Accounting Research Journal

Emerald Article: Auditor appointment in compulsory audit tendering Kym Butcher, Graeme Harrison, Jill McKinnon, Philip Ross

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To cite this document: Kym Butcher, Graeme Harrison, Jill McKinnon, Philip Ross, (2011),"Auditor appointment in compulsory audit tendering", Accounting Research Journal, Vol. 24 Iss: 2 pp. 104 - 149 Permanent link to this document: http://dx.doi.org/10.1108/10309611111163682 Downloaded on: 27-09-2012 References: This document contains references to 62 other documents Citations: This document has been cited by 1 other documents To copy this document: permissions@emeraldinsight.com This document has been downloaded 825 times since 2011. *

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ARJ 24,2

Auditor appointment in compulsory audit tendering

Kym Butcher
School of Accounting, University of Western Sydney, Sydney, Australia

104

Graeme Harrison and Jill McKinnon

Department of Accounting and Finance, Macquarie University, Sydney, Australia, and

Philip Ross
School of Accounting, University of Western Sydney, Sydney, Australia
Abstract
Purpose The purpose of this paper is to examine what auditor and audit environmental attributes affect auditor appointment decisions in compulsory audit tendering, and whether the attributes affecting appointment of a new auditor (rotation) are consistent with or different from those affecting reappointment of the incumbent (retention). Design/methodology/approach New South Wales (NSW) local council nance managers were surveyed for importance ratings of 48 attributes. An hypothesis for differential ratings between rotators and retainers was formulated. Conrmatory factor analysis, tests of mean differences and logistic regression were used. Findings Consistent with the samples high retention rate, the most important attributes for all respondents related to the quality of previous experience with the incumbent. Consistent with hypothesis, attributes proxying for a quality auditor (technical competence, independence and reputation) were more important for rotators. Research limitations/implications The authors proxied rotation/retention by intention. Given the importance of audit quality attributes in the appointment decision and the high retention rate in compulsory audit tendering, future research could examine the relation between audit service quality attributes and retention. Originality/value This is the rst study to examine attributes affecting auditor appointment decisions in a mandatory choice setting. NSW local councils provide a unique opportunity to do so as it is one of few jurisdictions in which compulsory audit tendering operates. Compulsory tendering may be implemented if current legislation aimed at improving audit independence and quality through mandatory partner rotation proves infeasible. Keywords Australia, Compulsory audit tendering, Auditor appointment, Auditor choice, Auditor rotation, Auditor retention, Local government audit, Auditors Paper type Research paper

Accounting Research Journal Vol. 24 No. 2, 2011 pp. 104-149 q Emerald Group Publishing Limited 1030-9616 DOI 10.1108/10309611111163682

Associate Professor Jill McKinnon died in June 2008. Her co-authors acknowledge her invaluable contribution to this paper and the research leading thereto. The authors also acknowledge the helpful comments of Neil Fargher, Russell Craig, Renee Radich, Ken Trotman, Lawrence Abbott, David Hay, Alicia Jiang and two anonymous reviewers. The authors are grateful for the support of this research by the NSW Division of Local Government, Department of Premier and Cabinet, the Local Government Managers Australia NSW, Local Government Finance Professionals, the Local Government Internal Audit Network NSW and the Chief Financial Ofcers/Finance Managers of NSW local councils.

1. Introduction Compulsory audit tendering was introduced to local government in the Australian state of New South Wales (NSW) through The Local Government Act in 1993 (NSW Government, 1993) as the means of external auditor procurement for local councils. The Act mandates that NSW local councils call open tenders for audit services every six years for the following (guaranteed) six-year tenure period, with the incumbent auditor eligible to reapply. Councils are not required to accept the lowest bid, and both price and service quality factors are taken into account (Boon et al., 2005). Tenderers submit a joint price and quality plan and must trade-off between the chance of failing an undened quality threshold and the need to keep costs down to outbid other tenderers whose plans pass the undened quality test (Boon et al., 2005; Cripps and Ireland, 1994)[1]. If the incumbent reapplies, councils choose between the incumbent and other audit rm tender applicants. If the incumbent does not reapply, councils choose a new auditor from the tenderers. The purpose of this study is twofold. First, we provide descriptive evidence on what auditor and audit environmental attributes affect auditor appointment decisions in the context of compulsory audit tendering. Second, we examine whether the attributes that affect the appointment of a new auditor (a rotation decision) are consistent with, or different from, those that affect the reappointment of the incumbent auditor (a retention decision). The rst motivation for the study is that few studies have examined auditor appointment in a mandated context, with the majority of prior studies focusing on the voluntary context (Sands and McPhail, 2003; Beattie and Fearnley, 1995; Deloitte, Haskins and Sells, 1978). All the limited mandated auditor choice studies have taken advantage of the collapse of former Big 5 rm Arthur Andersen to examine the inuence of (predominantly) demand-side attributes on the forced selection of a new auditor by Andersens clients (Nagy, 2005; Blouin et al., 2007; Bewley et al., 2008; De Martinis et al., 2009). However, while, demand-side characteristics are likely to be inuential in the type and size of audit rm selected (Beattie and Fearnley, 1998a; Woo and Koh, 2001), Sands and Huang (2002) argue that supply-side characteristics are the key inuence in the auditor replacement decision. Hence, this study will contribute to the auditor choice literature by examining the inuence of supply-side attributes on the auditor appointment decision in a mandated setting. Compulsory audit tendering provides a unique opportunity to examine attributes affecting auditor appointment in a mandated tendering context. Attributes inuencing appointment in a voluntary regime may not be generalizable to a compulsory regime because an entitys need to make a decision (a forced decision) is different from an entitys desire to make a decision (a voluntary decision) (Nagy, 2005). Under a voluntary regime, appointment decisions are desired in that entities are unlikely to incur the cost of tendering for audit services unless they are dissatised with their incumbent auditor, and are predisposed to changing auditors (Lorentzen, 1992). That is, a decision is made voluntarily to terminate the incumbent auditor, usually due to dissatisfaction or intent to change, and tenders for audit services are called, with the incumbent having a lower likelihood of being retained (Beattie and Fearnley, 1998a, b; Johnson, 1993). Under a mandated (compulsory) regime, such as that for NSW local councils, auditor appointment is a needed decision in that, as noted previously, it is a legislative requirement that councils tender for audit services every six years.

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That is, the incumbent auditor is mandatorily terminated every six years and a decision made to reappoint the incumbent (if the incumbent reapplies), or to appoint a new auditor for the next six-year guaranteed tenure period. In a mandated regime, councils may be predisposed to either retaining or changing their incumbent leading up to the tender, based on the quality of their experience with the incumbent during the preceding tenure period. Empirical evidence suggests that if the incumbent reapplies, there is a high probability of retention (Boon et al., 2005). A different predisposition to changing auditors prior to tendering suggests that auditor attributes are likely to be differentially important in the auditor selection decision under a voluntary versus mandated tendering regime. This study will contribute to the auditor choice literature by examining whether attributes relevant to auditor appointment in a mandated (needed) context are consistent with, or different from, those considered important in auditor appointment decisions in a voluntary (desired) context. The second motivation is that while compulsory audit tendering has been proposed as a way to improve auditor independence and audit quality, there is little empirical evidence on the consequences of compulsory tendering. Understanding those consequences is important because, following the independence concerns surrounding the corporate collapses in the early 2000s (e.g. Enron and WorldCom in the USA and HIH and One.Tel in Australia), CPA Australia called for the introduction of compulsory audit tendering every ve years to the private sector audit market (Bufni, 2002). Current legislation in Australia (the Corporate Law Economic Reform Program 9, CLERP 9 (Commonwealth of Australia, 2004, 2006)) and the Sarbanes-Oxley Act, 2002 in the USA provide for compulsory audit partner rotation every ve years. However, research has suggested that compulsory partner rotation might not prove feasible, particularly in the Australian audit services market for small audit rms, rms in non-major cities, and industry specialist rms, because of the limited number of audit partners available to meet the legislative requirement (Ryken et al., 2007)[2], [3]. If mandatory partner rotation proves inadequate or infeasible, compulsory audit tendering is an alternative, motivating the need for empirical research into the consequences of compulsory audit tendering for auditor appointment decisions and its likely effect on independence and audit quality[4]. The study contributes to the audit regulation literature generally by providing evidence on potential consequences of compulsory audit tendering for auditor appointment decisions. The study has specic implications for the regulators of, and professional support bodies associated with, NSW local councils, such as the Local Government Managers Australia NSW. This association is a non-regulatory body that provides support to local council managers, and issued councils with a sample tender specication when compulsory audit tendering was introduced in 1993. The specication details nine categories of auditor attributes that councils should consider in an auditor selection decision[5]. However, the extent to which the specication is relevant and useful in local council decisions is unknown. This is because, while the specication details the attributes councils should take into account, it is a guide only, and descriptions in audit tenders are incomplete, imprecise and open to a variety of interpretations (Boon et al., 2005). How councils interpret and weight these attributes is unknown as the specication was established in 1993 and has not been re-examined for its relevance to councils in practice. Hence, the ndings of this study will inform regulators on revisions that may be needed

to make the specication more contemporarily relevant. Our ndings also have implications for audit rms tendering to local councils. Tendering is costly and our results allow rms to direct tenders towards those attributes of most importance to councils[6]. We survey NSW local council nance managers for their perceived importance ratings of 48 auditor and audit environmental attributes in auditor appointment decisions. The attributes are based on the auditor appointment literature and on the sample tender specication provided to councils to guide appointment decisions. The specication itself is not sufcient to supply the attributes for examination because it is incomplete and may potentially not contain attributes considered important by local councils. We nd that the most important attributes across all respondents relate to the quality of previous experience with the incumbent audit rm (specically, the overall quality of audit services provided by the audit rm, the quality of advice to council management, and the ability of the audit partner(s) to meet deadlines). The importance of these attributes is consistent with the composition of the sample which had a high rate of retention of the incumbent auditor. Also important across the total sample are audit rm reputation, independence, and experience in conducting local government audits and audits generally. With regard to differences in attributes that affect the appointment of a new auditor versus reappointment of an incumbent, we nd that attributes proxying for a quality auditor, specically technical competence, independence and audit rm reputation, are more important for rotators than retainers. This is consistent with our hypothesis. 2. Literature, theory and hypothesis development 2.1 Prior literature The majority of prior auditor choice research focuses on auditor appointment in a voluntary auditor procurement context. This literature examines the importance of a wide variety of client (demand-side), auditor (supply-side) or audit environmental (audit engagement) attributes on two decisions; a decision to reappoint the incumbent auditor (a retention decision) or a decision to appoint a new auditor (a rotation decision) (Hermanson et al., 1994)[7]. Attributes relevant to both decisions are interrelated (Hermanson et al., 1994; Beattie and Fearnley, 1995) but the relative importance of attributes is likely to vary across decisions (Beattie and Fearnley, 1995; Rummel et al., 1999; Stanny et al., 2000; Sands and Huang, 2002: Sands and McPhail, 2003). Auditor rotation is typically seen as involving both change and selection decisions (Eichenseher and Shields, 1983; Francis and Wilson, 1988; Beattie and Fearnley, 1998b; Sands and Huang, 2002; Sankaraguruswamy and Whisenant, 2004). That is, a decision is made rst to change audit rm, and then subsequently a new rm is selected[8]. In the mandated setting of compulsory audit tendering, the change decision has occurred during the six-year period leading to the tender. Hence, councils approach the tender with a predisposition to change or retain their incumbent audit rms. We therefore focus on the selection decision only, and specically, on the appointment of a new auditor or reappointment of the incumbent. Studies that have examined attributes relevant to appointment of a new or reappointment of an incumbent auditor have included a multitude of attributes, with the major nding that technical competence is the most important in appointment decisions (Addams and Allred, 2002; Beattie and Fearnley, 1995; Deloitte, Haskins and Sells, 1978).

