued in response to the transition of
business cycle expansion into recession. Precise standards clearly or sharply state a procedure or
process and may include detailed examples and guidance for auditors to follow. Precise
standards make an audit’s compliance with auditing standards easier to document and provide
the auditor with a defense if an audit fails. In this study, precise standards clearly or sharply state
procedures or processes, in contrast to ambiguous standards, which may be open to multiple
interpretations. Precise auditing standards may “crowd out” auditor judgment in designing audit
procedures and tests, resulting in “check the box” audits. Ye and Simunic (2013) consider public
and auditor preferences for auditing standard precision in developing auditing standards. They
predict that auditing standard setters prefer precise standards to provide auditors with a defense
against litigation for failure to conduct an adequate audit. Precise auditing standards also signal
audit quality and that preference is stronger for larger auditing firms. They argue that less precise
auditing standards allow auditors to minimize the cost of conducting an audit. It is an empirical
question as to whether auditing standard setters will issue relatively more precise auditing
standards to protect against litigation or whether they will issue relatively less precise auditing
standards to allow auditors to minimize auditing costs in the aftermath of an economic downturn
or recession. Ye and Simunic (2013) assert that regulatory enforcement impacts these
preferences. Thus, I control for enforcement as measured by the Securities and Exchange
Commission’s (SEC’s) Accounting and Auditing Enforcement Releases (AAERs) and
3

For example, Statement of Auditing Procedure (SAP) 1 requires auditors to observe the client’s counting of their
physical inventory. This standard was in response to the McKeeson & Robbins scandal in which auditors relied on
accounting records instead of observing the actual inventory. Statement on Auditing Standards (SAS) 99,
Considerations of Fraud in a Financial Statement Audit, was issued in response to the Enron and WorldCom
scandals in the early 2000s.
4
For example, Statement of Auditing Standard (SAS) No. 83 requires that auditors obtain an engagement letter
detailing the nature and scope of the audit.

3

presidential political party affiliation. To test this hypothesis, I create a measure of auditing
standard precision that considers new compliance procedures, an expansion of auditor
responsibility, an increase in the specificity of the auditor report and level of detailed guidance.
While I find evidence of auditing standard setters responding to fluctuations in the business
cycle, the response is greater to the regulatory environment and the influence of BigN auditors. 5
Interestingly, while the 1970s reformation of the ASB was to reduce BigN audit firms’ influence
and increase the influence of other constituents, their influence is stronger since the reformation.
Consistent with Ye and Simunic’s (2013) prediction, fewer precise auditing standards are issued
as the regulatory environment changes, as measured by AAER enforcement and the change to a
Democratic president.
To control for changes in the frequency of auditing standards over time, in Hypothesis 3 I
posit that the proportion of precise auditing standards issued increases following the transition
into recession. However, the results do not support a relationship between the proportion of
precise auditing standards and recession. Consistent with a decrease in the frequency of precise
standards issuance as regulatory enforcement actions increase, the proportion of precise
standards also decreases. Auditing standards became more precise in response to the election of a
Republican president and the reformation of the ASB in the 1970s. These results are consistent
with auditing standard setters signaling audit quality by issuing precise (tougher) auditing
standards. Taken together, auditing standard setters prefer less precise auditing standards,
perhaps at the expense of increased protection from litigation and regulatory enforcement
5

The BigN audit firms are Deloitte Touche Tohmatsu Limited, EY (formerly Ernst & Young), KPMG, and
PricewaterhouseCoopers LLP. Prior to its demise in 2002, Arthur Anderson LLP was included as a BigN firm.
Legacy firms include Arthur Young & Co, Coopers & Lybrand LLP, Deloitte Haskins & Sells, Deloitte & Touche
LLP, Ernst and Ernst, Ernst & Young LLP, Ernst & Whinney LLP, Haskins & Sells, KPMG Peat Marwick LLP
(formerly known as KPMG Peat Marwick, Peat Marwick Main & Co., Peat Marwick & Mitchell & Co.), Lybrand,
Ross Brother & Montgomery, Price Waterhouse LLP, Touche, Ross Bailey & Smart, and Touche Ross & Co.

4

actions.
This study contributes to the literature in three ways. First, it provides descriptive
evidence of changes over time in the frequency with which auditing standards are issued. The
results provide evidence of changes in the power of various constituents. Regulators and BigN
auditors’ influence has strengthened as the accounting standard setters’ influence has moderated.
Second, I provide evidence that private auditing standard setters were responsive to investor and
regulatory concerns of decreased audit quality, including changes in the economy. Third, the
results provide some support for analytical theories of auditing standard setting. Specifically, I
find support for the Bertomeu and Magee (2011) prediction that auditing standard setters, as
delegated regulators, respond to investor demand for higher financial reporting quality. In
addition, I find support for the Ye and Simunic (2013) prediction that auditing standard setters
respond to increases in regulatory enforcement toughness by issuing less precise standards. This
study should be of interest to regulators responsible for creating and enforcing auditing
standards, as well as preparers, auditors, and other constituents impacted by auditing standards.
The paper is organized as follows. In Chapter 2, I provide a brief discussion of regulatory
models and auditing standard setting and develop the hypotheses. In Chapter 3, I describe the
sample and research design. In Chapter 4, I present the results and in Chapter 5 provide the
conclusion. Appendix 1 provides a listing of the acronyms used. The variables are defined in
Appendix 2. Appendix 3 defines precise features and identifies example auditing standards. The
tables of results are presented in Appendix 4.

5

CHAPTER 2: BACKGROUND AND HYPOTHESES DEVELOPMENT
As the professional association of public accountants, the American Institute of Certified
Public Accountants (AICPA)6 is responsible for representing their members’ interests. The
AICPA recognizes the primary value of public accountants is its “public watchdog” role.7 In
their book, Ethical Standards of the Accounting Profession, Carey and Doherty (1966), AICPA
staff, describe general principles to guide the public accountant. They summarize these standards
as a promise to protect the public in performing their work.
“A code of professional ethics is a voluntary assumption of self-discipline above and
beyond the requirements of the law. It serves the highly practical purpose of notifying the
public that the profession will protect the public interest. The code in effect is an
announcement that, in return for the faith which the public reposes in them, members of
the profession accept the obligation to behave in a way that will be beneficial to the
public” (Carey and Doherty 1966, 3).
The AICPA establishes membership conduct standards (code) in fulfillment of its “watchdog”
role. The standards focus on promoting and preserving the quality of the Certified Public
Accountant’s (CPA’s) product, the audit. Although auditing relies on accounting information,
auditing verifies what accounting measures and communicates (Mautz and Sharaf 1961, 14–15;
Knechel et al. 2013). The purpose of the current study is to understand how auditing standards
are created, and takes as given that auditing standards are created to maintain or improve audit
quality. In this chapter, I discuss the models of regulation and standard setting and provide a

6

The AICPA started as the American Association of Public Accountants in 1887. After various mergers with other
professional accounting associations, it became the American Institute of Accountants (AIA) in 1917. The AIA
merged with the American Society of Certified Public Accountants in 1936 to form the AICPA. I refer to AICPA
and its legacy organizations as the AICPA.
7
In the United States v. Arthur Young & Co., 465 U.S. 805 (1984), the Supreme Court reaffirmed the SEC
delegation of protecting public investors.

6

review of the history of auditing standard setting in the U.S. I close by discussing three
hypotheses.

2.1. Models of Regulation and Standard Setting8
Much of the literature on financial accounting uses economic models of regulation to
evaluate the role that politics play in standard setting (Gipper et al. 2013). These studies view the
political process as special interest groups lobbying for self-interested reasons (Zeff 2002;
Gipper et al. 2013). In a review of this literature, Gipper, Lombardi, and Skinner (2013) identify
two9 major regulatory models used by researchers to explain accounting standards: regulatory
capture and ideology. In the regulatory capture model, regulation favors the interests of the
regulated. In other words, the regulator works to advance the interests of the regulated rather
than the public. Financial Accounting Standards Board (FASB) standards affect many different
constituencies (e.g., various types of auditing firms and their various clients, investors, creditors,
and analysts). Research in this area has focused on FASB board members’ political power and
various constituencies’ lobbying campaigns. Watts and Zimmerman (1978) examine comment
letters on accounting standards to document firms’ incentives to lobby. Using comment letters on
pension accounting (Statement of Financial Accounting Standards No. 87), Francis (1987)
models the determinants of firms’ decisions to lobby. Allen et al. (2012) submit that BigN
accounting firms are concerned about decreased “reliability” in FASB proposed accounting
standards, documenting that firms lobby on their own behalf, as well as their clients. Allen and
Ramanna (2013) document accounting standard setters’ preferences’ for “reliability” and
“relevance” based on professional and personal characteristics. Since the FASB reflects these
8

This section draws heavily on Kothari et al. (2010) and Gipper et al.(2013).
They identify a third model, the public interest model, but find researchers rely more on the regulatory capture and
ideology models (Gipper et al. 2013).
9

