From Observation to Research Success

Auditing Section Doctoral Consortium

Los Angeles, CaliforniaJanuary 12, 2006

William R. Kinney, Jr. University of Texas at Austin

Outline

• Overview of process

• X, Y, V, and Z - a framework for planning

• The scholarly researcher’s problem

• Threats to research validity

• Other barriers and special problems

1. Process overview

Suppose that you have an observation (bad “facts” or peculiar “facts” or claims)

• What barriers must be overcome? (data/ estimation/ causal theories; research design; exposition)

• Who will want to read the paper?

• What is your comparative advantage?

1. Process overview

Hint: “One gets the biggest potatoes on the first pass through the field” (Irish agricultural economics principle per Frank O’Connor, University of Iowa)

Suppose that you have an observation (bad “facts” or peculiar “facts” or claims)

• What barriers must be overcome? (data/ estimation/ causal theories; research design; exposition)

• Who will want to read the paper?

• What is your comparative advantage?

The Sarbanes-Oxley Act . . .

• Result of 25 year economic, technological, social, and professional/regulatory changes

• Challenges– Relevance of GAAP– Reliability of auditing standards– Trustworthiness of auditors, independent directors,

standards setters, financial intermediaries and employ-ment contracts that bind them

• Mandates a new (3rd) role for accounting

. . . this is a big new potato -- new states, new actions need new theories to explain/understand

Y = f ( X, Vs, Zs )

Y = phenomenon to be explained

X = your (new) theory about a cause of Y

Vs = prior causes of Y

Zs = contemporaneous causes of Y

2. A Framework

How does X (treatment) get there? Experiments vs. Archival studies

{V-3, V -2, V -1 } Y1

X0

Z0

?

Random assignment or independent of V vs. Self selection or V(s) determine X

3. Scholarly Researcher’s Problem:

= risk that data incorrectly “accepts” new theory = risk that data incorrectly “rejects” new theory = true size of X effect on Y

= residual variation given research design (i.e., after effects of Vs and Zs)

n = available sample size

All five are related through a single, simple formula

The Sample Size formula:

(Z + Z) .

n = ( )

2

Researcher’s Problem (continued)

is fixed at .05 or .10 by journal editors

is the researcher’s risk of failing (you want to minimize ) = f ( X : Y relation) = f ( Vs, Zs)

n is semi-fixed by data availability or cost

= f ( n ) - - + -

**

Graphically . . . (small , small okay)

_Y| H0, n,

_Y| HA, n,

0

Accept H0 Reject H0

Y

Graphically . . . (large , large okay)

_Y| H0, n,

0Y

Accept H0 Reject H0

_Y| HA, n,

Graphically . . . (small , large

yikes!)

_Y| H0, n,

0 Y

Accept H0 Reject H0

_Y| HA, n,

4. Analyze Threats to Validity using Predictive Validity (Libby) Boxes

5

Control Other potentially influential variables Vs and Zs

4

2 3

Operational X

Operational Y

Operational

Theoretical X (X )

Theoretical Y (Y)

Conceptual1

Independent Dependent

It is believable that X causes Y if:

• X and Y are correlated• Vs and Zs ruled out by design, including

– Y causes X– X and Y caused by an omitted V or Z

• Reason to believe that operational X and Y measure X and Y

• Reason to believe that X : Y relation generalizes to other persons, times, and settings.

Validity threats linked to Libby boxes (and Vs and Zs)

• Statistical Conclusion Validity (5)

• Internal Validity (4)

• Construct Validity (2 and 3)

• External Validity ( 1 generalizes to ??)

Auditor independence and non-audit services: Was the U.S. government right?

(Kinney, Palmrose, Scholz, JAR 2004)

Does an audit firm’s dependence on fees for FISDI, internal audit, and certain other services to an audit client reduce financial reporting quality?

The answer is important because a) the Sarbanes-Oxley Act presumes so, banning such services to audit clients, and b) some registrants now voluntarily restrict tax and other legally permitted services.

Using fee data from 1995-2000 for restating and similar non-restating registrants, we find no consistent association between fees for FISDI or internal audit services with restatements, but find significant positive association between unspecified services fees and restatements and significant negative association between tax services and restatements.

Libby boxes for KPS

Lower quality financial reporting

Auditor dependence on client

1

Non-audit fees Restatement

2 3

5

Industry, size, audit policies, acquisitions, etc.

4

Conceptual

Operational

Control

Independent Dependent

Your main contribution is:

1. New data

2. New estimation

3. New theory (or new problem)

5. Other barriers and problemsHint one:

Whatever it is, Exploit it!

Broaden your contribution (and reader interest) by:

1. Making your theory elaborate

2. Using multi-methods and multi-measures

3. Generalizing your approach across contexts, disciplines, cultures, and time

Hint Two:

In introducing your paper, tell the reader:

1. What problem or issue will be addressed

2. Why the problem or issue is important

3. How you will address the problem or issue (and what you found)

Hint Three:

Order of importance of clear and compelling exposition

TitleAbstract

IntroductionConclusions

. . . rest of text

Research using Analysis

• Need models for: – value of process vs. state reliability– role of subjective “fair presentation” – reporting and auditing “second moments”– economics of auditing as a regulated activity– auditing in context of corporate governance– rules-based vs. risk-based auditing

standards• Barrier: extra parties and institutions hard to

model

Research using Experiments

• Questions: – How reliable is auditing of fair values?– Does SAB No. 99 work (Nelson et al. 2003)? – Will IAASB ED on accounting estimates work?– Does SAS No. 99 work?– Does ERM (COSO II) improve COSO?

• Barrier: How to convince regulated audit firms that your experiments are valuable to them – what’s in it for them now?

Research using Archival data

• What are the effects of – fee disclosures on profits and performance?– PCAOB as standards setter and regulator

(similar to evaluating the FASB and SEC)?– SOX on innovation in auditing and

standardized business measurement?– SOX provisions on attracting new CPAs?

• Barrier - How to work with PCAOB and regulated audit firms as independent researchers – why should they help you?

Remember . . .• Plan for research success

– write the three paragraphs before you do the work

– minimize ex ante

– maximize validity ex ante

• Make your unique contribution apparent to all• Your present model of the world is simplified – be

alert to revision via new problems, theories, data, and methods (read, take courses, attend seminars in potentially related areas for new theories, monitor data sources, scan for useful research tools)

References• Cook, and D. Campbell, Quasi-experimentation

design & analysis issues for field settings. Houghton Mifflin Co. (New York) 1971 (Validity types).

• Kinney, W., "Empirical Accounting Research Design for Ph.D. Students," The Accounting Review, April 1986 (3 paragraphs and integration).

• Libby, R., Accounting and human information processing: Theory and applications. Prentice-Hall, Inc., (Englewood Cliffs) 1981 (Boxes).

• Runkel, P., and J. McGrath, Research on human behavior – A systematic guide to method. Holt, Rinehart, and Winston, Inc., (New York) 1972 (Boxes).

• Simon, J., and P. Burstein, Basic Research Methods in Social Science (3rd ed.). Random House, (New York) 1985 (Chapter 3 – X, Y, Vs, Zs).