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Several studies have focused on attributes differentially affecting appointment of a new auditor compared to retention of the incumbent. The majority of these studies are practitioner based (Stanny et al., 2000; Rummel et al., 1999; Gabhart and Miller, 1984) with Sands and McPhails (2003) academic study being a notable exception. In relation to the appointment of a new auditor, the practitioner-based studies nd expertise to be the most important, whilst Sands and McPhail (2003) found that audit fee and effective preparation and communication of the audit submission were more important to rotators[9]. In relation to reappointment of the incumbent, no common attributes emerge. Rather, the practitioner-based studies nd a range of attributes relevant to experience with the incumbent to be important, including data processing capabilities and the ability of the partner to communicate effectively (Gabhart and Miller, 1984), staff personalities and meeting deadlines (Rummel et al., 1999), and overall quality of services (Stanny et al., 2000). 2.2 Theory and hypothesis development We develop an hypothesis for the second purpose of our paper which is to examine whether there is a difference in the perceived importance of attributes affecting appointment of a new auditor (a rotation decision) versus those affecting the reappointment of the incumbent (a retention decision). We hypothesize that there will be a difference in attributes affecting rotation and retention decisions because of a difference in the predisposition to change audit rm leading up to the compulsory tender. In a voluntary audit tendering context, clients are likely to be predisposed to changing their audit rm (Lorentzen, 1992). By contrast in the mandated context (of NSW local councils), councils will approach the appointment decision at the time of compulsory tender with either a predisposition to change or retain their incumbent, based on dissatisfaction or satisfaction with the quality of the audit services provided by the incumbent developed during the six-year tenure period. The guaranteed tenure period affects councils predisposition in that: . should a new auditor prove unsatisfactory, the council is locked-in for the six-year period; and . the costs of training a new auditor are likely to be high given the complex nature of council activities, duties and compliance requirements. Councils will likely be predisposed to retaining their incumbent auditor if the incumbent reapplies and the council is satised with the quality of services provided during their tenure (Rummel et al., 1999; Pandit, 1999; Stanny et al., 2000). Councils will likely be predisposed to appointing a new auditor if the incumbent does not reapply, or reapplies but the council is dissatised with the quality of the audit services provided (Burton and Roberts, 1967; Bedingeld and Loeb, 1974; Williams, 1988; Beattie and Fearnley, 1995; Behn et al., 1997). In this mandated context, we expect that the majority of councils will be predisposed to retaining their incumbent. This is for two reasons. First, Boon et al. (2008) found that NSW local councils are generally satised with the quality of audit services provided by their incumbent auditors. Second, Boon et al. (2005) provide evidence of high retention rates in NSW local government, with 59 percent and 75 percent of councils retaining their auditors at the rst and second mandated tenders in 1995 and 2001 (and 86 percent at the third tender in 2007). This contrasts with

the low retention rates of 18 and 17 percent, respectively, found in Beattie and Fearnleys (1998a) and Johnsons (1993) voluntary audit tendering studies. Beattie and Fearnley (1995) found that the two most frequently stated reasons for considering auditor change were the level of audit fee and dissatisfaction with the quality of the incumbent. In a voluntary tendering context, fee considerations are likely to be more important than quality considerations, with Beattie and Fearnley (1998a, b) noting the concern by regulators and academics that the tendering process would be used as a fee-minimization strategy, hence compromising auditor independence and audit quality. In the mandated context of NSW local government, however, quality considerations are likely to be more important than the level of fees. This is because, as Boon et al. (2005) show, audit fees for all local councils decreased by 40 percent at the time of introduction of compulsory tendering in 1993, and have remained at that lower level. Hence, fees are not expected to be important in auditor appointment decisions in our study. We hypothesize that councils predisposed to change their auditor because of dissatisfaction with the incumbent will likely rotate towards a quality auditor (Boon et al., 2005). These councils have no direct experience with the quality of prospective new auditors, and, hence, must use proxies for audit quality determinable from the tender submissions or other publicly available sources. That is, they must rely on attributes observable ex ante about the quality of prospective auditors. In terms of observable proxies for audit quality ex ante, the denition of audit quality is an initial reference point. DeAngelo (1981a) dened audit quality as comprising competence (the probability that the auditor will discover a breach or misstatement) and independence (the probability that the auditor will report the breach or misstatement). Herrbach (2001) dened audit quality similarly as technical quality (competence) and professional behaviour (independence). Moizer (1997, p. 63) argued that reputation (image or brand-name) was also an important observable ex ante proxy for audit quality. Consistent with DeAngelo (1981a), Herrbach (2001) and Moizer (1997), we contend that the best observable ex ante proxies for audit quality are technical competence, independence, and audit rm reputation. We hypothesize that councils predisposed to rotate auditors at compulsory tender will rate these proxies for quality as more important in their auditor appointment decisions compared to councils predisposed to retain their incumbent. Technical competence is important because a client, here a local council, needs to have considerable condence in the technical skill set of the partners, managers and staff professionals in order to choose a rm (Addams and Allred, 2002, p. 63). Technical competence comprises technical qualications, audit experience generally and audit expertise at both the audit rm and audit team (individual) level. Consistent with Ghosh and Moons (2005) distinction of audit experience and audit expertise, experience is dened as expert knowledge gained through years of on-the-job experience (Ashton, 1991), while expertise relates to industry-specic experience (or specialization) (Velury et al., 2003). Expertise allows auditors to identify and address industry-specic issues and problems more comprehensively and, hence, obtain an advantage relative to auditors without industry knowledge (Chaney et al., 1997; Velury et al., 2003). Audit independence is dened as independence in fact and in appearance (Richard, 2006). Independence in fact refers to attitudes of impartiality and objectivity, while independence in appearance refers to perceptions by third parties that the auditor

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is capable of maintaining impartiality and capacity of judgment, and resisting pressures from client management (Richard, 2006, p. 156). Auditor reputation (image or brand-name) is important because, in the absence of users ability to assess quality directly, audit rms with a well-known (unfamiliar) reputation are regarded as providing a higher (lower) quality audit (Moizer, 1997). Reputation provides information on service quality, and also represents a bond that the audit rm dissipates if it fails to supply the contracted-for quality (Healy and Lys, 1986), the consequences of which are potential loss of reputation, audit fees and client base (DeAngelo, 1981b; Francis and Wilson, 1988; Bedard et al., 2000; Citron and Manalis, 2001; Chaney et al., 2004). In addition, with respect to independence and reputation, NSW local councils have accountability and stewardship relationships with the state government and community as the councils stakeholders. Councils, therefore, are likely to value perceptions of independence and an auditors reputation as a means of enhancing their own reputation in the eyes of stakeholders (Healy and Lys, 1986). Thus, we hypothesize that councils predisposed to rotate auditors at compulsory audit tender will seek to align themselves with a quality auditor where a quality auditor is proxied by ex ante observable characteristics of technical competence, independence and reputation: H1. Councils predisposed to rotate auditors at compulsory audit tender will rate technical competence, independence and reputation as more important in the auditor appointment decision compared to councils predisposed to retain their incumbent auditor. 3. Method 3.1 Variable identication A review of the auditor choice literature, specically the multi-attribute studies that focus on auditor appointment from a behavioural perspective, and the sample tender specication provided to local councils by the Local Government Managers Australia NSW, identied a number of auditor (supply-side) and audit environmental (audit engagement) attributes for inclusion in the survey[10]. Table I details a taxonomy of 48 attributes identied from the literature and the sample tender specication which were used in constructing the survey questionnaire[11]. The 48 attributes were categorized theoretically and nine broad categories were identied. These were four supply-side (auditor) attributes of audit rm reputation, location, ability to provide non-audit services and technical competence; and ve audit environmental characteristics of the audit plan, audit fee, independence, relationships with the incumbent audit rm and tender documents/process. These nine categories are labeled attribute groupings level 1 in column 2 of Table I. These attribute groupings are used in the hypothesis development and conrmatory factor analysis. Column 3 classies each level 1 attribute grouping into sub-groupings (labeled attribute groupings level 2), while column 4 details the individual items that fall within each level 2 grouping (labeled attribute groupings level 3 survey items). These individual items are used in the survey questionnaire. Column 5 shows each items question number in the questionnaire[12]. The last column shows the references from which the attributes and survey items were developed.

Attribute characteristic Attribute groupings level 3 survey items 1 24 26 35 2 9 45 48 25 47 Casabona and Barbera (1987) Deloitte, Haskins and Sells (1978), George and Solomon (1980), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Hermanson et al. (1994), Scott and van der Walt (1994), Beattie and Fearnley (1995), Sands and Huang (2002), tender specication

Attribute groupings level 1

Attribute groupings level 2

Attribute Attribute source from literature and sample number tender specication

Supply-side

Audit rm reputation General

Specic (contextual) reputation Audit partners References/acceptability References from senior NSW local council to third parties representatives that have experience with the audit rm References from major clients of the audit rm The audit rm is acceptable to the councils regulators Reputation other clients Details of major audit clients of the audit rm

The overall reputation of the audit rm The audit rm is not being involved in embarrassing litigation The audit rms professional indemnity insurance complies with the minimum requirements of ICAA or CPA Australia Belief that the audit rm will give the council an unqualied opinion The reputation of the audit rm in providing audit services to local councils The reputation of the audit engagement partner(s)

Reputation size 40 41 4

The audit rm is a small international or national audit rm The audit rm is a large local or regional audit rm The audit rm is a small local audit rm The audit rm is a Big 4 international audit rm

Deloitte, Haskins and Sells (1978), Gabhart and Miller (1984), Beattie and Fearnley (1995), Stanny et al. (2000) Barlev (1977), George and Solomon (1980), Casabona and Barbera (1987), Addams and Davis (1994), Scott and van der Walt (1994), Beattie and Fearnley (1995), Addams and Davis (1996), Rummel et al. (1999), Stanny et al. (2000), Addams and Allred (2002), Sankaraguruswamy and Whisenant (2004),tender specication Deloitte, Haskins and Sells (1978), George and Solomon (1980), Gabhart and Miller (1984), Scott and van der Walt (1994), Beattie and Fearnley (1995), Sankaraguruswamy and Whisenant (2004), tender specication Barlev (1977), George and Solomon (1980), Eichenseher and Shields (1983), Casabona and Barbera (1987), Addams and Davis (1994), Scott and van der Walt (1994), Beattie and Fearnley (1995), Addams and Davis (1996), Rummel et al. (1999), Stanny et al. (2000), Addams and Allred (2002), Sankaraguruswamy and Whisenant (2004) (continued )

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Table I. Literature summary and taxonomy of attributes

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Attribute characteristic Attribute groupings level 3 survey items The audit rm has an ofce in close proximity to the council 7 Location

Table I.
Attribute groupings level 2 Attribute Attribute source from literature and sample number tender specication NAS operational The capability of the audit rm to provide nonaudit services such as operational audits and/or consulting services 3 10 11 12 20 29 32 (continued ) Deloitte, Haskins and Sells (1978), George and Solomon (1980), Eichenseher and Shields (1983), Casabona and Barbera (1987), Addams and Davis (1994, 1996), Beattie and Fearnley (1995, 1998b), Rummel et al. (1999), Stanny et al. (2000), Addams and Allred (2002), Sands and Huang (2002), Sands and McPhail (2003), Sankaraguruswamy and Whisenant (2004) Barlev (1977), Deloitte, Haskins and Sells (1978), George and Solomon (1980), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Addams and Davis (1994, 1996), Scott and van der Walt (1994), Beattie and Fearnley (1995), Rummel et al. (1999), Stanny et al. (2000), Addams and Allred (2002), Sands and Huang (2002), Sands and McPhail (2003), tender specication Deloitte, Haskins and Sells (1978), Eichenseher and Shields (1983), Beattie and Fearnley (1995), Addams and Davis (1996), Stanny et al. (2000), Addams and Allred (2002), Sands and McPhail (2003), tender specication Deloitte, Haskins and Sells (1978), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Sands and McPhail (2003), tender specication NAS generally Technical competence The technical qualications of the proposed qualications audit engagement partner(s) The technical qualications of the proposed audit team manager(s) The technical qualications of the proposed audit team supervisor(s) Technical competence The experience of the proposed audit experience engagement partner(s) in conducting audits generally The experience of the proposed audit manager(s) in conducting audits generally The experience of the proposed audit team supervisor(s) in conducting audits generally

Attribute groupings level 1

Location

Ability to provide NAS

Technical competence

Attribute characteristic Attribute groupings level 3 survey items 6 44 Technical competence The audit rm is considered to be a specialist in expertise audit rm level local government audit Details of other councils currently audited by the audit rm

Attribute groupings level 1

Attribute groupings level 2

Attribute Attribute source from literature and sample number tender specication

21 30 33 13 14 23 16 15 22 Gabhart and Miller (1984) Casabona and Barbera (1987) Deloitte, Haskins and Sells (1978), Beattie and Fearnley (1995), tender specication Casabona and Barbera (1987), tender specication Casabona and Barbera (1987), tender specication

Deloitte, Haskins and Sells (1978), George and Solomon (1980), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Hermanson et al. (1994), Scott and van der Walt (1994), Beattie and Fearnley (1995), Rummel et al. (1999), Sands and Huang (2002), Stanny et al. (2000), Addams and Allred (2002), Sands and McPhail (2003), Sankaraguruswamy and Whisenant (2004), tender specication Deloitte, Haskins and Sells (1978), Gabhart and Miller (1984), Addams and Davis (1994, 1996), tender specication

Environmental Audit plan

Technical competence The experience of the proposed audit engagement partner(s) in conducting local expertise individual government audits level The experience of the proposed audit manager(s) in conducting local government audits The experience of the proposed audit team supervisor(s) in conducting local government audits General The detail and completeness of the proposed audit plan Audit approach/strategy The nature of the proposed audit approach Audit technology/audit The computer audit capability of the audit rm structure/computer audit Audit timing The proposed timing of audit work in terms of the number, duration and approximate date of visits by the audit rm Audit hours The proposed number of hours to conduct the audit (from the beginning of eld work to the audit report date) The proposed involvement of the audit partner(s) in the conduct of the audit in terms of estimated audit hours (continued )

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Table I.