7

various constituencies, it is unclear who captures the standard setter (Gipper et al. 2013). In
addition, the positions of various audit clients may vary based on the proposed standard. In other
words, an auditing firm will not necessarily present a consistent position on any given
accounting standard (Haring 1979; Brown 1981; Gipper et al. 2013).
Alternatively, employing the ideology theory, researchers suggest a standard setter bias
toward certain types of rules rather than toward certain entities. For example, in accounting
standard setting, there may be a bias toward fair value or historical cost (Gipper et al. 2013). By
understanding the bias of the standard setter, those subject to the standard can increase their
lobbying effectiveness.
Gipper et al. (2013) propose another model: the regulatory model of accounting rules.
They argue that as standards move from a process based on general acceptability to one based on
formal regulation, the standards become focused on compliance rather than outcomes. Evidence
of compliance to the standard becomes the measure of quality. This model led to the literature
comparing rule-based accounting standards with principle-based accounting standards (Ball
2009; Mergenthaler 2009; Donelson et al. 2012; Dichev et al. 2013).
Gipper et al.’s (2013) regulatory model is related to sociological theories of regulation
and contracting theory. Auditing standards are an example of “certification” standards designed
to govern complex and distant economic transactions (Busch 2011, 204–205). Busch (2011)
proposes that certification standards exist to induce trust between two or more parties and that
trust in the certifier (auditor) transfers to trust in the certification results (audit). Trust established
through certification can be used as a tool to reduce the risk that arises as ownership becomes
diffuse or the distance between managers and owners increases. Management reduces risk by
hiring an auditor, while investors reduce risk by demanding an audit. Similarly, auditing

8

standards may also be viewed as a contract between the auditor and the investing public.
Consistent with contracting theory, complex transactions are governed by incomplete or less
precise contracts (Williamson 2000; Williamson 2002). Conversely, as transactions become
more routine or if there is a lack of trust between the parties, the contract becomes more precise
to allow for efficient monitoring of contract compliance (Williamson 1993; Williamson 2000;
Williamson 2002).
To reduce risk of investments losses, investors also apply political pressure to standard
setters to hold auditors accountable (Power 1993; 1997, 31; O’Neill 2002). Power (1997) and
O’Neill (2002) propose that standard setters respond to these pressures by designing standards to
increase auditor accountability. Byington and Sutton (1991) hypothesize that one likely response
to political pressure is an increase in the number of standards, which may be viewed by investors
as a proxy for the standard setter’s response. Another response is to issue more precise standards.
Precise standards clearly or sharply state a procedure or process and may include detailed
examples and guidance for auditors to follow. These types of standards make the audit auditable
and provide the auditor with a defense if an audit fails (Power 1997, 33; O’Neill 2002; Busch
2011, 217). An auditable audit is one where another monitor replicates the first auditor’s work. If
the audit subsequently fails, the auditor is able to provide a due diligence defense against charges
of an inadequate audit. Consistent with contract theory, ex post consequences replace ex ante
incentives (Williamson 2002). In other words, precise standards allow for ex post enforcement
actions.
Since early standards are typically voluntary, standard setters must prove their legitimacy
by adopting standards that are cost-effective (Brunsson and Jacobsson 2000). Private
organizations with expertise in the subject area, such as a professional association, often create

9

standards (Brunsson and Jacobsson 2000, 40 – 49). As a result, early standards often codify
professional norms, and in recognition of the general acceptability of current practice, are
flexible and cost-effective. To achieve legitimacy, standard setters need a broad base of support
and agreement on standards (i.e., standards must be generally acceptable to parties that rely on
the standard). Certification standards, such as auditing standards, must satisfy diverse parties
such as investors, firms, and auditors. Flexible, or less precise, standards allow the auditor to
tailor procedures to the specific needs of each party and still comply with the standard (Watts
2006; Brunsson et al. 2012; Ye and Simunic 2013). Using related economic arguments,
Causholli and Knechel (2012) argue that an audit is a credence good. It is difficult for consumers
to evaluate a credence good’s quality because they must rely on the producer to recommend and
provide the service. In addition, short of a failure, consumers cannot assess the delivered
service’s quality (Nelson 1970; Causholli and Knechel 2012). As a result, to signal quality, the
producer invests in branding (Darby and Karni 1973; Dulleck and Kerschbamer 2006). Auditing
standard setters invest in the audit brand by issuing standards. These standards signal the auditors
can be trusted to deliver suitable quality.
To summarize, sociological and economic theory and prior auditing research indicates
that auditing standard setters, as industry representatives, develop standards that are acceptable to
the profession and responsive to constituents’ concerns. “General acceptability” guides standard
setters when creating standards. Auditing standard setters consider both frequency and precision
in responding to investor, regulators and the auditing profession.

2.2. The Auditing Standard-Setting Process
The evolution of auditing standards is consistent with regulation and standard setting

10

models. Beginning in 1917, the AICPA provided voluntary auditing guidance through pamphlets
that summarized generally accepted practice. Congress began regulating the accounting and
auditing professions when it made the SEC responsible for creating accounting and auditing
standards as an outgrowth of the Securities Act of 1933 and Securities Exchange Act of 1934.
The SEC delegated both auditing and accounting standard setting to the professional association.
In 1939, the AICPA created the Committee on Auditing Procedures (CAP) to set auditing
standards and the Committee on Accounting Procedures to set accounting standards. CAP
members were volunteers viewed as experts (e.g., the partners of the largest auditing firms). The
first CAP standard was a codification (summary) of current auditing practices, or generally
accepted auditing standards (GAAS), and was approved by the entire AICPA membership.
In response to another wave of accounting scandals, FASB, the independent organization
that establishes financial accounting standards governing nongovernmental entities’ financial
report preparation, replaced the AICPA Accounting Principles Board (APB)10 in 1973. Although
FASB membership was smaller than APB membership, it reflected the interests of a broader set
of users and preparers than did APB. Relatedly, to signal a new standard setting regime, in 1973
the AICPA consolidated CAP’s position as the senior committee responsible for interpreting
GAAS, renaming it the Audit Standards Executive Committee (AudSEC). SAS No. 1, a
codification of all SAPs, was the first of 23 standards issued by AudSEC. The ASB replaced
AudSEC in 1978.11 ASB adopted a more inclusive standard setting process than CAP, created an
advisory council, and replaced AICPA committees with task forces that focused on new and
emerging issues. As presented in figure 1, the ASB recognizes the accounting profession, users
of audit reports, other standard setters and regulators as its constituents (Carmichael 1982).
10

In 1959, the AICPA replaced the Committee on Accounting Procedures with the Accounting Principles Board,
which was also a committee of the AICPA.
11
For simplicity, I refer to all auditing standard setting bodies in this study as ASB.

11

Figure 1
ASB Constituents

However, like CAP members, ASB members are volunteers with extensive auditing experience.
Two-thirds of the 15-member board is in public practice (AICPA 1978).12 The ASB relied on
active auditors to identify topics of potential auditing standards. To encourage public
participation in setting standards, both FASB and ASB substantially adopted the Administrative
Procedure Act (APA).13 The APA requires a notice of proposed rulemaking and a public
comment process before the rule is adopted. The notice of the proposed rule requires a

12

In 2004, the ASB expanded membership to 19 and allocated specific seats to different industry constituencies.
Four seats are held by BigN auditors, five seats by non-BigN auditors, five seats are filled by representatives from
the National Association of State Boards of Accountancy, and five seats by other public accountants, including those
working in industry, government or academics (AICPA 2010).
13
The APA (Pub. L. 79-404) is the law that oversees rulemaking for federal agencies.

12

description and basis for the rule. It is standard practice to allow 60 days from the proposed
rule’s issuance for public comment and another 30 days for the agency to incorporate public
comments before final rule issuance.
Consistent with the APA, ASB includes a proposed standard on its public agenda at least
twice, inviting public comment before final approval. Therefore, the speed of standard setting
varies based on the number of ASB meetings each year. The time from proposal to approval was
4–6 ASB meetings. The annual meeting frequency has varied since 1939 and approval has varied
from 2 to 18 months. Every standard discloses each board member’s name, the number of
members approving the standard, and the names of the 1–3 primary technical staff responsible
for its preparation. Board members vote on each paragraph of the standard. The final standard
also discloses the detailed rationale behind a board member’s dissent or qualification. Over the
course of the ASB, most standards have no dissent or qualification.

2.3. Hypothesis Development
2.3.1. Hypothesis 1: Political Pressure and Auditing Standards Issuance
Auditors look to their professional association for guidance. As a result, auditing
standards are issued for various reasons. Some auditing standards are in response to a new
accounting standard (e.g., SAP No. 44, Reports Following a Pooling of Interests), while others
are a response to a new government regulation (e.g., SAS No. 63, Compliance Auditing
Applicable to Governmental Entities and Other Recipients of Governmental Financial
Assistance). New business technologies and methods also result in new standards (e.g., SAS No.
3, The Effects of EDP on the Auditor’s Study and Evaluation of Internal Control; SAS No. 44,
Special-Purpose Reports on Internal Accounting Control at Service Organizations; and SAS No.

13

51, Reporting on Financial Statements Prepared for Use in Other Countries). And standards are
issued to reflect expanding responsibilities, such as guidance to detect and report fraud and
illegal acts (e.g., SAS No. 53, the Auditor's Responsibility to Detect and Report Errors and
Irregularities, and SAS No. 54, Illegal Acts by Clients).
Figure 2
Business Cycle and Auditing Standards

Standards are also issued in response to political pressure from constituents. Watts (2006)
proposes that political pressure reflects market forces at work to promote and constrain private
benefits sought by self-interested parties. Bertomeu and Magee (2011) describe regulators who
are responsive to constituents’ needs. Similarly, my definition of constituents (figure 1) does not
distinguish between self-interested parties’ private benefits and protection of the public. A
politically sensitive regulator (auditor) responds to varying degrees to all constituents. The
regulator’s values and interpretations are also incorporated into their response. Investor demand

14

for financial reporting quality increases as business cycle expansion slows to a moderate phase,
like before a recession (Bertomeu and Magee 2011). This is the same time that firm managers’
preferences for reduced quality becomes stronger. In expansionary periods, firms that are not
doing well try to hide poor performance, but as the expansion slows to contraction, this becomes
more difficult. As businesses often fail during recessionary periods,14 investors evaluate whether
a poor quality audit is responsible for their inability to detect impending failure. Thus, a
recession may trigger political pressure by investors.
Much of the accounting standard setting literature focuses on the association between
accounting standards’ content and political pressure (Watts and Zimmerman 1978; Francis 1987;
Allen et al. 2012; Allen and Ramanna 2013). However, Byington and Sutton (1991) argue that
accounting and auditing standards are issued to prevent regulatory oversight of the accounting
and auditing profession. Their study focuses on four events they assert put the accounting and
auditing profession’s self-regulation at risk. The first event, Accounting Series Release 4 in
1938, delegated accounting and auditing standard setting to the respective professions. The
second, in 1971, was legislation providing guidance on investment tax credit accounting. Both
the 1978 Moss-Metcalf Hearings and the 1985 Dingell Hearings considered establishing
oversight of the auditing profession, which became the basis of the PCAOB mission in 2002.
Unlike Byington and Sutton (1991), in this study I consider explanations other than avoiding
regulatory oversight for issuing auditing standards. Like accounting standards, auditing standards
promote investor confidence in financial reporting and protect auditors from costly litigation and
regulatory oversight. This implies that like accounting standard setters, auditing standard setters

14

The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic
activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income,
employment, industrial production, and wholesale-retail sales.”(NEBR,
http://www.nber.org/cycles/general_statement.html accessed 12/28/2013).

15

may also be responsive to political pressure from users other than regulators.
However, ASB differs from FASB in several respects. For example, ASB has always
been a committee of the AICPA, the auditor trade association, while accounting standard setting
by FASB only started in 1972. As a result, ASB consists solely of auditors, while the
composition of FASB’s membership reflects various constituencies. The change in the
membership may have caused accounting standard setting to become more overtly political. As
the ASB membership composition did not change, it is not clear whether auditing standard
setting would also become more political.
To strengthen independence, FASB has seven full-time employees with five-year
appointments, which may be renewed for five more years. In contrast, to identify issues quickly,
ASB has 15 volunteer members, currently in public practice, who serve part-time for up to three
years. Due to the limited scope of auditing, the AICPA concluded that unlike accounting
standards, there was little interest outside the auditing profession in auditing standards (AICPA
1978). However the AICPA set up an advisory council to seek views from the users of audited
financial statements. The advisory council included securities lawyers, financial analysts,
governmental officials, bankers, underwriters, and corporate executives (Carmichael 1982).15
Independent commissions and congressional hearings in the 1970s and 1980s, as well as the
PCAOB creation in 2002 call the ASB’s responsiveness to investor concerns into question. In
1978, the Cohen Commission recommended significant changes to the standards setting process,
although granted the effectiveness and responsiveness of auditing standard setters (Cohen 1978;
AICPA 1978). In contrast, Byington and Sutton (1991) argue that the 1978 Moss and Metcalf
hearings and the 1985 Dingell hearings are evidence the auditing profession was not responsive

15

In the post PCAOB era, the advisory council has come to be dominated by regulators of these users.

16

to investor concerns.16 Thus, the response of auditing standard setters to political pressure is an
empirical question.
An audit, a credence good, is difficult for the public to evaluate for quality (Causholli et
al. 2010; Causholli and Knechel 2012). By extension, investors are also unable to evaluate the
quality of auditing standards. In their study of the accounting profession’s efforts to avert
government oversight, Byington and Sutton (1991) argue that the public likely views the number
of standards issued as a proxy for the intensity of the profession’s response. In other words,
auditing standard setters will issue more standards to signal the seriousness of the topic, as well
as the appropriateness of their response.
In the U.S., the late 1960s and 1970s were periods of accounting and political scandals
and the start of economic deregulation. Wage, price, and other economic controls were removed
for several industries (e.g., transportation, oil and gas, and financial institutions). In addition, the
federal government looked into anticompetitive practices (e.g., the prohibition against
advertising and solicitation of clients) in the auditing profession. FASB and the ASB were
created as a political response to the deregulatory efforts and the political and accounting
scandals. The AICPA kept control of the auditing standard setting, but not the accounting
standard setting. Power (1997, 31) asserts that regulators’ withdrawal from rule (standard) setting
(i.e., deregulation) results in the delegation of greater regulatory power to audit standard setters.
In the case of auditing standard setting, the SEC identified the ASB as the official source of
auditing standards. With this delegation of power, the political pressure on audit standard setters
likely increased, resulting in more standards.
As representatives of the audit profession, the ASB issues auditing standards to guide
auditors in their work and to promote the profession to the investing public. Changes in the
16

Starting in 2002, the PCAOB creates auditing standards for audits of publicly-held firms.

17

1970s suggest that the public and regulators became more important constituents to the ASB,
while auditors had been more important before the 1970s. As the SEC delegated auditing
standard setting to the ASB to restore investor confidence in financial statements, the ASB
should be responsive to the concerns of the investing public when developing auditing standards.
As it is difficult for investors to evaluate an audit and the auditing standards governing the audit,
I propose the following in the null form:
Hypothesis 1: Ceteris paribus, auditing standard issuance is not related to the business
cycle.

2.3.2. Hypothesis 2: Political Pressure and Auditing Standards Precision
Hypothesis 1 examines the association between political pressure applied in the business
cycle and the frequency with which auditing standards are issued. Political pressure also
influences the properties of the standards and is the focus of Hypothesis 2. As discussed above,
certification standards, which are tools designed to increase trust, may also be a way to decrease
risk (Busch 2011, 215). Investors reduce their risk of relying on bad information by demanding
an audit. Managers reduce the risk of being charged with failure to tell investors of relevant
information by buying an audit. Auditors reduce their risk of being charged with conducting an
inadequate audit by relying on auditing standards that provide a benchmark of compliance with a
generally accepted level of quality.
Research in standards theory provides evidence there is greater general acceptability and
a higher rate of adoption (Brunsson et al. 2012) when standards are less precise and adoption is
voluntary.17 Less precise auditing standards allow auditors to exercise greater judgment in

17

The ASB considered several precise requirements in SAS No. 47, Audit Risk and Materiality, that were not
included in the final standard due to the lack of majority agreement (Kinney Jr 2005).

18

developing auditing tests and procedures and minimize costs in conducting the audit. Ye and
Simunic (2013) argue that standard setters prefer less precise standards when they are subject to
regulatory enforcement actions that are not ideal. In addition, less precise auditing standards
allow the auditor to vary audit effort to match investor requirements (Ye and Simunic 2013). The
ability to vary audit effort also allows the auditor to compete with other auditors on price .
However, less precise standards increase an auditor’s risk of being charged with
conducting an inadequate audit. When standards are precise, it is easier for regulators to monitor
auditors (Power 1997, 33). Auditors and those who regulate them can then cite procedures rather
than judgment in support of audit conclusions (Power 1997, Chapter 5; Busch 2011, 217). Thus,
compliance with precise standards provides a “due diligence” or “safe harbor” defense. Precise
standards also protect auditors from charges of favoring one special interest group over another.
When regulatory enforcement is either too tough or too loose, auditing standard setters prefer
less precise standards. Too tough of standards may require procedures that do not provide
support for the auditor’s conclusion. Standards that are too loose may be inadequate to inspire
trust by the investing public. As standard setters issue standards to signal to users that an audit is
valuable to them, standard setters will adjust the issue with more precise standards in response to
regulatory enforcement.
To summarize, sociological and auditing standards theorists suggest that standard setters
issue less precise auditing standards to ease auditing standard adoption. Auditing standards
setters also prefer less precise standards to minimize audit effort and to apply proper procedures
to the economic situation. However, constituent auditors may want more precise standards as
protection from charges of inadequate procedures that result in litigation or regulatory actions
and to signal audit quality. I propose the following in the null form:

19

Hypothesis 2: Ceteris paribus, precise auditing standard issuance is not related to the
business cycle.

2.3.3. Hypothesis 3: Political Pressure and the Proportion of Precise of Auditing Standards
In Hypotheses 1 and 2, I consider that the demand for auditing standards may differ from
the demand for precise auditing standards. In Hypothesis 3, I consider the proportion of precise
auditing standards to gain insight into the strength of demand for precise auditing standards. I
propose the following in the null form:
Hypothesis 3: Ceteris paribus, the proportion of precise auditing standard is not related to
the business cycle.

20

CHAPTER 3: SAMPLE DESCRIPTION AND RESEARCH DESIGN
In this chapter, I examine auditing standard setting from 1939 to 2002 (63 years), when
the profession was regulated by ASB and AICPA membership sanctions. CAP issued Statements
on Auditing Procedures (SAP) from 1939 to 1972. The first Statement of Auditing Standards
(SAS) was issued in November 1972. Therefore, I explore differences in the two regimes and the
resulting standards issued. For ease of discussion, I refer to the two regimes based on the
standards issued (SAP and SAS). I provide descriptive data about the ASB and its standards. I
also discuss the research design and develop models to test the three hypotheses.

3.1. Composition of ASB
The financial accounting standard setting literature focuses on FASB and SEC board
composition (Kothari et al. 2010; Gipper et al. 2013; Allen and Ramanna 2013; Bertomeu and
Cheynel 2013); however there is little information on auditing standard setters. In Table 1, I
describe the ASB and auditing standards. There have been over 350 volunteer ASB board
members from 1939 to 2002; many more volunteers have been involved in developing and
issuing auditing standards through advisory councils and task forces. ASB membership has
ranged from 11 to 25 people, with a mean (median) of 19 (18) people. In the 1970s reformation,
ASB reduced its membership to 15 to be more nimble in standard setting (AICPA 1978).18 The
mean (median) term is 2.8 (3) years, and members served from 1 to 9 years. ASB issued a mean
(median) of 7.5 (6) standards per member, with a range of 1–29 standards per member.19 There
were 22 ASB chairs during the sample period, with 18/22 (82%) representing a BigN firm.
Interestingly, there were 11 chairs (9 BigN and 2 non-BigN) before and after the 1972

18
19

As noted in footnote 12, in 2004 ASB membership increased to 19.
Standards issued when the member was chair are included.