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Attribute characteristic Attribute groupings level 3 survey items 31 34 17 18

Table I.
Attribute groupings level 2 Attribute Attribute source from literature and sample number tender specication Audit fee The proposed involvement of the audit manager(s) in the conduct of the audit in terms of estimated audit hours The proposed involvement of the audit team supervisor(s) in the conduct of the audit in terms of estimated audit hours The competitiveness of the pricing structure of the audit rm for the provision of audit services The audit fee estimate provided by the audit rm is commensurate with the audit work required Independence The independence of the audit rm from your council 19 Incumbent auditor 27 28 39 38 (continued ) Previous experience of the audit rm with your council as an incumbent auditor Quality of working relationship with audit partners Quality of working relationships with audit engagement staff The quality of the audit rms advice to council management, including management letters, internal control reports The overall quality of service provided by the audit rm 8 George and Solomon (1980), Casabona and Barbera (1987), Addams and Davis (1994), Hermanson et al. (1994), Scott and van der Walt (1994), Beattie and Fearnley (1995, 1998b), Addams and Davis (1996), Rummel et al. (1999), Stanny et al. (2000), Addams and Allred (2002), Sands and Huang (2002), Sands and McPhail (2003), Sankaraguruswamy and Whisenant (2004), tender specication Barlev (1977), George and Solomon (1980), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Addams and Davis (1994, 1996), Scott and van der Walt (1994), Beattie and Fearnley (1998b), Stanny et al. (2000), Addams and Allred (2002) Deloitte, Haskins and Sells (1978), Eichenseher and Shields (1983), Gabhart and Miller (1984), Casabona and Barbera (1987), Scott and van der Walt (1994), Beattie and Fearnley (1995, 1998b), Rummel et al. (1999), Stanny et al. (2000), Sands and McPhail (2003), Sankaraguruswamy and Whisenant (2004)

Attribute groupings level 1

Audit fee

Independence

Relationships with the incumbent audit rm

Attribute characteristic Attribute groupings level 3 survey items 36 37 42 43 46 Addams and Davis (1994, 1996), Beattie and Fearnley (1998b), Stanny et al. (2000), Addams and Allred (2002), Sands and McPhail (2003), Sankaraguruswamy and Whisenant (2004)

Attribute groupings level 1

Attribute groupings level 2

Attribute Attribute source from literature and sample number tender specication

Tender documents/ process

Tender proposal

The accessibility of the partner-in-charge of the engagement The ability of the audit partner to meet deadlines The quality of the audit rms written tender proposal The quality of the audit rms oral presentation The personal relationships established between the audit rms key people and council management during the tender process

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Table I.

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Table II presents the taxonomy used for the sensitivity analysis. This taxonomy was the nine categories in the sample tender specication: (1) capacity-including quality and availability of workforce; (2) quality and depth of audit performance and experience; (3) proposed audit plan; (4) price; (5) value-added services; (6) technical expertise; (7) referees; (8) tender proposal process; and (9) other. These nine categories are shown in column 1 of Table II. Column 2 classies each category into sub-categories which column 3 describes as being either a supply-side (auditor) or environmental (audit engagement) characteristic. Column 4 shows the order in which the attributes were presented in the survey, while column 5 details the description of each of the 48 items used in the survey. 3.2 Survey design and administration The survey questionnaire used closed-form questions and consisted of two sections. The rst asked respondents to rate the importance of the 48 attributes using a seven-point Likert-type scale with anchors ranging from minus three (very unimportant) to plus three (very important), with a neutral response (zero) being the mid-point of the scale[13]. Similar to Beattie and Fearnley (1995), questions were framed as a generic task and no reference was made to the councils incumbent auditor. Respondents were asked to assume that tenders for audit services had been called by their council and they were involved in selecting an auditor (either reappointing the incumbent or appointing a new auditor). Respondents were asked to what extent each auditor attribute is important in your auditor appointment decision. The order of the 48 attributes was randomized both within and across attribute groupings to overcome potential bias of demand characteristics or halo effect. Some similar items were grouped together (e.g. items concerning the audit partner) to avoid the respondent having to change mind-sets too often. The second section of the questionnaire contained demographic questions: . the length of time the respondent had been in the position of nance manager; . council size in terms of population and revenue; . whether the council was metropolitan or non-metropolitan; . the type of incumbent audit rm; . the length of the incumbent auditors tenure; and . the report type of the councils last audit (modied or unmodied). Respondents were also asked the number of bids that would be expected if their council were calling for tenders at the time of the survey, and their preferred outcome

Category as per tender specication 10 11 12 22 31 34 8 47 20 29 32 38 39 Environmental 15 37 13 14

Sub-category

Attribute classication

Survey attribute no. Survey attribute description

Capacity including quality and availability of workforce

Technical qualications Supply-side

Availability proposed Environmental involvement of audit team

Environmental Quality and depth of audit Prior experience with audit rm performance and experience Depth of audit experience rm Depth of audit experience team Quality of performance of audit rm and/or staff

The technical qualications of the audit engagement partner(s) The technical qualications of the audit team manager(s) The technical qualications of the audit team supervisor(s) The proposed involvement of the audit partner(s) in the conduct of the audit in terms of estimated audit hours The proposed involvement of the audit manager(s) in the conduct of the audit in terms of estimated audit hours The proposed involvement of the audit team supervisor(s) in the conduct of the audit in terms of estimated audit hours Previous experience of the audit rm with your council as incumbent auditor Details of major audit clients of the audit rm

Proposed audit plan

General audit plan Audit approach/ strategy Audit hours

The experience of the audit engagement partner(s) in conducting audits generally The experience of the audit manager(s) in conducting audits generally The experience of the audit team supervisor(s) in conducting audits generally The overall quality of audit services provided by the audit rm The quality of the audit rms advice to council management, including management letters, internal control reports The ability of the audit partner(s) to meet deadlines The detail and completeness of the proposed audit plan The nature of the proposed audit approach The proposed number of hours to conduct the audit (from the beginning of eld work to the audit report date) (continued )

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Table II. Taxonomy of attributes classied according to the sample tender specication

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Category as per tender specication 16 Environmental 18 Supply-side Environmental Supply-side 44 21 30 33 Supply-side 45 3 23 17

Price

Value-added services

Technical expertise

Referees

Tender proposal process 43

Table II. Attribute classication The proposed timing of audit work in terms of the number, duration and approximate date of visits by the audit rm The computer audit capability of the audit rm The competitiveness of the pricing structure of the audit rm for the provision of audit services The audit fee estimate provided by the audit rm is commensurate with the audit work required Survey attribute no. Survey attribute description 27 28 36 6 Environmental 48 25 42 The capability of the audit rm to provide non-audit services such as operational audits and/or consulting services Quality of working relationship with the audit partner(s) Quality of working relationships with the audit engagement staff The accessibility of the partner(s)-in-charge of the engagement The audit rm is considered to be a specialist in local government audit Details of other councils currently audited by the audit rm The experience of the audit engagement partner(s) in conducting local government audits The experience of the audit manager(s) in conducting local government audits The experience of the audit team supervisor(s) in conducting local government audits References from senior NSW local council representatives that have experience with the audit rm References from major audit clients of the audit rm The audit rm is acceptable to the councils regulators The quality of the audit rms written tender proposal The quality of the audit rms oral presentation (continued )

Sub-category

Audit timing Computer audit capability Competitiveness of audit fee Audit fee commensurate with a quality audit Non-audit services

Quality of working relationships

Expertise rm

Expertise team

References

Tender proposal process

Category as per tender specication 46 Supply-side

Sub-category

Attribute classication

Survey attribute no. Survey attribute description

Other

Audit rm size

Reputation

Supply-side

5 40 41 4 1 24 2 9 35 19 26 7

Non-independence Supply-side Supply-side

Environmental

Independence Professional indemnity insurance Audit rm location

The personal relationships established between the audit rms key people and council management during the course of the tender proposal process The audit rm is a small international or national audit rm The audit rm is a large local or regional audit rm The audit rm is a small local audit rm The audit rm is a Big 4 international audit rm The overall reputation of the audit rm The audit rm is not involved in embarrassing litigation The reputation of the audit rm in providing audit services to local councils The reputation of the audit engagement partner(s) Belief that the audit rm will give the council an unqualied audit report The independence of the audit rm from your council The audit rms professional indemnity insurance complies with the minimum requirements of ICAA or CPA Australia The audit rm has an ofce in close proximity to the council

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Table II.

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of whether the council would appoint a new audit rm or reappoint the incumbent. Responses to this question formed the dependent variable. Questionnaire design and administration followed Dillmans (2000) tailored design method. Three follow-ups to an initial mailing were conducted, two by mail and one by phone. All councils were phoned prior to the third mail-out to ask if they had responded to the survey[14], [15]. 3.3 Sample selection and data collection The sample was the population of 152 NSW local council nance managers. Finance managers were the appropriate respondents because they are crucial members of the tender committee that appoints the auditor, and they liaise closely with the external auditors during the annual audit of the councils nancial statements. Appendix 1 shows the demographics of the sample. NSW councils are small in population (70.7 percent have less than 50,000 residents) and revenue (66.7 percent have revenue less than $50m), and are largely non-metropolitan (74.8 percent). They are mostly audited by large local or regional rms (64 councils or 52 percent). A total of 79 (64.2 percent) have been audited by their incumbent for one tender period and 44 (35.8 percent) for two tender periods. Virtually all (93.5 percent) received unmodied opinions on their last audit report[16]. If tenders for audit services were called at the time of the survey, the majority of councils would expect to receive between four and six bids (73 councils or 59.3 percent). The demographic data also showed 27 (22 percent) of councils would prefer to rotate their auditors and 96 (78 percent) would prefer to retain their incumbent. Demographics for councils preferring to rotate and retain are shown in columns 4 and 5, respectively. The demographics for each group essentially mirror those for the total. The data were collected in the middle of calendar year 2006, that is, towards the end of the second compulsory tender and at the beginning of the last year of the six-year mandatory tenure period (the tender period had commenced 1 July 2001 and was due to end 30 June 2007). Council nance managers, as respondents, therefore had at least ve years experience with their incumbent auditors. 3.4 Response rate From the population of 152 nance managers, 148 (97 percent) responded. In 25 responses one or more items of missing data were found and were deleted, meaning all analyses were conducted on 123 responses. Aside from follow-up efforts, the high response rate was achieved due to interest in the survey because of: . previous contact between the researchers and the nance managers as participants at a national conference of local government nance professionals shortly before the survey; and . the support of the survey by the NSW Local Government Finance Managers Executive. Given the high response rate, non-response bias is not a threat to the validity of the results. 3.5 Method of analysis A forced conrmatory factor analysis was conducted for each of the attribute groupings level 1 (column 2 in Table I). Attribute groupings for location, ability