21

reformation. ASB chairs served a mean (median) term of 2.1 (2) years, issuing a mean (median)
7.1 (5.5) standards. Non-BigN chairs presided over the fewest standards issued (1) and the
second most (18) of all chairs.

0

5

10

15

20

Figure 3
Number of Auditing Standards Issued Each Year

1940

1950

1960

1970
Year

1980

1990

2000

Figure 3 presents the number of auditing standards issued each year from 1939 through
2002. The mean (median) number of SAS auditing standards a year increased to 3.3 (3)
compared to 1.7 (1) SAP auditing standards. Following the banking crisis in the 1980s, the
highest number of auditing standards was issued in 1988 (10). To guide federal contract
reporting during World War II, the second highest number of standards (8) were issued in 1942.
Figure 4 presents the number of accounting standards issued each year from 1939 through 2002.
Accounting standard setting has also increased in number since the ASB reformation (which
coincided with FASB formation): a mean (median) 5.3 (4) FASB accounting standards have
been issued, up from 2.6 (2) APB accounting standards. Similarly, both the number and
22

proportion of annual “precise” standards, defined more fully in the discussion of tests of
Hypothesis 2 in Chapter 3.3, have increased (see figures 5 and 6).

0

5

10

15

20

Figure 4
Number of Accounting Standards Issued Each Year

1940

1950

1960

1970
Year

23

1980

1990

2000

0

5

10

15

20

Figure 5
Number of Precise Auditing Standards Issued Each Year

1940

1950

1960

1970
Year

1980

1990

2000

0

.2

.4

.6

.8

1

Figure 6
Precise Auditing Standards as a Percent of Total Auditing Standards Issued

1940

1950

1960

1970
Year

24

1980

1990

2000

The mean (median) number of precise standards have increased from 0.76 (1) SAP (before 1973)
to 2.3 (2) SAS (after 1973), representing a proportional increase from of 37.8% (18.8) SAP
standards to 64.4% (72.5) SAS standards. While the number of AAERs has been steadily
increasing, the number of AAERs against auditors has remained relatively flat (see figure 7).
Figure 7
AAERs Issued
250

# of
AAERs Issued

200

150

100

50

0
1982

1987
AAERs Issued

1992

1997

2002

Auditor AAERs Issued

3.2. Test of Hypothesis 1: Political Pressure and Auditing Standards Issuance
Hypothesis 1, that auditing standard setters respond to political pressure by issuing
auditing standards, is tested with a regression model as follows:

(1)
The dependent variable is the number of auditing standards issued in year t, #AuditStandt. A

25

Poisson regression is used because #AuditStandt is a count variable.20 In the current study, the
number of auditing standards issued in a year varies from 0 to 10, with 11 (17%) years where no
standards were issued and 32 (50%) years where only one or two standards were issued. The
independent variable, Recessiont-1, equals 1 if six months or more of the year was in a NBER
defined recession,21 and is 0 otherwise.22 Bertomeu and Magee (2011) propose that reporting
quality declines as the expansion moderates and improves as the economy enters a recession in
response to demand for quality financial reporting (and audits).23 As investors identify a slowing
in the economy at the end of an economic expansion, they typically pressure auditing standard
setters for higher audit quality. While the investor notes a decline in financial reporting quality
occurs before an economic contraction starts, auditing standard setters need time to recognize
and respond with new standards. Recessiont-1 captures the predicted lag in the response time of
auditing standard setters.

3.2.1. Control Variables
Accounting scandals are widely recognized as causing accounting and auditing standards
to be issued (Roth 1969; Merino and Previts 1998; Zeff 2003a; 2003b; Clikeman 2009). To
control for accounting scandals, Scandalt-1, an indicator variable that equals 1 if a major
accounting scandal occurred in year t - 1, and is 0 otherwise is included. This study relies of the
20

Count variables are non-negative integers that follow a Poisson distribution. Poisson distributions can be used to
predict the probability of the number of occurrences of an event, also nonnegative integers. Poisson distributions
frequently have meaningful zero responses and a low level of occurrences (Kennedy 2003, 264; Wooldridge 2010,
907).
21
As described in footnote 14, the NBER defines a recession as “a significant decline in economic activity spread
across the economy, lasting more than a few months, normally visible in real GDP, real income, employment,
industrial production, and wholesale-retail sales.”(NEBR, http://www.nber.org/cycles/general_statement.html
accessed 12/28/2103).
22
If the recession spans more than one year, and less than six months were in either year, the year in which the
recession started is identified as Recession.
23
I re-estimate the model to test the sensitivity of the timing of the response to the contraction. Results are
presented in Chapter 4.4.

26

accounting scandals Clikeman (2009) identifies as most significant to the formation of
accounting and auditing. I corroborate and supplement this list with observations by Zeff (2003a,
2003b). Table 2 presents the accounting scandals included in this study.
AAERs are regulatory actions taken against firms and their auditors for violations of SEC
and federal rules (i.e., improper accounting or violations of securities laws). Regulatory actions
against firms or auditors were minimal before 1982 when the SEC started issuing AAERs. The
AAER database was developed by Dechow et al. (2011) and is maintained by the Center for
Financial Reporting and Management.24 As the ASB represents auditors, it should be sensitive to
enforcement actions against them. AAERAUDt-1, the annual auditor enforcement actions scaled
by annual total number of AAERs issued in time t, proxies for enforcement actions against
auditors. Auditor AAERs are scaled by total AAERs to account for changes in total enforcement
actions over time.
Auditing standard setters also develop new standards to respond to new accounting
standards. Accounting standards are issued after a lengthy process and typically have a delayed
implementation date. This suggests that auditing standard setters can respond concurrently.25 I
control for that response by including AveAccStandardst, the average number of accounting
standards issued in year (t + t - 1)/2.
Among other things, presidential elections reflect public assessment of the economy. A
change in the political party of the presidency may imply public dissatisfaction with the
economy’s direction. Newly elected presidents outline an agenda on how to manage the

24

I thank the Center for Financial Reporting and Management in providing additional assistance with the auditorspecific AAERs.
25
Few auditing standards are issued in response to a specific accounting standard (e.g., SAS 28, Supplementary
Information on the Effects of Changing Prices). Those auditing standards that are issued in response to a specific
accounting standard are generally effective prior to the effective date of the accounting standard, if not in the same
year as the accounting standard was issued.

27

economy. Historically, the Democratic Party prefers regulatory oversight of business, while the
Republican Party prefers market forces as discipline. Thus, a political change in the presidency
typically forecasts a change in the regulatory climate. To control for such a change, ChgtoDemt-1
and ChgtoRept-1, which equals 1 if the election in t - 1 changed the political party of the
presidency to Democratic or Republican, respectively, and 0 otherwise are included.
Ye and Simunic (2013) find that BigN auditors prefer standards to signal a high level of
quality, while non-BigN auditors prefer the flexibility of fewer standards. Differences in auditor
wealth at risk in an audit failure drive the preference for precise auditing standards. The chair of
the ASB establishes the priorities of the ASB by topic and numbers of items. To control for the
BigN chair, I include the indicator variable BigNChairt-1, which equals 1 if the chair of the ASB
was from a BigN firm in year t – 1, and is 0 otherwise.
The ASB reformed its standard setting in the early 1970s following accounting scandals
and formation of FASB. To prove its responsiveness to public and regulatory concerns, I expect
ASB to issue more standards under the new standard-setting regime. The first standard issued
under the new regime was SAS No. 1 in 1973. I include an indicator variable, SAS, which equals
1 for years 1973 and after, and is 0 otherwise.
Banking crises are extended periods of poor economic performance, often with a high
incidence of accounting scandals, including fraud (Reinhart and Rogoff 2009, 10). There is one
banking crisis in this study, 1984–1991. To control for a banking crisis, Crisis, an indicator
variable equals 1 for 1984–1991, and is 0 otherwise is included. On entering World War II,
nearly all the business capacity was converted to supporting the war effort. Managing the
contracts with the federal government, coupled with the reduced number of auditors (many
auditors became soldiers), was difficult. To control for the impact of World War II on general

28

business conditions in the U.S., WW2, an indicator variable that equals 1 for 1942–1945, and is 0
otherwise is included.26

3.3. Test of Hypothesis 2: Political Pressure and Auditing Standards Precision
The dependent variable is the number of auditing standards issued in year t, #AuditStandt.
To test this relationship and to better understand auditing standard setters’ preferences for precise
auditing standards, I re estimate equation (1), replacing #AuditStandt with #PreciseStandardt.
Following sociology standards theory (Brunsson et al. 2012), Ye and Simunic (2013)
define as precise those standards with less ambiguity about a “due diligence” level of audit
effort. Precise standards clearly or sharply state a procedure or process and are in contrast to
ambiguous standards, which may be open to more than one interpretation. Precise auditing
standards may “crowd out” auditor judgment in designing audit procedures and tests, resulting in
“check the box” audits. I draw on the auditing practitioner and financial accounting standards
literature to develop a precision measure. Douglas Carmichael (1982), AICPA vice president of
auditing, observed that auditing standards have become more precise over time. This trend was
most prominent in three areas: 1) an increase in the specificity of auditing procedures (new
compliance requirement); 2) an expansion of auditor responsibility; and 3) an increase in the
specificity of auditor reports. In the accounting literature, an analogous discussion occurs around
rules versus principles. Similarly, Mergenthaler (2009) and Donelson et al (2012) identify four
criteria to measure how rules-based an accounting standard is: 1) bright-line thresholds; 2) scope
and legacy exceptions; 3) large volumes of implementation guidance; and 4) a high level of
detail.
#PreciseStandardt incorporates measures from both Carmichael (1982) and Mergenthaler
26

Twelve auditing standards were issued in 1942–1945.

29

(2009). Each auditing standard is coded for new compliance procedures, an expansion of auditor
responsibility, or an increase in the specificity of the auditor report. Although auditing standards
do not contain the bright-line thresholds or the scope and legacy exceptions of financial
accounting standards, they may contain implementation guidance or contain a high level of
detail. The coding scheme also includes an indicator for detailed guidance. A standard is also
coded as precise if the standard’s page length is in the top decile of all auditing standards or if an
appendix or examples of procedures and reports are included. Thus, a standard is coded as
precise if it has only one of the four features (new compliance requirement, responsibility
expansion, report specificity, and length and/or appendix/examples).27 (See Appendix 3 for each
feature’s definition and example auditing standards.)

3.4. Test of Hypothesis 3: Political Pressure and the Proportion of Precise of Auditing
Standards
In Hypothesis 2, I posit that there is an association between precise auditing standards
and economic recessions. As the number of auditing standards has increased over time, in
Hypothesis 3 I also test the relationship of the proportion of precise auditing standards and
economic recessions. I therefore estimate the following model:

(2)
I use ordinary least squares (OLS) to measure the association between political pressure
and precise auditing standards because the dependent variable, PreciseStdt, is not a count
27

To test the sensitivity of the measure of precision, in Chapter 4.4.2, a standard is coded as precise if it has more
than one of the four features.

30

variable; it is the ratio of the number of precise auditing standards issued in year t scaled by the
total number of standards issued in year t,

#PreciseStandardt, is the sum of the

number of precise standards in year t, the dependent variable in Hypothesis 2. The denominator
is #AuditStandardt, the dependent variable in Hypothesis 1. I scale the number of precise
auditing standards to control for changes in the frequency of standards over time. The
independent variable of interest is Recessiont-1.

3.4.1. Control Variables
In addition to issuing proportionally more precise auditing standards in response to a
recession, auditing standard setters will issue more precise standards in response to accounting
scandals. Precise standards provide a defense against litigation by making the audit more
auditable. Thus the equation 2 includes Scandalt-1.
When third-party regulators, such as the SEC, enforce compliance with an auditing
standard, enforcement efforts against firms and their auditors alter compliance incentives and
indirectly influence the nature of the standard (Brunsson and Jacobsson 2000). Based on an
analytical model, Ye and Simunic (2013) suggest an association between auditing standards
precision and enforcement. They posit that when enforcement of standards toughens, auditors
prefer less precise standards to preserve the flexibility to match the standard with economic
reality and to minimize audit effort.28 I include AAERAUDt-1, the annual auditor enforcement
actions scaled by annual total number of AAERs issued in time t, as a proxy for enforcement
actions against auditors. Similarly, the regulatory priorities in the U.S. are broadly set by the

28

Power (1997, 28) observes that an audit provides assurance of the credibility of the financial statements subject to
the cost of the audit. Ye and Simunic (2013) posit that an auditor commits to the highest standard his wealth permits.
An investor observes the auditor’s wealth and hires an individual who matches their need for flexibility.

31

president. To proxy for a change in regulatory priorities, I include ChgtoDemt-1 and ChgtoRept-1,
which equals 1 if the election in t - 1 changed the political party of the presidency to Democratic
or Republican respectively, and 0 otherwise.
Ideology regulatory theory asserts that BigN firm representation on the ASB board may
provide insight on auditing standard precision. Ye and Simunic (2013) theorize that BigN firms
have a bias toward precise auditing standards to protect themselves from litigation and to signal
the quality of their work when the firm can influence standard enforcement. When these firms
cannot influence regulatory enforcement, they prefer less precise standards; precise standards
may result in over auditing. Since the ASB chair sets the standards agenda, I include an indicator
variable, BigNchairt-1, which equals 1 if the ASB chair in year t - 1 is from a BigN firm, and is 0
otherwise.
Although auditing standard setters develop standards in response to new accounting
standards, it is unclear what impact these standards may have on an auditing standard’s
precision. I consider that response by including AveAccStandardst, the average number of
accounting standards issued in year t + t - 1.
The ASB reformation in the early 1970s resulted in procedures designed to increase
participation in auditing standard setting. Increased participation allows for more intense political
pressure, thus the precision of standards will likely increase as well. Thus, equation 2 includes
SAS, the proxy for the more inclusive standard setting regime and Crisis and WW2. Recall, the
most auditing standards were issued during the 1980s banking crisis and World War II and it is
important to control for these unusual conditions.

32

CHAPTER 4: EMPIRICAL RESULTS
4.1. Tests of Hypothesis 1
Table 3 presents the results of the Hypothesis 1 test. Incident rate ratios (IRRs)29 are
presented for ease of discussion. I use the Newey-West correction for standard errors as the
sample is a time series and may display autocorrelation. On average, an ASB member serves 2.8
years, which rounds to a lag of three years for the Newey-West correction.30 To better
understand any effects of the 1970 era auditing standard setting reforms, the sample is split. As
posited in Hypothesis 1, ASB issues almost another standard after a recession (1.535, p = .007).
Consistent with Power’s (1997, 31) prediction that deregulation increased the sensitivity of
standard setters to political pressure, the ASB is more responsive to economic conditions after
the reformation (1.914, p > .000). This result also provides supporting evidence of the theoretical
prediction of Bertomeu and Magee (2011), who find that standard setters respond to investors’
changing demand for quality across the business cycle.
As expected, ASB issues more than twice as many auditing standards after a major
accounting scandal (2.035, p = .003) (see table 3). Given that most accounting scandals occurred
after 1972, the SAS regime, it is not surprising that ASB was more responsive with SASs (1.949,
p = .024) than SAPs (1.693, p = .024). The negative association with AAERAUDt-1 (-.278, p =
.001) provides support for the idea the ASB is a delegated regulator that is a substitute for the
SEC.
Although positive and significant (1.117, p = .002), ASB’s response to the frequency of
accounting standards issued was greater (1.524, p = .002) when issuing SAPs than when issuing

29

Similar to an odds ratio, the IRR reports the average rate of incidence and is not affected by changes in
nonconfounding variables (Cummings 2009).
30
This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of observations
(630.25 = 2.82).

33

SASs (1.078, p = .006). Recall when the ASB was issuing SAPs, accounting standard setting was
also controlled by a committee of the AICPA. The annual volume of FASB accounting standards
nearly doubled under the AICPA (mean 5.3, 2.6, respectively), making accounting standard
issuance less salient. In addition, the attenuation of the response to the accounting profession
likely reflects the expansion of constituents. ChgtoDemt-1 and ChgtoRept-1 reflect the public
opinion of regulatory enforcement priorities. A change in the political party of the presidency
suggests public dissatisfaction with the economy and signals a change in regulatory priorities.
The negative and significant association between #AuditStandt and both ChgtoDemt-1 and
ChgtoRept-1 (-0.615, p = .007 and -0.641, p = .009, respectively) likely reflects the ASB waiting
for governmental regulations to be issued as a substitute for private standard setting.31 The
positive and significant association between #AuditStandt and ChgtoDemt-1 prior to 1973 is
related to the election of President John F. Kennedy. His economic priorities included
deregulation and the reduction of taxes. As predicted by Ye and Simunic (2013), the ASB
increased the issuance of auditing standards to signal continued quality to offset the relaxation of
governmental regulations. With the revisions of the APA in 1966, administrative rulemaking
subsequently accelerated under both Democratic and Republican administrations. Consistent
with the substitution role of the ASB, the association with between #AuditStandt and a change in
the political party of the presidency turned negative after 1972. The negative and significant
coefficient on ChgtoDemt-1 (-0.452, p = .000) indicates almost two fewer auditing standard are
issued after a Democrat president is elected. The negative and significant coefficient on
ChgtoRept-1 (-0.513, p = .002) indicates one and a half fewer auditing standards are issued after a
Republican president is elected. The difference in the number of standards issued provides

31

Note if the variables ChgtoDemt-1 and ChgtoRept-1 were combined into a single variable, the response would be -1,
0 and 1. In untabled correlation tests, ChgtoDemt-1 and ChgtoRept-1 are not correlated (-0.0582, p=.6504)

34

evidence in support of each party’s historical reliance on regulation.
Although one of the goals of the 1970s reformation of the ASB was to dilute the
influence of the big auditing firms, the results indicate a greater influence after 1972, i.e., the
SAS era. Along with greater wealth at risk in the event of audit failure, the association between
#AuditStandt and BigNChairt-1 after 1972 is positive and significant (1.768, p = .001). As
suggested by the ASB reformation as a political response to the accounting scandals of the late
1960s and early 1970s and the creation of FASB, ASB issued more than twice as many auditing
standards after 1972 (2.134, p = .010) than before. The negative and significant coefficient on
Crisis (-0.675, p = .023) in the latter period suggests that political pressure was not exerted on
auditing standard setters during a banking crisis. It is likely that regulatory efforts were directed
at the financial sector. WW2 is positively associated with the #AuditStandt (2.182, p = .003).
These results provide support for Hypothesis 1 that auditing standard setters respond to
political pressures related to recessions by issuing more auditing standards. The results also
provide evidence that auditing standard setters are sensitive to public and regulatory concerns, as
well as the needs of the profession they represent. In addition, there is evidence that relative to
accountants, investors and regulators have become more important constituencies to auditing
standard setting since 1972.