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to provide NAS and independence could not be factor analysed because they consisted of only one item. The factor analysis was performed using the principal components extraction method with Varimax (Kaiser normalisation) rotation. Each factor was converted into a single factor score (following Field, 2000). The factor scores and means for the single attributes of location, ability to provide NAS and independence were then used in a logistic regression as predictor variables explaining intention to rotate or retain the incumbent auditor. Forced conrmatory factor analysis was used as it provides factors coterminous with the attribute grouping taxonomy developed from the literature, and allows testing of the hypotheses. Conrmatory factor analysis removes within-attribute collinearity, although not between-attribute collinearity. Its purpose is to reduce predictor variables to a subset of uncorrelated factors (Field, 2000, pp. 431-2). 3.6 Model specication The auditor choice model to be estimated is as follows (ignoring council and time period subscripts): Intention to rotate b0 b1 Audit firm reputation b2 Location b3 Ability to provide NAS b4 Technical competence b5 Audit plan b6 Audit fee b7 Independence b8 Relationships with the incumbent audit firm b9 Tender documents=process e

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where: Intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise. Independent variables continuous independent variables; factor scores derived from factor analysing attributes comprising the corresponding attribute category, or attribute mean scores where the category contained a single attribute. Single attribute categories are location, ability to provide NAS and independence. The demographic data (Appendix 1) were also included in the logistic regression as controls. The only control that was signicant was the number of bids, indicating the competitiveness of the market. As no other control was signicant, the model does not specify the controls and none of the results for the controls are reported. We used intention or preference to rotate or retain auditors as the dependent variable. A dichotomous measure was used to reect the nature of the decision. The demand-side studies also use this dichotomy (Woo and Koh, 2001). A measure of preferred outcome or intention follows Pandit (1999), and is based on research that shows intention follows attitude and precedes behaviour; and is a commonly used approach in the behavioural literatures to measure the likelihood of action (Pandit, 1999, p. 176). The questionnaires were anonymous so we have no ability to match intention at the time of the survey with behaviour at the next tender (which took place 12 months after the study). However, at the subsequent tender 14 percent of councils rotated their auditors

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and 86 percent retained their incumbents. These percentages are relatively consistent with the percentages of intending rotators (22 percent) and retainers (78 percent) in our study. 3.7 Sensitivity analysis A forced conrmatory factor analysis was conducted for each of the nine categories in the sample tender specication set out in Table II, to identify a single factor for each category. principal components extraction method with Varimax (Kaiser normalisation) rotation was used. Each factor was converted into a single factor score (Field, 2000). These (uncorrelated) factor scores were then used in a logistic regression as predictor variables explaining intention to rotate or retain the incumbent auditor, hence facilitating tests of the hypothesis and allowing examination of the usefulness of the sample tender specication. The auditor choice model to be estimated is as follows (ignoring council and time period subscripts): Intention to rotate b0 b1 Capacity 2 including quality and availability of workforce b2 Quality and depth of audit performance and experience b3 Proposed audit plan b4 Price b5 Valueadded services b6 Technical expertise b7 Referees b8 Tender proposal process b9 Other e where: Intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise. Independent variables continuous independent variables; factor scores derived from factor analysing attributes comprising the corresponding attribute category. Consistent with the main results, the demographic data were included in the logistic regression as controls. Again, no control was signicant other than the number of bids. Therefore, the model does not specify controls and none of the results for controls are reported. 4. Results 4.1 Descriptives Appendix 2 presents the importance ratings (means, medians and standard deviations) for the 48 individual attributes on a scale of minus three (very unimportant) to plus three (very important). Column 3 shows the importance ratings for the total sample. Columns 4 and 5 show the ratings for the councils preferring to rotate and retain their incumbent auditor, respectively. The attributes are ranked in descending order of importance for the total sample, i.e. the most important attribute is listed rst. The three most important attributes overall (for the total sample) relate to the councils relationship with their incumbent auditors and are associated with the quality of performance of the audit rm and/or staff. These are: 2

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(1) the overall quality of audit services provided by the audit rm; (2) the quality of the audit rms advice to council management, including management letters and internal control reports; and (3) the ability of the audit partner(s) to meet deadlines. The next three items in order of importance are reputation (both in providing audit services to local councils and overall) and independence. Three of the four items comprising the remainder of a Top 10 relate to technical expertise and depth of experience of the audit team; specically experience of the audit manager(s) and partner(s) in conducting local government audits and audits generally. One audit fee attribute (the fee is commensurate with the audit work required) was ranked ninth. However, the other fee attribute (the competitiveness of the pricing structure of the audit rm) was ranked 23rd and below other quality related attributes. The four attributes considered least important were all associated with audit rm size and type; specically: (1) the audit rm is a Big 4 international audit rm; (2) the audit rm is a small international or national audit rm; (3) the audit rm is a small local rm; and (4) the audit rm is a large local or regional audit rm[17]. Also rated in the ten least important attributes were the belief that the audit rm will give the council an unqualied audit report, the audit rm has an ofce in close proximity to the council, details of major audit clients of the audit rm, and the capability of the audit rm to provide non-audit services. These ndings provide descriptive evidence that, in the context of compulsory audit tendering, quality considerations are important in auditor appointment decisions. Local councils value the importance of, and are likely to appoint, audit rms that are reputable, independent, have audit teams with technical competence, particularly local council industry expertise, and provide quality audit services in their relationships with the council. Given the predominance of retainers in the sample, these ndings support the premise that satisfaction with the quality of the incumbent auditor is associated with retention of the incumbent. 4.2 Univariate results Column 6 in Appendix 2 shows t-statistics and signicance levels for tests of differences of attribute means between councils preferring to rotate their incumbent auditor (rotators) and councils preferring to retain (retainers). Of the 48 attributes, 17 were positive and signicant (six at p , 0.01 and 11 at p , 0.05) and four were positive and marginally signicant ( p , 0.10), meaning they were more important to rotators. One attribute (the councils previous experience with the incumbent auditor) had a negative sign (signicant at p , 0.05), meaning it was more important to retainers. The descriptive statistics suggest that respondents intending to rotate are more highly sensitised to the importance of audit quality attributes overall compared to those intending to retain. Table III presents the results of the conrmatory factor analysis conducted on the nine attributes (attribute groupings level 1) in column 2 of Table I.

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Attribute no.

Audit rm reputation (100 percent) 48 References from major audit clients of the audit rm (0.170) 47 Details of major audit clients of the audit rm (0.161) 5 The audit rm is a small international or national audit rm (0.155) 45 References from senior NSW local council representatives that have experience with the audit rm (0.147) 9 The reputation of the audit engagement partner(s) (0.146) 41 The audit rm is a small local audit rm (0.143) 4 The audit rm is a Big 4 international audit rm (0.141) 40 The audit rm is a large local or regional audit rm (0.139) 24 The audit rm is not involved in embarrassing litigation (0.133) 1 The overall reputation of the audit rm (0.120) 35 Belief that the audit rm will give the council an unqualied audit report (0.115) 25 The audit rm is acceptable to the councils regulators (0.096) 2 The reputation of the audit rm in providing audit services to local councils (0.079) 26 The audit rms professional indemnity insurance complies with the minimum requirements of ICAA or CPA Australia (0.071) Kaiser-Meyer-Olkin measure of sampling adequacy 0.704 Bartletts test of sphericity: approx. x 2 609.042, (sig.) (0.000) Technical competence (100 percent) 32 The experience of the audit team supervisor(s) in conducting audits generally (0.155) 33 The experience of the audit team supervisor(s) in conducting local government audits (0.155) 12 The technical qualications of the audit team supervisor(s) (0.153) 11 The technical qualications of the audit team manager(s) (0.145) 29 The experience of the audit manager(s) in conducting audits generally (0.144) 30 The experience of the audit manager(s) in conducting local government audits (0.141) 10 The technical qualications of the audit engagement partner(s) (0.134) 20 The experience of the audit engagement partner(s) in conducting audits generally (0.120) 21 The experience of the audit engagement partner(s) in conducting local government audits (0.114) 6 The audit rm is considered to be a specialist in local government audit (0.102) 44 Details of other councils currently audited by the audit rm (0.066) Kaiser-Meyer-Olkin measure of sampling adequacy 0.780 Bartletts test of sphericity: approx. x 2 979.790, (sig.) (0.000) Audit plan (100 percent) 31 The proposed involvement of the audit manager(s) in the conduct of the audit in terms of estimated audit hours (0.200) 34 The proposed involvement of the audit team supervisor(s) in the conduct of the audit in terms of estimated audit hours (0.192) 14 The nature of the proposed audit approach (0.182) (continued )

Table III. Conrmatory factor analysis

Attribute description

Attribute no.

Attribute description

22 The proposed involvement of the audit partner(s) in the conduct of the audit in terms of estimated audit hours (0.178) 13 The detail and completeness of the proposed audit plan (0.174) 15 The proposed number of hours to conduct the audit (from the beginning of eld work to the audit report date) (0.172) 23 The computer audit capability of the audit rm (0.160) 16 The proposed timing of audit work in terms of the number, duration and approximate date of visits by the audit rm (0.141) Kaiser-Meyer-Olkin measure of sampling adequacy 0.822 Bartletts test of sphericity: approx. x 2 395.224, (sig.) (0.000) Audit fee (100 percent) 17 The competitiveness of the pricing structure of the audit rm for the provision of audit services (0.583) 18 The audit fee estimate provided by the audit rm is commensurate with the audit work required (0.583) Kaiser-Meyer-Olkin measure of sampling adequacy 0.500 Bartletts test of sphericity: approx. x 2 30.159, (sig.) (0.000) Relationships with the incumbent auditor (100 percent) 28 Quality of working relationships with the audit engagement staff (0.245) 27 Quality of working relationship with the audit partner(s) (0.242) 37 The ability of the audit partner(s) to meet deadlines (0.231) 36 The accessibility of the partner(s)-in-charge of the engagement (0.221) 38 The overall quality of audit services provided by the audit rm (0.213) 39 The quality of the audit rms advice to council management, including management letters, internal control reports (0.185) 8 Previous experience of the audit rm with your council as an incumbent auditor (0.150) Kaiser-Meyer-Olkin measure of sampling adequacy 0.729 Bartletts test of sphericity: approx. x 2 291.276, (sig.) (0.000) Tender documents/process (100 percent) 42 The quality of the audit rms written tender proposal (0.475) 46 The personal relationships established between the audit rms key people and council management during the course of the tender proposal process (0.457) 43 The quality of the audit rms oral presentation (0.335) Kaiser-Meyer-Olkin measure of sampling adequacy 0.585 Bartletts test of sphericity: approx. x 2 72.685, (sig.) (0.000)

Notes: Each of the attributes comprising the categories reported in Table I, column 2, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; the numbers in parentheses after the attribute descriptions are the factor loadings from the pooled factor analysis; the attributes location, ability to provide NAS and independence were unable to be factor analysed because they were single attributes

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Table III.