4.2. Tests of Hypothesis 2
Table 4 presents the results of the Hypothesis 2 test. IRRs are presented for ease of
discussion. Consistent with Hypothesis 2 that auditing standard setters issue more precise
standards in response to recession, ASB issues almost 50% more or almost three quarters of a
precise standard after a recession (p = .069). Consistent with Power’s (1997, 31) prediction that

35

deregulation increased the sensitivity of standard setters to political pressure, the ASB is more
responsive to economic conditions after the reformation (1.751, p > .043). This result also
provides support for the theoretical prediction of Bertomeu and Magee (2011), who find that
standard setters respond to business cycle contractions.
As expected, ASB issues more precise auditing standards after a major accounting scandal
(1.643, p = .048). Although more scandals occurred in the SAS regime (after 1972), the ASB was
only responsive in the SAPs (2.262, p = .024) regime. The ASB, as the representative of the
auditing profession, likely concluded that precise auditing standards generally are unable to
provide a “safe harbor.” The preference for flexibility was more valuable than the protection
precise auditing standards could afford. The negative association of AAERAUDt-1 (-0.106, p =
.000) with #PreciseStandardt provides support for the idea the ASB trades audit precision for
regulatory enforcement actions, as predicted by Ye and Simunic (2013).
Although positive and significant (1.056, p = .055), ASB’s response to the frequency of
accounting standards issuance (1.362, p = .002) is similar to the response to scandals, reflecting a
change in the constituencies. When the ASB was issuing SAPs, accounting standard setting was
also controlled by a committee of the AICPA, reflecting a greater coordination between
accountants and auditors. The coefficient (-0.407, p = .053) on ChgtoDemt-1 is only significant
after the reformation of the 1970s. This is consistent with the reliance of the Democratic Party on
administrative regulation and thus the expectation by ASB of forthcoming regulatory efforts.
Similar to the association of BigNChairt-1 and #AuditStandt, the #PreciseStandardt issued in the
SAS era (2.097, p = .000) is more than twice the SAP era, which provides evidence in support of
Ye and Simunic’s (2013) and DeAngelo’s (1981) predictions.
As the ASB reformation was a political response to the creation of FASB, it is not

36

surprising that more than three times as many precise standards are issued as SASs (3.605, p =
.000). The lack of significance on the Crisis coefficient suggests ASB does not consider that
precise standards provide protection against litigation. WW2 is negatively associated with the
#PreciseStandardt (-0.516, p = .071), likely reflecting the speed with which those standards were
adopted.
These results provide limited support for Hypothesis 2 that precise auditing standards are
associated with the business cycle. There is evidence that the ASB has modified its view as to the
value of precise auditing standards, based on changing constituencies. BigN firms and the
expanded constituencies included as a result of the 1970 reformation support the idea that
auditing standards are influenced by political considerations. In addition, the idea that standard
setters respond to regulation enforcement by issuing less precise standards is supported.

4.3. Tests of Hypothesis 3
Table 5 presents the results of the multivariate analysis of equation (2), testing
Hypothesis 3. To test the relationship between precise auditing standards and economic
recession, I use OLS regression. Similar to the tests of Hypotheses 1 and 2, I use the NeweyWest correction for standard errors with a three-year lag.
Recessiont-1, the variable of interest, is negative and not significant at conventional levels
(-0.165, p = .154). Auditing standard setters are more concerned about preserving auditors’
flexibility to decide audit level procedures than minimizing litigation risk in response to
economic recessions. Similarly, the precision of an auditing standard is not associated with
Scandalt-1 (-0.007, p = .477). As predicted by Ye and Simunic (2013), as regulatory toughness
increases (AAERAUDt-1), the auditing standards become less precise (-0.493, p = .006).

37

Interestingly, although fewer auditing standards are issued in response to ChgtoRept-1
(Hypothesis 1), ChgtoRept-1 is significant and positive (0.354, p = .005). The change to a
Republican president results in fewer but more precise auditing standards. Ye and Simunic
(2013) predict that when regulatory enforcement is less tough, to signal high audit quality,
standard setters may issue more precise standards. As Republicans favor market-based solutions
to regulation, it is not surprising the private ASB responds to the change in regulatory priorities
by a signal of audit quality, issuing more precise auditing standards. As the ASB was reformed in
the 1970s to increase participation in the auditing standard setting, the positive and significant
coefficient on SAS (0.317, p = .002) is expected. The negative and significant coefficient on
WW2 (-0.321, p = .001) is surprising given the large issuance of government contracts during
WWII. However, less precise standards may be related to the need for prompt guidance.
Sociological theorists (Brunsson et al. 2012) and Ye and Simunic (2013) predict that it takes
longer to adopt precise standards as there are more potential areas of disagreement. Taken
together, the results do not provide support for Hypothesis 3, although there is evidence
supporting the trade-off of auditing standard precision and regulatory enforcement.

4.4. Robustness and Supplemental Analysis
4.4.1. Hypothesis 1
To test the sensitivity of the Hypothesis 1 results to the measure of recession, in Table 6 I
re-estimate the Model (1) and replace Recessiont-1 with Recessiont. Recessiont is significant but
negative (-0.580, p = .003) and suggests the ASB is not able to respond contemporaneously to
recessions. I also re-estimate Model (1) and replace Recessiont-1 with Contractiont-1 and
BizCyclet-1. Constant dollar GDP in 2005 is the basis used to measure Contractiont-1. To control

38

for general growth in the economy, I extract the business cycle portion of GDP from nominal
GDP by applying an ideal band pass filter (Christiano and Fitzgerald 2003), an enhancement on
the band pass method of Baxter and King (1999). Band pass filters are designed to separate time
series growth from other variations. In calculating the business cycle component, the filter uses a
moving average that is similar to NBER researchers’ definition of the business cycle, which is 6
to 32 quarters (Baxter and King 1999). Figure 6 shows GDP and the related business cycle
component. While there is some variation in the nominal GDP, the overall growth over time
makes it difficult to observe. Contractiont-1 equals 1 if the business cycle portion of GDP (i.e.,
the de-trended GDP) declined from the prior year, and is 0 otherwise. BizCyclet-1 is a continuous
measure of the business cycle component of 2005 constant dollar GDP.

250
200
150
100
50
0
-50
-100
-150
-200

14,000
12,000
10,000
8,000
6,000
4,000
2,000
0

Business Cycle

GDP

2005 constant dollars (billions)

2005 constant dollars (billions)

Figure 8
GDP and the Business Cycle

Linear (GDP)

The y-axis is reported in 2005 constant dollars (billions) and reflects the economic cycle component of GDP. The zaxis is reported in 2005 constant dollars (billions) and reflects nominal GDP. The business cycle is calculated using
the ideal band pass filter (Christiano and Fitzgerald 2003) STATA command cfitzrw. Note the variation in the
business cycle appears larger than nominal GDP due to the differing presentation scales.

The significant and positive coefficient on Contractiont-1 (1.383, p = .022) supports
Hypothesis 1. Although economically small, the negative association between the number of
audit standards issued and BizCyclet-1 (-0.997, p = .008) provides support for the sensitivity of
39

standard setters to the business cycle in general. Hypothesis 1 provides evidence of standard
setters responding to political pressure generated from economic variations.

4.4.2. Hypothesis 2
In Table 7 I again re-estimate Model (1) and replace Recessiont-1 with Recessiont,
Contractiont-1, and BizCyclet-1, to test the sensitivity of Hypothesis 2 results to the measure of
recession. Recessiont is insignificant while the other variables are qualitatively similar. The
significant and positive coefficient on Contractiont-1 (1.600, p = .015) provides support for
Hypothesis 2. Although economically small, the negative association between the number of
audit standards issued and BizCyclet-1 (-0.997, p = .016) provides support for the sensitivity of
standard setters to the business cycle in general. Hypothesis 2 provides evidence of standard
setters responding to political pressure generated from economic variations.
To test the sensitivity of Hypothesis 2 results to the measure of precision,
#PreciseStandardt, in Table 8 I require two or more precise features for a standard to be coded as
precise. Thus a precise standard will have at least two of the following features: new compliance
requirement, responsibility expansion, report specificity, and length and/or appendix/examples.
Although Recessiont-1 and Scandalt-1 are no longer significant (p=.327 and p=.430, respectively)
and Recessiont-1 becomes negative, the IRR for SAS (to 6.144, p=.000) and Crisis (2.253,
p=.063) nearly double. Interestingly, the ChgtoDemt-1 (-0.350, p=.031) and ChgtoRept-1(2.709,
p=.089) IRRs become stronger and significant. While AAERAUDt-1 remains significant and
negative, the IRR becomes nearly zero. Taken together, these results support the idea that the
ASB is sensitive to the regulatory environment, trading flexibility in auditing standards for
protection from litigation.

40

4.4.3. Hypothesis 3
I re-estimate the model using Recessiont, Contractiont-1, and BizCyclet-1to test the
sensitivity of Hypothesis 3 results to the recession proxy (see Table 9). Supporting my primary
results, the coefficients on Recessiont and Contractiont-1 are insignificant (-0.014, p = .897 and 0.114, p = .123, respectively). Although economically insignificant, the negative and significant
coefficient on BizCyclet-1 (-0.001, p = .047) provides support for Hypothesis 3. Thus when
controlling for the number of auditing standards issued, standard setters do not issue more
precise standards.

4.4. Summary
Taken together, the results of the determinants of auditing standards and standard
precision suggest the ASB responds to stakeholder concerns, both those of the public and the
profession, especially during economically risky periods. Although more precise standards are
issued, after controlling for the number of standards issued, standard setters demonstrate a
preference for flexibility in standards, rather than the safe harbor precise standards may afford. In
addition, in response to regulatory changes, less precise standards are also consistent with the
preference for flexibility. The evidence supports the idea that auditing standard setters respond to
regulatory enforcement actions by issuing fewer precise standards the year after the enforcement
action.