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126

The attributes location, ability to provide NAS and independence were unable to be factor analysed because they were single attributes. Table IV presents the Spearman correlations among the dependent variable, Intention to rotate and the independent variables (based on means for the three single-item factors and factor scores for the other six factors). Table IV shows signicant correlations between intention to rotate and audit rm reputation ( r 0.320), technical competence (r 0.314) and independence (r 0.192). These results provide initial support for the hypothesis that councils intending to rotate are seeking a quality auditor with the characteristics of reputation, technical competence and independence. There were no high correlations among the independent variables, suggesting multicollinearity does not affect the results. Table V presents the results of independent t-tests of differences in the relative importance of the nine theoretically derived attribute groupings (six factor scores and three attributes) between rotators and retainers. Table V shows that the t-statistics (one-tailed) for audit rm reputation (t 3.256, p , 0.000), technical competence (t 3.437, p , 0.000), audit plan (t 2.154, p , 0.017) and independence (t 2.031, p , 0.022) are positive and signicant, indicating that they were considered more important by rotators than retainers in their auditor appointment decisions. 4.3 Multivariate results To test the hypothesis, the six factor scores and three individual attributes were included in a logistic regression model explaining audit rm rotation/retention. The results are presented in Table VI. Table VI shows that the model is signicant overall (x 2 statistic 18.929, prob. , 0.000) and the Nagelkerke R 2 is 21.9 percent. The coefcients for audit rm reputation (Wald 1.955, p , 0.081), technical competence (Wald 3.921, p , 0.024) and independence (Wald 1.624, p , 0.101) are positive and signicant (one-tailed), indicating that these factors/attributes are considered more important by rotators than retainers when making auditor appointment decisions. Expressed another way, the signicant positive coefcients mean that the higher the importance rating attached to these factors/attributes, the greater the likelihood of rotation to a new auditor perceived to possess these attributes[18]. The results provide support for the hypothesis that councils predisposed to rotate auditors because of dissatisfaction with the quality of their incumbent auditor are rotating towards a quality auditor where a quality auditor is proxied by technical competence independence and reputation. 4.4 Sensitivity results Table VII presents the results of the forced conrmatory factor analysis conducted on the nine categories of the sample tender specication provided to assist councils in auditor appointment decisions (shown in column 1 of Table II). The nine factors extracted were converted to factor scores and univariate and multivariate analyses were conducted to ascertain whether there were differences between potential rotators and retainers in the importance of attributes in auditor appointment decisions. 4.4.1 Univariate results. Table VIII presents the Spearman correlations among the dependent variable, Intention to rotate and the independent variables. There were no high correlations among the independent variables, suggesting multicollinearity does not affect the results.

Ability to Audit provide Technical rm Intention NAS competence to rotate reputation Location Audit plan Audit fee

Tender Relationships with the incumbent audit documents/ process rm Independence

1.000 0.085 0.275 * * 1.000 0.043 1.000 0.308 * 0.428 * * 0.134 0.185 * 1.000 0.624 * * 0.404 * * 0.312 * * 1.000 0.484 * * 1.000 0.362 * * 0.202 * 1.000 0.271 * * 1.000 0.292 * * 1.000 0.163 0.636 * * 0.378 * * 0.414 * * .520 * * 0.642 * * 0.330 * * 0.355 * * 0.289 * * 0.054 0.064 2 0.035 2 0.109 0.116 0.030 0.566 * * 0.558 * 0.316 * * 0.288 * * 0.485 * * 0.534 * *

Intention to rotate 1.000 Audit rm reputation 0.320 * * Location 2 0.091 Ability to provide 0.048 NAS Technical competence 0.314 * * Audit plan 0.191 * Audit fee 0.114 Independence 0.192 * Relationships with the incumbent audit rm 0.141 Tender documents/ process 0.137

Notes: Correlation is signicant at the *0.05 and * *0.01 levels; n 123; where: intention to rotate categorical dependent variable, coded one for

intention to rotate, zero otherwise; independent variables continuous independent variables, factor scores derived from factor analysing attributes comprising the corresponding attribute category, or attribute mean scores where the category contained a single attribute; single attribute categories are location, ability to provide NAS, and independence

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Table IV. Spearman correlations among dependent variable intention to rotate and independent variables

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Factor score/attributea Audit rm reputation Location Ability to provide NAS Technical competence Audit plan Audit fee Independence Relationships with the incumbent audit rm Tender documents/process

Mean value of factor scoresa Test results Potential rotators Potential retainers Signicance (n 27) (n 96) t-statistic (one-tailed)b 0.5329473 0.52 1.52 0.5600990 0.3608258 0.2052785 2.74 0.2759666 0.2794105 2 0.1498914 0.67 1.41 2 0.1575278 2 0.1014823 2 0.0577346 2.36 2 0.0776156 2 0.0785842 3.256 2 0.425 0.418 3.437 2.154 1.210 2.031 1.634 1.655 0.000 * * * 0.336 0.339 0.000 * * * 0.017 * * 0.115 0.022 * * 0.053 0.051

128

Notes: Signicant at the *10, * *5, and * * *1 percent levels (one-tailed); aeach of the attributes comprising the categories reported in Table I, column 2, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; the attributes location, ability to provide NAS and independence were unable to be factor analysed because they were single attributes; ba positive (negative) t-statistic that is signicant ( p , 0.10, one-tailed) indicates that the variable is more important to rotators (retainers); where: intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise; independent variables continuous independent variables; factor scores derived from factor analysing attributes comprising the corresponding attribute category, or attribute mean scores where the category contained a single attribute; single attribute categories are location, ability to provide NAS, and independence

Table V. Results of t-tests of mean differences between rotators and retainers

Table VIII shows signicant and positive correlations between intention to rotate and capacity-including quality and availability of workforce (r 0.235), quality and depth of audit performance and experience (r 0.221), proposed audit plan (r 0.190), technical expertise (r 0.310), referees (r 0.182) and other (r 0.346). These results lend initial support to the hypothesis that councils intending to rotate are seeking a quality auditor: particularly in terms of the categories: capacity which includes technical qualications; quality and depth of audit performance and experience which includes audit experience and the quality of services provided to the council; and technical expertise which includes experience in conducting local government audits. Rotators are also placing greater importance on the proposed audit plan and referees than retainers. The signicance of the category other indicates that rotators place greater importance on audit quality attributes not included specically in the sample tender specication. Table IX presents the results of independent t-tests of differences in the relative importance of the nine categories between rotators and retainers. The t-statistics (one-tailed) for capacity-including quality and availability of workforce (t 2.401, p , 0.018), quality and depth of audit performance and experience (t 2.503, p , 0.014), proposed audit plan (t 2.231, p , 0.028), technical expertise (t 3.261, p , 0.001) and other (t 3.455, p , 0.001) are positive and signicant, indicating that they were considered more important by rotators than retainers in their auditor appointment decisions. 4.4.2 Multivariate results. The factor scores for the nine categories were included in a logistic regression model explaining audit rm rotation/retention, providing a second test of the hypotheses using the specication categories. The results are presented in Table X.

Factor score/attributea,b coefcient Constant Audit rm reputation Location Ability to provide NAS Technical competence Audit plan Audit fee Independence Relationships with the incumbent audit rm Tender documents/process

Coefcient 2 2.443 0.509 2 0.155 2 0.223 0.812 2 0.071 2 0.037 0.517 2 0.174 0.010

Wald statistic 4.782 1.955 0.909 0.957 3.921 0.029 0.015 1.624 0.231 0.001

Sig. (one-tailed)c 0.029 0.081 * 0.170 0.164 0.024 * * 0.432 0.452 0.101 * 0.315 0.488

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Notes: Categorical dependent variable, intention to rotate audit rm, coded one, versus intention to retain the incumbent auditor, coded zero; signicant at the *10, * *5, and * * *1 percent levels (onetailed); aeach of the attributes comprising the categories reported in Table I, column 2, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; the attributes location, ability to provide NAS and independence were unable to be factor analysed because they were single attributes; bthe logistic regression was run with the demographics shown in Appendix 1 as proxies for controls, i.e. other factors that may affect the auditor appointment decision; the controls were: (i) length of time in position, (ii) size (population and revenue), (iii) council location, (iv) type of audit rm of incumbent auditor, (v) length of incumbent auditors tenure, (vi) type of councils last audit report, and (vii) the number of bids expected to be received if bids were called now; the only control that was signicant was bids, which indicated the competitiveness of the market; none of the other controls were signicant; therefore, none of the results for the controls are reported; ca positive (negative) coefcient that is signicant ( p , 0.10, one-tailed) indicates that the variable is more important to rotators (retainers); sample size: 123; correct classication: 79.7 percent; x 2 statistic 18.929; prob. , 0.000; Nagelkerke R 2: 21.9 percent; where: intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise; independent variables continuous independent variables; factor scores derived from factor analysing attributes comprising the corresponding attribute category, or attribute mean scores where the category contained a single attribute; single attribute categories are location, ability to provide NAS, and independence

Table VI. Logit model relating auditor attributes to intention to rotate auditors

Table X shows that the model is signicant overall (x 2 statistic 18.211, prob. , 0.000) and the Nagelkerke R 2 is 21.1 percent. The coefcients for technical expertise (Wald 3.400, p , 0.065), and other (Wald 2.830, p , 0.093) are positive and signicant (one-tailed). The other category comprises, inter alia, attributes of audit rm reputation and independence. The sensitivity results support those in the main analysis and, in turn, provide support for the hypothesis that councils predisposed to rotate auditors because of dissatisfaction with the quality of their incumbent are rotating towards a quality auditor where a quality auditor is proxied by technical competence, independence and reputation. 5. Discussion and conclusions The rst purpose of this study was to provide descriptive evidence on what auditor and audit environmental attributes affect auditor appointment decisions in the context of compulsory audit tendering. We found the most important attributes affecting appointment decisions overall (for the total sample) relate to the quality of councils experience with their incumbent auditor; specically the overall quality of audit services provided by the audit rm, the quality of the rms advice to council

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Attribute no.

Capacity-including quality and availability of workforce (100%) 12 The technical qualications of the audit team supervisor(s) (0.251) 11 The technical qualications of the audit team manager(s) (0.246) 10 The technical qualications of the audit engagement partner(s) (0.237) 31 The proposed involvement of the audit manager(s) in the conduct of the audit in terms of estimated audit hours (0.215) 34 The proposed involvement of the audit team supervisor(s) in the conduct of the audit in terms of estimated audit hours (0.191) 22 The proposed involvement of the audit partner(s) in the conduct of the audit in terms of estimated audit hours (0.173) Kaiser-Meyer-Olkin measure of sampling adequacy 0.762 Bartletts test of sphericity: approx. x 2 478.154, (sig.) (0.000) Quality and depth of audit performance and experience (100%) 32 The experience of the audit team supervisor(s) in conducting audits generally(0.247) 29 The experience of the audit manager(s) in conducting audits generally (0.244) 20 The experience of the audit engagement partner(s) in conducting audits generally (0.216) 38 The overall quality of audit services provided by the audit rm (0.193) 39 The quality of the audit rms advice to council management, including management letters, internal control reports (0.186) 37 The ability of the audit partner(s) to meet deadlines (0.182) 47 Details of major audit clients of the audit rm (0.138) 8 Previous experience of the audit rm with your council as an incumbent auditor (0.105) Kaiser-Meyer-Olkin measure of sampling adequacy 0.806 Bartletts test of sphericity: approx. x 2 279.346, (sig.) (0.000) Proposed audit plan (100%) 14 The nature of the proposed audit approach (0.315) 13 The detail and completeness of the proposed audit plan (0.300) 15 The proposed number of hours to conduct the audit (from the beginning of eld work to the audit report date) (0.279) 23 The computer audit capability of the audit rm (0.249) 16 The proposed timing of audit work in terms of the number, duration and approximate date of visits by the audit rm (0.238) Kaiser-Meyer-Olkin measure of sampling adequacy 0.721 Bartletts test of sphericity: approx. x 2 169.104, (sig.) (0.000) Price (100%) 17 The competitiveness of the pricing structure of the audit rm for the provision of audit services (0.583) 18 The audit fee estimate provided by the audit rm is commensurate with the audit work required (0.583) (continued )

Table VII. Sensitivity analysis

Attribute description

Attribute no.

Attribute description

Kaiser-Meyer-Olkin measure of sampling adequacy 0.500 Bartletts test of sphericity: approx. x 2 30.159, (sig.) (0.000) Value-added services (100%) 28 Quality of working relationships with the audit engagement staff (0.415) 27 Quality of working relationship with the audit partner(s) (0.409) 36 The accessibility of the partner(s)-in-charge of the engagement (0.271) 3 The capability of the audit rm to provide non-audit services such as operational audits and/or consulting services (0.219) Kaiser-Meyer-Olkin measure of sampling adequacy 0.620 Bartletts test of sphericity: approx. x 2 151.682, (sig.) (0.000) Technical expertise (100%) 30 The experience of the audit manager(s) in conducting local government audits (0.293) 33 The experience of the audit team supervisor(s) in conducting local government audits (0.286) 21 The experience of the audit engagement partner(s) in conducting local government audits (0.266) 6 The audit rm is considered to be a specialist in local government audit (0.246) 44 Details of other councils currently audited by the audit rm (0.165) Kaiser-Meyer-Olkin measure of sampling adequacy 0.806 Bartletts test of sphericity: approx. x 2 281.107, (sig.) (0.000) Referees (100%) 45 References from senior NSW local council representatives that have experience with the audit rm (0.518) 48 References from major audit clients of the audit rm (0.516) 25 The audit rm is acceptable to the councils regulators (0.295) Kaiser-Meyer-Olkin measure of sampling adequacy 0.547 Bartletts test of sphericity: approx. x 2 40.997, (sig.) (0.000) Tender proposal process (100%) 42 The quality of the audit rms written tender proposal (0.475) 43 The quality of the audit rms oral presentation (0.457) 46 The personal relationships established between the audit rms key people and council management during the course of the tender proposal process (0.335) Kaiser-Meyer-Olkin measure of sampling adequacy 0.585 Bartletts test of sphericity: approx. x 2 72.685, (sig.) (0.000) (continued )

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Attribute no.

Other (100%) 5 The audit rm is a small international or national audit rm (0.211) 9 The reputation of the audit engagement partner(s) (0.203) 40 The audit rm is a large local or regional audit rm (0.194) 4 The audit rm is a Big 4 international audit rm (0.194) 41 The audit rm is a small local audit rm (0.183) 1 The overall reputation of the audit rm (0.179) 24 The audit rm is not involved in embarrassing litigation (0.164) 35 Belief that the audit rm will give the council an unqualied audit report (0.136) 19 The independence of the audit rm from your council (0.128) 2 The reputation of the audit rm in providing audit services to local councils (0.110) 26 The audit rms professional indemnity insurance complies with the minimum requirements of ICAA or CPA Australia (0.089) 7 The audit rm has an ofce in close proximity to the council (0.064) Kaiser-Meyer-Olkin measure of sampling adequacy 0.650 Bartletts test of sphericity: approx. x 2 466.485, (sig.) (0.000)

Notes: Conrmatory factor analysis as per the sample tender specication; each of the attributes comprising the categories reported in Table II, column 1, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; the numbers in parentheses after the attribute descriptions are the factor loadings from the pooled factor analysis

Table VII.

Attribute description

Intention to rotate Price Other

Capacity-including quality and availability of workforce Quality and depth of Proposed audit audit performance plan and experience Valueadded Technical services expertise Referees Tender proposal process

1.000

0.235 * * 1.000 0.661 * * 0.604 * * 0.383 * * 0.662 * * 0.554 * * 0.419 * * 1.000 0.610 * * 0.444 * * 0.663 * * 0.554 * * 0.419 * * 1.000 0.466 * * 0.620 * * 0.510 * * 0.407 * * 1.000 0.475 * * 1.000 0.362 * * 0.435 * * 0.342 * * 0.371 * * 1.000 0.475 * * 1.000 0.490 * * 0.507 1.000 0.442 1.000 0.389 * * 0.552 0.361 * * 0.413 * * 0.323 * * 0.493 0.493 0.237 0.336 * * 0.567 0.336 * * 0.440 * *

Intention to rotate Capacity-including quality and availability of workforce Quality and depth of audit performance and experience Proposed audit plan Price Value-added services Technical expertise Referees Tender proposal process Other

0.221 * 0.190 * 0.114 0.153 0.310 * * 0.182 *

0.137 0.346 * * *

Notes: Correlation is signicant at the *0.05 and * *0.01 levels; n 123; where: intention to rotate categorical dependent variable, coded one for

intention to rotate, zero otherwise; independent variables continuous independent variables, factor scores derived from factor analysing attributes comprising the corresponding attribute category

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Table VIII. Sensitivity analysis, Spearman correlations among dependent variable intention to rotate and independent variables

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Factor scorea Capacity-including quality and availability of workforce Quality and depth of audit performance and experience Proposed audit plan Price Value-added services Technical expertise Referees Tender proposal process Other

Mean value of factor scoresa Potential rotators Potential retainers (n 27) (n 96) 0.4004417091 0.4165904500 0.3732064391 0.2052784506 0.2400328353 0.5337875949 0.3248694263 0.2794104523 0.5627840704 2 0.1126242307 2 0.1171660641 2 0.1049643110 2 0.0577345642 2 0.0675092349 2 0.1501277611 2 0.0913695261 2 0.0785841897 2 0.1582830198

Test results Signicanceb t-statistic (one tailed) 2.401 2.503 2.231 1.210 1.418 3.261 1.932 1.655 3.455 0.018 * * 0.014 * * 0.028 * * 0.229 0.159 0.001 * * * 0.056 * 0.101 0.001 * * *

134

Table IX. Sensitivity analysis

Notes: Results of t-tests of mean differences between rotators and retainers; signicant at the *10, * *5, and * * *1 percent levels (one-tailed); aeach of the attributes comprising the categories reported in Table II, column 1, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; ba positive (negative) t-statistic that is signicant ( p , 0.10, one-tailed) indicates that the variable is more important to rotators (retainers); where: intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise; independent variables continuous independent variables, factor scores derived from factor analysing attributes comprising the corresponding attribute category

management, and the ability of the audit partner(s) to meet deadlines. Also of high importance are the reputation of the rm (both in providing audit services to councils and overall), independence, technical expertise and the experience of the audit team in conducting local government audits and audits generally. The least important attributes included the size and type of the audit rm, the ability to provide non-audit services, and location in terms of proximity to the council. The second purpose of the study was to examine whether the attributes that affect the appointment of a new auditor (a rotation decision) are consistent with, or different from, those that affect the reappointment of the incumbent auditor (a retention decision). We found that respondents predisposed to rotate were more highly sensitised to the importance of the 48 individual attributes than those predisposed to retain. We also found that three attribute groupings were considered more important to rotators; technical competence, audit rm reputation and independence. These ndings are consistent with the hypothesis that councils predisposed to rotate auditors because of dissatisfaction with the quality of their incumbent will rate attributes proxying for a quality auditor as more important than councils predisposed to retain their incumbent. Given the predominance in our sample of councils intending to retain the incumbent, these ndings also support the premise that satisfaction with the quality of the incumbent auditor is associated with retention. Several conclusions may be drawn from these ndings. The rst is the importance of attributes associated with a quality auditor in councils appointment decisions. Prior studies of attributes affecting auditor appointment or reappointment decisions in the voluntary audit tendering context have typically found technical competence to be the most important (Addams and Allred, 2002; Beattie and Fearnley, 1995, Deloitte,

Factor scorea,b Constant Capacity-including quality and availability of workforce Quality and depth of audit performance and experience Proposed audit plan Price Value-added services Technical expertise Referees Tender proposal process Other

Coefcient 2 1.573 0.230 0.005 0.123 2 0.012 2 0.382 0.772 2 0.161 2 0.035 0.644

Wald statistic 31.779 0.303 0.000 0.085 0.001 0.967 3.400 0.220 0.011 2.830

Sig. (one-tailed)c 0.000 0.582 0.990 0.771 0.970 0.326 0.065 * 0.639 0.916 0.093 *

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Notes: Categorical dependent variable, intention to rotate audit rm, coded one, versus intention to retain the incumbent auditor, coded zero; signicant at the *10, * *5, and * * *1 percent levels (one-tailed); aeach of the attributes comprising the categories in Table II, column 1, were forced into one factor; the extraction method is principal components analysis; the orthogonal rotation method used is Varimax with Kaiser normalisation; bthe logistic regression was run with the demographics shown in Appendix 1 as proxies for controls, i.e. other factors that may affect the auditor appointment decision; the controls were: (i) length of time in position, (ii) size (population and revenue), (iii) council location, (iv) type of audit rm of incumbent auditor, (v) length of incumbent auditors tenure, (vi) type of councils last audit report, and (vii) the number of bids expected to be received if bids were called now; the only control that was signicant was bids, which indicated the competitiveness of the market; none of the other controls were signicant; therefore, none of the results for the controls are reported; c a positive (negative) coefcient that is signicant ( p , 0.10, one-tailed) indicates that the variable is more important to rotators (retainers); sample size: 123; correct classication: 78.9 percent; x 2 statistic 18.211; prob. , 0.000; Nagelkerke R 2: 21.1 percent; where: intention to rotate categorical dependent variable, coded one for intention to rotate, zero otherwise; independent variables continuous independent variables, factor scores derived from factor analysing attributes comprising the corresponding attribute category

Table X. Sensitivity analysis logit model relating auditor attributes to intention to rotate auditors

Haskins and Sells, 1978). We also nd technical competence to be important. However, we nd further that other attributes associated with a quality auditor, specically reputation, independence, technical expertise and experience (including industry experience), are important both in appointment decisions overall and to councils seeking to rotate their incumbent. Our ndings are consistent with the literature that denes audit quality generally in these terms (DeAngelo, 1981a; Herrbach, 2001; Moizer, 1997), and suggest that audit quality considerations in the context of compulsory audit tendering are no less important than in the voluntary tendering context. The second conclusion is that, although one audit fee attribute (the fee is commensurate with the work required) ranked highly in importance, the other (the competitiveness of the fee) ranked much lower. The introduction of compulsory audit tendering to NSW local councils in 1993 had the effect of decreasing fees to a relatively common level across competing rms, such that fee competitiveness is not an important attribute in subsequent tenders. By contrast with the context of voluntary tendering where fee minimization is a signicant motivation for tendering, and fee considerations are likely to be more important than quality considerations (Beattie and Fearnley, 1995), we nd that fees are less important than audit quality attributes in auditor appointment in the compulsory audit tendering context.

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These two conclusions allow the third that compulsory audit tendering is not associated with impairment of audit quality or auditor independence. It has been debated whether compulsory tendering might impair quality or independence because of the pressure it can place on fee competition and on its association with long tenure periods. We nd no evidence of this. By contrast, we nd that clients (here, councils) value the importance of, and are likely to appoint auditors that are reputable, independent, have audit teams with technical competence and expertise, and that provide quality services to the council. We nd that clients (councils) intending to retain their incumbent auditor do so because of satisfaction with the quality of their incumbent; and that clients (councils) that intend to rotate their auditor are seeking to appoint a quality auditor, where quality is proxied by technical competence, reputation and independence. These ndings have implications for regulators generally. The ndings suggest that, should existing legislation requiring compulsory audit partner rotation prove infeasible or ineffective in maintaining audit quality and auditor independence in specic audit markets, compulsory audit tendering may be a viable alternative, capable of providing such quality and independence. Our ndings also have implications for the regulators of councils in NSW who provide a sample tender specication to direct councils auditor appointment decisions but have no systematic evidence on how councils weight criteria in the specication. Our results show that councils place greater importance on the expertise and experience of the audit team than they do on technical qualications; and on reputation and independence than on price or value-added services. Our results also suggest that several criteria given prominence in the specication (such as references, details of other councils and clients audited, audit time, number of visits, computer audit capability) rank lowly in importance in councils decisions. These ndings allow regulators to re-evaluate and potentially revise the specication. Our ndings also have implications for audit rms at tender. Tendering is costly and our results allow rms to direct their tenders toward those attributes most important to councils. For example, as noted previously, councils place greatest importance on the overall quality of services provided by the audit rm, the quality of advice to council management, and the ability of the audit partner(s) to meet deadlines. Also of greater importance are the quality of working relationships with the audit partner(s) and the audit engagement staff, and the accessibility of the partners(s). These attributes are more available to councils about their incumbent auditors than about new auditors. Nonetheless, their importance suggests that non-incumbent tenderers might seek to provide evidence on these attributes. Although the tender specication does not address these attributes directly, it does allow tenderers to provide any other information they wish to support the application. Our ndings suggest that evidence of the accessibility of the audit partner, over and above the formal hours of the partners involvement in the audit, might be usefully included in other information supporting the tender. 6. Limitations and future research A limitation of our study is that we use a dichotomous dependent variable of preferred intention to appoint a new auditor or reappoint the incumbent. This is consistent with the decision that has to be made in practice and has literature support and precedent in prior studies. However, a dichotomous measure precludes analysis based on the strength of preference that might have allowed ner insights into the attributes