41

CHAPTER 5: CONCLUSION
This study is one of the first archival studies to examine of the determinants of private
auditing standard setting, the period from 1939 - 2002. The results provide evidence that private
auditing standard setters are responsive to political pressures exerted when investors are most at
risk of loss (i.e., during economic contractions). The evidence also supports the Bertomeu and
Magee (2011) model of a (delegated) regulatory response to changing economic conditions.
After controlling for the number of auditing standards issued, ASB prefers standard setting
flexibility to safe harbor precision to match investors’ preferences. In addition, I find limited
evidence to support the work of Ye and Simunic (2013), who suggest that auditing standard
setters trade precision with regulatory enforcement toughness in the creation of auditing
standards.
This study provides early descriptive evidence of economic cycles and enforcement
activities to explain auditing standard adoption. Enforcement activities are another way in which
auditing standards are created and are a limitation of this study. However, the results may not be
predictive of future determinants or properties as public company auditing standard setting is no
longer determined by the self-regulated ASB. Researchers may wish to consider the implications
of auditing standard precision and enforcement activities on auditing quality in future research.

42

APPENDICES

43

Appendix 1: List of Acronyms

44

Acronym
AIA

Definition
American Institute of Accountants

AICPA

American Institute of Certified Public Accountants

AAER

Accounting and Auditing Enforcement Releases

APA

Administrative Procedures Act

APB

Accounting Principles Board

ASB

Auditing Standards Board

AudSEC

Auditing Standards Executive Committee

CAP

Committee on Auditing Procedures

CPA

Certified Public Accountant

FASB

Financial Accounting Standards Board

GAAS

Generally Accepted Auditing Standards

NBER

National Bureau of Economic Research

PCAOB

Public Company Oversight Board

SAP

Statement of Auditing Procedure

SAS

Statement of Auditing Standards

SEC

Securities and Exchange Commission

45

Appendix 2: Variable Definitions

46

Variable
#AuditStandard

Definition
The number of auditing standards issued in year t.

#PreciseStandard

The number of precise auditing standards issued in year t.

PreciseStd

The number of precise auditing standards scaled by total
auditing standards,
.

Recession

An indicator variable that equals 1 if six months or more of
the year was in recession, 0 otherwise.

Contraction

An indicator variable that equals 1 if the business cycle
component of 2005 constant dollar GDP declined from the
prior year, and is 0 otherwise.

BizCycle

The business cycle component of 2005 constant dollar
GDP.

Scandal

An indicator variable that equals 1 if a major accounting
scandal as identified in Table 2, and is 0 otherwise.

AAERAUD

The number of annual auditor AAERs scaled by the annual
total AAERs issued in year t.

#AveAccStandards

The average number of accounting standards issued in the
current and prior year ((t + t + 1)/2)).

ChgtoDem

An indicator variable that equals 1 if the party of the
president changed to the Democratic Party in year t – 1,
and is 0 otherwise.

ChgtoRep

An indicator variable that equals 1 if the party of the
president changed to the Republican Party in year t – 1, and
is 0 otherwise.

SAS

An indicator variable that equals 1 for the years 1973 and
after, and is 0 otherwise.
An indicator variable that equals 1 for 1984 – 1991, and is
0 otherwise.

Crisis

WW2

An indicator variable that equals 1 for 1942 – 1945, and is
0 otherwise.

BigNchair

An indicator variable that equals 1 if the ASB chair was
from a BigN firm, and is 0 otherwise.

47

Appendix 3: Precise Features and Example Auditing Standards

48

New Compliance Requirement: Auditing procedures are frequently in use prior to being
included in an auditing standard. Often these procedures are best practices that are not yet
codified. To be coded as a new compliance requirement, the auditing standard identifies the
procedure as a new requirement. For example, in SAS No. 85, Management Representations:

Responsibility Expansion: “Pronouncements based on obligation of the independent auditor
rather than on what might be necessary to form an opinion on the financial statements.”
(Carmichael 1982). For example, SAS No. 20, Required Communication of Material
Weaknesses in Internal Accounting Control.

Report Specificity: Standards that specifically modify or supersede the auditor’s report. For
example, in SAS No. 72, Letters for Underwriters and Certain Other Requesting Parties:

Length and/or Appendix/Examples: The standards are sorted according by page length,
longest to shortest. Those standards in the top decile of pages are coded as precise. In addition,
any standard that has an appendix or examples are also coded as precise.

49

Appendix 4: Tables

50

Mean

Table 1
Descriptive Statistics
25%
Median

75%

Range

ASB
Membership
19
Term (years)
2.8
Standards per
7.5
member
BigNchair
81.8%
Term as chair (years)
2.1
Standards per year
3.3
Standards per chair
7.1
Precise Standards per
3.9
chair
Non-BigNchair
18.2%
Term as chair (years)
2.25
Standards per year
3.8
Standards per chair
10
Precise Standards per
3.9
chair
#AuditStandardt per year
Total
2.5
SAP
1.7
SAS
3.3
#pages per standard
Total
16.6
SAP
11.3
SAS
18.4
#AccStandardst per year
Total
3.7
APB
2.6
FASB
5.3
#PreciseStandardt per year
Total
1.5
SAP
.76
SAS
2.3
BigNchair
1.92
Non-BigNchair
2.55

18
3
6

11-25
1-9
1-29

1
1.5
3
1

2.0
3.3
5.5
2

3
4.7
12
7

1-5
1-7
1-20
1-10

1
1.5
7
2

2.5
4.1
10.5
5

3
4.7
14
8

1-3
1-7
1-18
1-12

1
1
2

2
1
3

3.5
2
5

0-10
0-8
0-10

6
4
7

10
7
11

16
11
20

2-220
2-83
2-220

2
1
3

3
2
4

4
4
6

0-18
0-7
2-18

0
0
1
1
2

1
1
2
2.5
5

2
1
3
7
10

0-8
0-4
0-8
1-10
1-12

51

Mean
PreciseStd per year
Total
CAP
SAS
AAERs per year
Total
Auditor
Auditor/Total

Table 1 (cont’d)
25%
Median

75%

Range

50.1%
37.6
64.4

0
0
42.9

50
18.8
72.5

100
57.1
100

0-100%
0-100
0-100

79.4
15.3
29.7%

36
11
15

76
15
22.2

120
20
30

2-213
2-30
9-100%

52

Table 2
Accounting Scandals
Year
1938

Scandal
McKesson & Robbins

1964

Allied Crude Vegetable Oil Refining Corporation

1966

Yale Express

1969

Continental Vending

1970

National Student Marketing

1973

Equity Funding

1985

ESM Government Securities

1987

ZZZZ Best

1989

Lincoln Savings & Loan

1998

Waste Management

2001

Enron

2002

WorldCom

Although other major scandals may have occurred in a given year, I am interested in the existence or absence of
major accounting scandals in year t of which this listing is representative. (AICPA 1978; Zeff 2003a; 2003b;
Clikeman 2009).

53

Table 3
Poisson Regression of Frequency of Auditing Standards

Recessiont-1
Scandalt-1
AAERAUDt-1
#AveAccStandardst
ChgtoDemt-1
ChgtoRept-1
BigNChairt-1
SAS
Crisis
WW2
Number of Observations
Model
Prob > 2
Pseudo R2
Goodness of fit 2
Prob > 2

# of Total
Auditing
Standards
1.535
2.035
-0.282
1.117
-0.586
-0.597
1.285
2.183
-0.792
2.182

# of SAP
Auditing
Standards
(1939 – 1972)
z-value
1.645
1.60 *
1.693
1.98 **

z-value
2.45 ***
2.81 ***
-3.05 ***
2.91 ***
-2.44 ***
-2.37 ***
1.26
2.34 **
-0.91
2.78 ***

1.524
1.832
1.404
-0.670

2.93 ***
2.46 ***
1.01
-0.76

# of SAS
Auditing
Standards
(1973 – 2002) z-value
1.914
5.48 ***
1.949
2.20 **
-0.294 -2.71 ***
1.078
2.50 *
-0.452 -6.20 ***
-0.513 -2.93 ***
1.768
3.45 ***
-0.675

1.487

63
51.28
0.000
0.188
74.18
(52)
0.023

33
31.10
0.000
0.252
29.05
(25)
0.262

-2.01 **

0.86
30
22.15
0.005
0.169
25.27
(21)
0.234

See Appendix 1 for variable definitions. *, **, *** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively. The results are
the incident rate ratios. I use the Newey-West adjustment to account for heteroscedasticity and serial correlation. As the mean length of ASB membership is 2.8
years, which rounds to a lag of three years. This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of observations (630.25 =
2.82). The Pearson goodness-of-fit test indicates that p-values greater than .1000 are a better fit.

54

Recessiont-1
Scandalt-1
AAERAUDt-1
#AveAccStandardst
ChgtoDemt-1
ChgtoRept-1
BigNChairt-1
SAS
Crisis
WW2
Number of Observations
Model
Prob > 2
Pseudo R2
Goodness of fit 2
Prob > 2

Table 4
Poisson Regression of Frequency of Precise Auditing Standards
# of SAP
# of SAS
# of Precise
Auditing
Auditing
Auditing
Standards
Standards
Standards
z-value
(1939 – 1972)
z-value
(1973 – 2002) z-value
1.491
1.49 *
1.153
0.28
1.751
1.72 **
1.643
1.67 **
2.262
1.75 **
1.307
0.98
-0.106
-3.27 ***
-0.094 -3.31 ***
1.056
1.60 *
1.362
1.55 *
1.025
0.94
-0.595
-1.13
2.733
2.45 ***
-0.407 -1.62 *
1.026
0.07
1.659
1.39 *
1.015
0.03
1.661
2.06 **
-0.765
-0.38
2.097
2.96 ***
3.605
3.61 ***
1.203
0.82
1.178
0.77
-0.649
-1.20
-0.516
-1.47 *
63
45.89
.000
.206
69.68
(52)
.051

33
9.37
.227
.120
30.51
(25)
.206

30
19.89
.011
.168
29.10
(21)
.112

See Appendix 1 for variable definitions. *, **, *** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively. The results are
the incident rate ratios. I use the Newey-West adjustment to account for heteroscedasticity and serial correlation. As the mean length of ASB membership is 2.8
years, which rounds to a lag of three years. This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of observations (630.25 =
2.82). The Pearson goodness-of-fit test indicates that p-values greater than .1000 are a better fit.