affecting the preference. Additionally, we used preferred intention to proxy for the actual decision. While this has support in the behavioural literature that shows intention precedes behaviour, it remains a proxy and may have the potential to introduce error of validity or measurement to the dependent variable. Future research could usefully examine the relationship between the attributes that our study nds to be important in the intention to retain or rotate auditors and the attributes that are important for actual appointment/reappointment decisions. This relationship may be examined through interviews with council nance managers, or through observational research. Given the importance of audit quality attributes in the appointment decision and the high rate of auditor retention in the compulsory audit tendering context, future research could also usefully be conducted into the association between attributes of audit service quality and auditor retention in this context.
Notes 1. Tenders are a reverse auction (Beattie and Fearnley, 1998b) whereby the buyers (local councils in this study) put services out to tender. Audit tendering in NSW local government reects the third of three types of auctions suggested by Cripps and Ireland (1994), i.e. the submission of a joint price and quality plan with the tender allocated to the lowest priced plan that satises an unknown quality threshold. The other two auction types are submission and evaluation of the quality plan prior to bidding and price bidding prior to quality tests (Cripps and Ireland, 1994). 2. This is the case in the audit market in NSW local government. The market is dominated by mid-tier, regional and local audit rms which have one specialist local government audit partner for each ofce (if the audit rm has multi-ofces). Even in the two Big N rms operating in the market, there is only one local government specialist audit partner for each ofce, with the same partner signing the audit report for the last three tenders, or 18 years. Hence audit rms in markets similar to ours are unlikely to have the capacity to rotate audit partners. 3. Additionally, Blouin et al. (2007), in their study of forced auditor rotation of Arthur Andersens clients, found no evidence that mandatory auditor rotation improves nancial reporting or earnings quality. 4. There is debate as to whether compulsory audit tendering is associated with improved or impaired audit quality. Compulsory audit tendering is argued to improve auditor independence because it introduces a mandatory tenure period which means that the auditor faces no dismissal risk for the period and can be more independent of management (Communale and Sexton, 2005). At the end of the tenure period, the client may change auditors meaning that the quality of the predecessors audit will be subject to scrutiny (Petty and Cuganesan, 1996; Vanstraelen, 2000, p. 425). As the incumbent cannot assume reappointment, the potential for their audit to be scrutinized by a new auditor is an incentive to maintain independence and audit quality. This scrutiny is likely to be intense because new auditors have an incentive to provide superior service in the initial years of engagement to demonstrate their ability to deliver a quality audit (Craswell et al., 1995). However, compulsory audit tendering is argued to impair audit quality because it is associated with signicant audit fee reductions which may impair auditor independence. If independence is compromised, there is a reduced likelihood that auditors will report any irregularities or issue an audit modication (Lennox, 2005; Barkess and Simnett, 1994), hence resulting in lower audit quality. Compulsory audit tendering is also associated with high auditor retention rates that introduce long periods of auditor tenure, a familiarity threat to auditor independence, and hence the potential to lower audit quality. 5. The sample tender specication itself is not a public document; however it is available in the invitations issued by councils for the tender of audit services, which are public documents.

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While councils show some variation in the specic wording or format of their tender specications, the sample specication is consistently inuential therein. For example, the tender specications for Willoughby City Council (a Sydney Metropolitan Council with an annual budget of $85m and some 30,000 rate assessments in 2006/2007) follow the sample tender specication closely (in its most recent invitation to tender for the six-year period 2007-2013). The seven assessment criteria listed in Willoughby City Councils specications are identical in wording to the rst seven categories in column 1 of Table II. The tender specications for Upper Lachlan Shire Council (a rural NSW council with annual revenues of $25m and 5,700 rate assessments) vary the wording but cover the same assessment criteria as those in the sample specication. Please refer to: www.willoughby.nsw.gov.au/IgnitionSuite/ uploads/docs/Tender%20Specications%20for%20Auditing%20Services.pdf (accessed 19 May 2010). 6. Tender specications are relevant in all contexts of private and public sector tendering such that the results of our study will also be important in wider private sector jurisdictions in which mandatory audit tendering and tenure periods are used or may be considered. 7. While the denitions of demand, supply and environmental characteristics broadly remain the same across the auditor choice literature, the attributes listed under each denition vary a little. See, for example, the classications used in DeAngelo (1981a) and Sands and Huang (2002) versus those used in OKeefe and Westort (1992). 8. Views on whether rotation is a one-stage or two-stage decision process vary. Sands and Huang (2002, pp. 168-9) note that the earlier audit literature (Burton and Roberts, 1967; Bedingeld and Loeb, 1974) regarded rotation as a one-stage decision, considering the termination of the incumbent auditors appointment and the selection of the replacement auditor to be a one-stage decision to overcome the mismatch of audit services demanded and offered. More recent studies (Williams, 1988; Beattie and Fearnley, 1995, 1998a) have recognised that terminating the incumbent auditors appointment and hiring the replacement auditor are two separate events (Sands and Huang, 2002, p. 169). Blouin et al. (2007, p. 622) support the two-stage process, but note that prior auditing change research has been unable to examine the two actions separately and, therefore, has focused on the joint decision. Support for a two-stage decision process also includes Eichenseher and Shields (1983), Francis and Wilson (1988), Beattie and Fearnley (1998b), Sands and Huang (2002) and Sankaraguruswamy and Whisenant (2004). 9. Sands and McPhail (2003) examined whether selection criteria, and the importance of the criteria, differed in the decision to appoint a new auditor compared to the decision to reappoint the incumbent. Sands and McPhail examined nine attributes; technical competence, client orientation, perceived quality of audit service, level of audit fees, reliability and courteous accessibility, effective preparation and communication of the audit submission, range of non-audit services, industry specialization, and geographical proximity. They found that seven of the nine criteria were considered of equal importance for both the new auditor appointment and incumbent reappointment decisions. Only two criteria differed, with audit fee and effective preparation and communication of the audit submission more important to rotators. 10. There are two widely accepted methodological approaches to examine the impact of demand, supply and environmental attributes on auditor appointment decisions; a behavioural approach and an economic approach. Research using the behavioural approach seeks to understand auditor choice decisions by asking those involved, predominantly via survey questionnaires (Burton and Roberts, 1967; Bedingeld and Loeb, 1974; Casabona and Barbera, 1987; Addams and Allred, 2002), interviews (Beattie and Fearnley, 1998b) or by evaluating Form 8-K auditor change reasons (Sankaraguruswamy and Whisenant, 2004), about the relative importance of a range of qualitative or behavioural attributes in their decision making. Demand side attributes (client characteristics) are not examined in this paper. Demand side attributes are normally examined in economic modeling studies using agency

and costly contracting theories. Examples include client size, level of gearing/leverage, management composition/share ownership, nancial condition, client expansion/growth and share issuances by the client (DeAngelo, 1981a, p. 133; Sands and Huang, 2002, p. 168). 11. The questionnaire was developed by the lead author for her PhD. To ensure that the questionnaire comprehensively captured attributes perceived to be important to auditor appointment decisions in the compulsory audit tendering context of NSW local councils, both the sample tender specication and the auditor choice literature were used to develop the survey questionnaire for two reasons. First, the descriptions used in the sample tender specication were brief, imprecise and/or incomplete. Second, the auditor choice literature, while extensive, did not have a comprehensive questionnaire available as the majority of studies are practitioner based and feature a limited number of attributes. Notable exceptions include Beattie and Feanleys (1995) study, which used a survey questionnaire including approximately 28 items and the Deloitte, Haskins and Sells (1978) study, which used a survey featuring approximately 24 attributes. 12. The question numbers in column 5 are not sequential as the attributes were randomly distributed in the questionnaire. 13. The respondents were also given a non-applicable option at the end of the scale. Distinguishing between a neutral and non-applicable answer is important. Neutral means the respondent knows and understands the attribute but is unaffected by its importance. Non-applicable means that the respondent either does not know or the attribute is irrelevant. 14. A complete mail-out was necessary as the responses were anonymous and unidentiable. 15. No particularities in the economic conditions or the circumstances affecting local government were present at the time of the survey to suggest any possible history effects on responses to the questionnaire. 16. The modications were not associated with rotation. Of the 27 councils whose respondents indicated an intention or preference to rotate auditors at the next tender, only two received a modied audit report at their last audit. 17. The nding that a Big 4 audit rm is not important to local councils is not surprising given that (i) only two of the Big 4 audit rms conduct NSW local council audits, that is, PricewaterhouseCoopers and KPMG, and (ii) only the rst of these is an industry specialist, with KPMG auditing only a few NSW local councils. 18. Although not reported in Table VI, Exp(B), the proportionate change in odds, was greater than one for all three signicant factor scores/attributes. Consistent with the positive coefcient sign, this indicates that the greater the score on the predictor variable (i.e. the higher the importance rating of the factor/attribute), the greater the odds of the outcome (i.e. rotation) occurring. References Addams, H.L. and Allred, A. (2002), Why the fastest growing companies hire and re their auditors, CPA Journal, Vol. 72, May, pp. 62-3. Addams, H.L. and Davis, B. (1994), Why the fastest growing companies in America hired and red their auditors. Privately held companies report reasons for selecting and switching auditors, CPA Journal, Vol. 64, August, pp. 38-41. Addams, H.L. and Davis, B. (1996), Publicly and privately held companies report reasons for selecting and switching auditors, CPA Journal, Vol. 66 No. 4, pp. 74-5. Ashton, A.H. (1991), Experience and error frequency knowledge as potential determinants of expertise, The Accounting Review, Vol. 66 No. 2, pp. 218-39. Barkess, L. and Simnett, R. (1994), The provision of other services by auditors: independence and pricing issues, Accounting & Business Research, Vol. 30, September, pp. 261-89.

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Appendix 1

Demographic 45 30 48 87 22 (17.9) 14 (11.4) 82 26 15 31 92 31 9 (7.3) 64 (52.0) 19 79 44 115 8 35 73 15 (6.5) (28.5) (59.3) (12.2) 2 3 22 2 (7.4) (11.1) (81.5) (7.4) (15.4) (64.2) (35.8) (93.5) 3 17 10 25 (11.1) (63.0) (37.0) (92.6) 3 (11.1) 13 (48.1) 6 (6.2) 51 (53.1) 16 (16.7) 62 (64.6) 34 (35.4) 90 (93.8) 6 (6.2) 32 (33.3) 51 (53.1) 13 (13.5) (66.7) (21.1) (12.2) (25.2) (74.8) (25.2) 18 5 4 8 19 8 (66.7) (18.5) (14.8) (29.6) (70.4) (29.6) 64 (66.7) 21 (21.9) 11 (11.5) 23 (24.0) 73 (76.0) 23 (24.0) 4 (14.8) 10 (10.4) 6 (22.2) 16 (16.7) (36.6) (24.4) (39.0) (70.7) 10 7 10 17 (37.0) (25.9) (37.0) (63.0) 35 (36.5) 23 (24.0) 38 (39.6) 70 (72.9)

Categories

Frequency total (%) (n 123)

Frequency rotators (%) Frequency retainers (%) (n 27) (n 96)

Length of time in position

Less than 3 years 4-6 years Greater than 6 years Approximate population of councils region Up to 50, 000 residents 50,000-100,000 residents Greater than 100,000 residents Approximate total revenue of council Up to $50m $50m to $100m Greater than $100m Location of council Metropolitan Non-metropolitan Type of audit rm of incumbent auditor Big N international audit rm National audit rm Large local or regional rm Small local rm Length of incumbent auditors tenure One tender period Two tender periods Type of councils last audit report Unmodied audit report Modied audit report Number of bids expected to be received if bids One to three bids were called now Four to six bids Greater than six bids

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Table AI. Demographics of sample

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Attribute no. Attribute descriptiona 1.559 (2 0.122) 1.305 (2 0.194) 1.879 (0.063) * 1.174 (2 0.243) 2.031 (0.044) * * 2.639 (0.009) * * * 3.825 (0.000) * * * 3.160 (0.002) * * * 1.397 (2 0.165) (continued )