55

Table 5
OLS Regression of Proportion of Precise Auditing
Standards
Predicted Sign
Coefficient
t-stat.
Recessiont-1

?

-.165

-1.45

Scandalt-1

+

-.007

-0.06

AAERAUDt-1

-

-.493

-2.61 ***

ChgtoDemt-1

?

.069

0.20

ChgtoRept-1

?

.354

2.70 ***

BigNchairt-1

-

.140

0.98

#AveAccStandardst

+

.005

0.24

SAS

+

.317

3.02 ***

Crisis

-

.084

0.42

WW2

+

-.321

Constant

.278

-3.57 **
1.57

63

Number of observations

9.94

F(10, 53)
Prob > F

.0000

Adjusted R2

.0762

The dependent variable, PreciseStdt, is the ratio of the number of precise auditing standards issued in year t scaled
by the total number of standards issued in year t,
See Appendix 1 for variable definitions. *, **,
*** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively, where a
prediction is presented, otherwise reflects a two-tailed test. Tests are two-tailed unless a predicted sign. The NeweyWest adjustment accounts for heteroscedasticity and serial correlation. As the mean length of ASB membership is
2.8 years, I round to a lag of three years and is consistent with Greene (2012, 920) where the lag equals T0.25 and T is
the number of observations.

56

Recessiont
Contractiont-1
BizCyclet-1
Scandalt-1
AAERAUDt-1
#AveAccStandardst
ChgtoDemt-1
ChgtoRept-1
BigNChairt-1
SAS
Crisis
WW2
Number of Observations
Model
Prob > 2
Pseudo R2
Goodness of fit 2
Prob > 2 (52)

# of Total
Auditing
Standards
-.580

1.980
-.207
1.154
-.523
-.845
1.039
2.039
-.840
1.971

Table 6
Poisson Regression of Frequency of Auditing Standards
Supplementary Analysis – Business Cycle Proxies
# of Total
# of Total
Auditing
Auditing
z-value
Standards
z-value
Standards
-2.83 ***
1.383
2.02 **
-.997
2.52 ***
1.878
2.47 ***
1.887
-3.39 ***
-.278
-3.39 ***
-.186
3.73 ***
1.124
3.34 ***
1.117
-3.32 ***
-.613
-2.61 ***
-.513
-0.67
-.767
-1.09
-.833
0.19
1.084
0.35
1.054
2.41 ***
2.204
2.52 ***
2.331
-0.57
-.821
-0.74
-.913
2.74 ***
2.428
3.10 ***
2.051

63
53.05
.000
.195
72.41
.032

63
51.21
.000
.188
74.25
0.023

z-value

-2.42
2.55
-3.84
3.45
-3.73
-0.75
0.25
3.29
-0.33
3.22

***
***
***
***
***

***
***

63
57.04
.000
.209
68.42
.063

See Appendix 1 for variable definitions. *, **, *** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively. The reported
results are the incident rate ratios. I use the Newey-West adjustment to account for heteroscedasticity and serial correlation. As the mean length of ASB
membership is 2.8 years, which rounds to a lag of three years. This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of
observations (630.25 = 2.82). The Pearson goodness-of-fit test indicates that p-values greater than .1000 are a better fit.

57

Recessiont
Contractiont-1
BizCyclet-1
Scandalt-1
AAERAUDt-1
#AveAccStandardst
ChgtoDemt-1
ChgtoRept-1
BigNChairt-1
SAS
Crisis
WW2
Number of Observations
Model
Prob > 2
Pseudo R2
Goodness of fit 2
Prob > 2 (52)

# of Total
Precise
Auditing
Standards
-.743

1.569
-.084
1.073
-.543
1.419
1.429
3.498
1.291
-.601

Table 7
Poisson Regression of Frequency of Precise Auditing Standards
Supplementary Analysis – Business Cycle Proxies
# of Total
# of Total
Precise
Precise
Auditing
Auditing
z-value
Standards
z-value
Standards
-1.15
1.600
2.18 **
-.997
1.45 *
1.453
1.37 *
1.515
-3.55 ***
-.107
-3.97 ***
-.082
1.75 **
1.061
1.79 **
1.058
-1.43 *
-.664
-.096
-.528
1.23
1.313
1.16
1.414
1.12
1.337
1.05
1.340
3.56 ***
3.729
3.99 ***
3.690
1.04
1.257
1.06
1.369
-1.51 *
-.802
-0.56
-.620

63
44.93
.000
.202
70.65
.044

63
48.51
.000
.218
67.07
0.078

z-value

-2.16
1.42
-4.36
1.47
-1.68
1.21
0.94
4.21
1.20
-1.68

**
*
***
*
**

***
**

63
49.05
.000
.220
66.53
.085

See Appendix 1 for variable definitions. *, **, *** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively. The results are
the incident rate ratios. I use the Newey-West adjustment to account for heteroscedasticity and serial correlation. As the mean length of ASB membership is 2.8
years, I round to a lag of three years. This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of observations (630.25 = 2.82).
The Pearson goodness-of-fit test indicates that p-values greater than .1000 are a better fit.

58

Recessiont-1
Scandalt-1
AAERAUDt-1
#AveAccStandardst
ChgtoDemt-1
ChgtoRept-1
BigNChairt-1
SAS
Crisis
WW2
Number of Observations
Model
Prob > 2
Pseudo R2
Goodness of fit 2
Prob > 2

Table 8
Poisson Regression of Frequency of Precise Auditing Standards
Supplementary Analysis – Precise Features
# of SAP
# of SAS
# of Precise
Auditing
Auditing
Auditing
Standards
Standards
Standards
z-value
(1939 – 1972)
z-value
(1973 – 2002) z-value
-0.775
-0.45
-0.614
-0.67
1.137
0.15
1.067
0.18
1.041
0.06
1.123
0.28
-0.013
-2.02 **
-0.016 -1.71 **
-0.924
-1.33 *
1.180
0.67
-0.918 -1.20
-0.350
-1.88 **
-0.000
-11.10 ***
-0.377 -1.81 **
2.709
1.35 *
6.554
4.71 ***
1.183
0.12
1.436
0.82
-0.497
-1.37 *
1.869
1.28
6.144
3.34 ***
2.253
1.95 **
1.830
1.21
-0.000
-16.45 ***
-0.000
-20.88 ***
63
29.53
.001
.186
66.45
(52)
.086

33
9.88
.196
.202
19.84
(25)
.755

30
10.87
.209
.118
40.89
(21)
.006

See Appendix 1 for variable definitions. *, **, *** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively. The results are
the incident rate ratios. I use the Newey-West adjustment to account for heteroscedasticity and serial correlation. As the mean length of ASB membership is 2.8
years, I round to a lag of three years. This lag is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the number of observations (630.25 = 2.82).
The Pearson goodness-of-fit test indicates that p-values greater than .1000 are a better fit.

59

Table 9
OLS Regression of Proportion of Precise Auditing Standards
Supplementary Analysis
Predicted Coefficient
Coefficient
Coefficient
Sign
(t-stat.)
(t-stat.)
(t-stat.)
Recessiont
?
-.014
(-0.13)
Contractiont-1
?
-.114
(-1.18)
BizCyclet-1
?
-.001 **
(-2.01)
Scandalt-1
+
.028
.044
.019
(0.23)
(0.36)
(0.15)
AAERAUDt-1
-.537 ***
-.496
-683 ***
(-2.65)
(-2.67)
(-434)
ChgtoDemt-1
?
.089
.074
.067
(0.26)
(0.20)
(0.20)
ChgtoRept-1
?
.259 **
.250 *
.276 **
(2.24)
(1.85)
(2.39)
.166
.202 *
.135
BigNchairt-1
(1.21)
(1.47)
(1.04)
+
.003
.005
-.005
#AveAccStandardst
(0.14)
(0.24)
(-0.26)
+
.335 ***
.311 ***
.385 ***
SAS
(3.39)
(2.87)
(3.48)
Crisis
.085
.063
.131
(0.47)
(0.34)
(0.77)
WW2
+
-.289 ***
-.358 ***
-.257 ***
(-3.35)
(-3.20)
-(3.01)
Constant
.231
.253
.278 *
(1.38)
(1.43)
(1.75)
Number of observations
63
63
63
F(10, 52)
9.11
9.11
16.68
Prob > F
.000
.000
.000
2
Adjusted R
.0547
.073
.0865
The dependent variable, PreciseStdt, is the ratio of the number of precise auditing standards issued in year t scaled
by the total number of standards issued in year t,
See Appendix 1 for variable definitions. *, **,
*** indicates statistical significance for a one-tail test at the 0.10, 0.05, or 0.01 level, respectively where a prediction
is presented, otherwise reflects a two-tailed test. Tests are two-tailed unless a predicted sign. The Newey-West
adjustment accounts for heteroscedasticity and serial correlation. As the mean length of ASB membership is 2.8
years, I round to a lag of three years and is consistent with Greene (2012, 920) where the lag equals T0.25 and T is the
number of observations.

60

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61

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