Table AII. Importance ratings for all attributes for total sample, rotators and retainers, and tests of mean differences between rotators and retainers

Appendix 2

Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96)

38

The overall quality of audit services provided by the audit rm

39

37

19

30

21

18

2.64 (3.00) 0.514 (1-3) The quality of the audit rms advice to council management, 2.63 (3.00) 0.518 including management letters, internal control reports (1-3) The ability of the audit partner(s) to meet deadlines 2.60 (3.00) 0.674 (2 1-3) The reputation of the audit rm in providing audit services to local 2.53 (3.00) 0.693 councils (0-3) The independence of the audit rm from your council 2.45 (3.00) 0.861 (2 2-4) The overall reputation of the audit rm 2.37 (2.00) 0.771 (2 1-3) The experience of the audit manager(s) in conducting local 2.53 (2.00) 0.721 government audits (2 2-3) The experience of the audit engagement partner(s) in conducting local 2.33 (2.00) 0.730 government audits (2 2-3) The audit fee estimate provided by the audit rm is commensurate 2.24 (2.00) 0.725 with the audit work required (2 1-3)

2.78 (3.00) 0.506 (1-3) 2.74 (3.00) 0.447 (2-3) 2.81 (3.00) 0.396 (2-3) 2.67 (3.00) 0.555 (1-3) 2.74 (3.00) 0.526 (1-3) 2.70 (3.00) 0.465 (2-3) 2.78 (3.00) 0.424 (2-3) 2.70 (3.00) 0.465 (2-3) 2.41 (3.00) 0.747 (0-3)

2.60 (3.00) 0.513 (1-3) 2.59 (3.00) 0.535 (1-3) 2.54 (3.00) 0.724 (2 1-3) 2.49 (3.00) 0.725 (0-3) 2.36 (3.00) 0.919 (2 2-4) 2.27 (2.00) 0.814 (2 1-3) 2.21 (2.00) 0.739 (2 2-3) 2.22 (2.00) 0.757 (2 2-3) 2.19 (2.00) 0.715 (2 1-3)

Attribute no. Attribute descriptiona 2.619 (0.010) * * * 0.680 (2 0.498) 0.984 (2 0.327) 1.029 (2 0.305) 2.306 (0.023) * * 2.588 (0.011) * * 2.444 (0.016) * * 2.138 (0.035) * * 0.223 (2 0.824) (continued )

Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96)

20

The experience of the audit engagement partner(s) in conducting audits generally

27

13

28

36

33

29

10

26

2.23 (2.00) 0.745 (0-4) Quality of working relationship with the audit partner(s) 2.23 (2.00) 0.913 (2 2-4) The detail and completeness of the proposed audit plan 2.20 (2.00) 0.826 (2 2-3) Quality of working relationships with the audit engagement staff 2.17 (2.00) 0.930 (2 2-3) The accessibility of the partner(s)-in-charge of the engagement 2.17 (2.00) 0.903 (2 2-3) The experience of the audit team supervisor(s) in conducting local 2.15 (2.00) 0.865 government audits (2 2-3) The experience of the audit manager(s) in conducting audits generally 2.15 (2.00) 0.732 (0-4) The technical qualications of the audit engagement partner(s) 2.13 (2.00) 0.877 (0-3) The audit rms professional indemnity insurance complies with the 2.11 (2.00) 1.115 minimum requirements of ICAA or CPA Australia (2 2-3)

2.56 (3.00) 0.506 (2-3) 2.33 (3.00) 0.832 (0-3) 2.33 (2.00) 0.620 (1-3) 2.33 (3.00) 0.832 (0-3) 2.52 (3.00) 0.700 (1-3) 2.52 (3.00) 0.580 (1-3) 2.44 (2.00) 0.577 (1-3) 2.44 (3.00) 0.847 (0-3) 2.15 (2.00) 1.027 (0-3)

2.14 (2.00) 0.777 (0-4) 2.20 (2.00) 0.936 (2 2-4) 2.16 (2.00) 0.875 (2 2-3) 2.12 (2.00) 0.954 (2 2-3) 2.07 (2.00) 0.932 (2 2-3) 2.04 (2.00) 0.905 (2 2-3) 2.06 (2.00) 0.751 (0-4) 2.04 (2.00) 0.870 (0-3) 2.09 (2.00) 1.143 (2 2-3)

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Table AII.

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Attribute no. Attribute descriptiona 1.034 (2 0.303) 0.293 (2 0.770) 2.152 (0.033) * * 2.499 (0.014) * * 0.677 (2 0.500) 2.085 (0.039) * * 1.741 (0.084) * 1.886 (0.062) * 1.753 (0.082) * (continued )

Table AII.
Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96) 2.30 (3.00) 1.137 (2 2-3) 2.15 (2.00) 1.134 (2 1-3) 2.37 (3.00) 0.792 (0-3) 2.41 (2.00) 0.636 (1-3) 2.11 (2.00) 0.641 (1-3) 2.30 (2.00) 0.724 (0-3) 2.22 (2.00) 0.751 (0-3) 2.19 (2.00) 0.786 (0-3) 2.04 (2.00) 0.759 (0-3) 2.05 (2.00) 1.070 (2 3-3) 2.07 (2.00) 1.190 (2 3-3) 1.98 (2.00) 0.846 (0-3) 1.94 (2.00) 0.916 (2 2-3) 2.00 (2.00) 0.781 (0-3) 1.88 (2.00) 0.976 (2 2-3) 1.90 (2.00) 0.888 (2 2-4) 1.77 (2.00) 1.061 (2 2-3) 1.74 (2.00) 0.785 (0-4)

The audit rm is considered to be a specialist in local government audit

25

11

14

17

12

32

44

2.11 (2.00) 1.085 (2 3-3) The audit rm is acceptable to the councils regulators 2.09 (2.00) 1.174 (2 3-3) The technical qualications of the audit team manager(s) 2.07 (2.00) 0.847 (0-3) The nature of the proposed audit approach 2.04 (2.00) 0.847 (2 2-3) The competitiveness of the pricing structure of the audit rm for the 2.02 (2.00) 0.752 provision of audit services (0-3) The technical qualications of the audit team supervisor(s) 1.97 (2.00) 0.940 (2 2-3) The experience of the audit team supervisor(s) in conducting audits 1.97 (2.00) 0.868 generally (2 2-4) The reputation of the audit engagement partner(s) 1.86 (2.00) 1.019 (2 2-3) Details of other councils currently audited by the audit rm 1.80 (2.00) 0.786 (0-4)

Attribute no. Attribute descriptiona 1.081 (2 0.282) 1.500 (2 0.136) 1.633 (2 0.105) 0.909 (2 0.365) 0.461 (2 0.645) 2.226 (0.028) * * 1.454 (2 0.148) 1.088 (2 0.279) 2.177 (0.031) * * (continued )

Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96)

22

31

34

45

16

24

43

42

15

The proposed involvement of the audit partner(s) in the conduct of the 1.80 (2.00) 0.905 audit in terms of estimated audit hours (2 2-4) The proposed involvement of the audit manager(s) in the conduct of 1.76 (2.00) 0.961 the audit in terms of estimated audit hours (2 2-4) The proposed involvement of the audit team supervisor(s) in the 1.76 (2.00) 1.019 conduct of the audit in terms of estimated audit hours (2 3-3) References from senior NSW local council representatives that have 1.73 (2.00) 1.017 experience with the audit rm (2 2-4) The proposed timing of audit work in terms of the number, duration 1.73 (2.00) 1.056 and approximate date of visits by the audit rm (2 2-3) The audit rm is not involved in embarrassing litigation 1.72 (2.00) 1.339 (2 3-4) The quality of the audit rms oral presentation 1.67 (2.00) 1.020 (2 1-4) The quality of the audit rms written tender proposal 1.64 (2.00) 0.933 (2 2-3) The proposed number of hours to conduct the audit (from the 1.62 (2.00) 1.251 beginning of eld work to the audit report date) (2 3-3)

1.96 (2.00) 0.980 (2 1-3) 2.00 (2.00) 1.000 (2 1-3) 2.04 (2.00) 0.854 (0-3) 1.89 (2.00) 1.013 (0-4) 1.81 (2.00) 1.145 (2 2-3) 2.22 (3.00) 1.086 (0-3) 1.93 (2.00) 1.072 (2 1-4) 1.81 (2.00) 0.834 (0-3) 2.07 (2.00) 1.207 (2 2-3)

1.75 (2.00) 0.883 (2 2-4) 1.69 (2.00) 0.944 (2 2-4) 1.68 (2.00) 1.051 (2 3-3) 1.69 (2.00) 1.019 (2 2-4) 1.71 (2.00) 1.035 (2 2-3) 1.58 (2.00) 1.374 (2 3-4) 1.60 (2.00) 1.000 (2 1-4) 1.59 (2.00) 0.958 (2 2-3) 1.49 (2.00) 1.240 (2 3-3)

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Table AII.

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Attribute no. Attribute descriptiona 1.708 (2 0.090) 2.688 (0.008) * * * 0.418 (2 0.677) 1.583 (2 0.116) 2 2.000 (0.048) * * 1.397 (2 0.165) 2 0.425 (2 0.672) 1.376 (2 0.171) 2.255 (0.026) * * (continued )

Table AII.
Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96) 1.85 (2.00) 0.949 (0-3) 1.96 (2.00) 0.898 (0-4) 1.52 (2.00) 1.122 (2 2-3) 1.48 (2.00) 0.802 (0-3) 0.44 (0.00) 1.423 (2 3-3) 1.15 (1.00) 1.725 (2 3-3) 0.52 (0.00) 1.156 (2 1-3) 0.96 (0.00) 1.786 (2 3-4) 0.81 (1.00) 1.178 (2 2-3) 1.48 (2.00) 1.015 (2 2-3) 1.39 (2.00) 1.009 (2 2-4) 1.41 (1.50) 1.261 (2 2-3) 1.09 (1.00) 1.197 (2 2-4) 1.11 (1.00) 1.569 (2 3-4) 0.60 (1.00) 1.803 (2 3-4) 0.67 (1.00) 1.702 (2 3-4) 0.34 (0.00) 2.137 (2 3-4) 0.11 (0.00) 1.486 (2 3-4)

23

The computer audit capability of the audit rm

48

47

46

35

40

1.56 (2.00) 1.009 (2 2-3) References from major audit clients of the audit rm 1.51 (2.00) 1.011 (2 2-4) The capability of the audit rm to provide non-audit services such as 1.43 (2.00) 1.229 operational audits and/or consulting services (2 2-3) Details of major audit clients of the audit rm 1.18 (1.00) 1.131 (2 2-4) Previous experience of the audit rm with your council as an 0.97 (1.00) 1.557 incumbent auditor (2 3-4) The personal relationships established between the audit rms key 0.72 (1.00) 1.794 people and council management during the course of the tender (2 3-4) proposal process The audit rm has an ofce in close proximity to the council 0.63 (1.00) 1.595 (2 3-4) Belief that the audit rm will give the council an unqualied audit 0.48 (0.00) 2.074 report (2 3-4) The audit rm is a large local or regional audit rm 0.27 (0.00) 1.449 (2 3-4)

Attribute no. Attribute descriptiona 0.07 (0.00) (2 0.190) 2.734 (0.007) * * * 1.610 (2 0.110) 0.32 (0.00) 1.319

Total sample Mean (median) SD (Min.-max.) (n 123) Rotators Mean (median) SD (Min.-max.) (n 27) Test of differences of means t-statistic (sig., two-tailed)b Retainers Mean (median) SD (Min.-max.) (n 96)

41

The audit rm is a small local audit rm

The audit rm is a small international or national audit rm

1.238 (2 2-4) 0.00 (0.00)

The audit rm is a Big 4 international audit rm

2 0.24 (0.00) 1.385 (2 3-4) 2 0.71 (0.00) 1.561 (2 3-4) 2 0.76 (0.00) 1.554 (2 3-4) 1.271 (2 2-3) 2 0.33 (0.00) 1.209 (2 3-1) 1.418 (2 3-4) 2 0.91 (2 1.00) 1.583 (2 3-4) 2 0.88 (2 1.00) 1.624 (2 3-4)

Notes: Generic question is the importance of this attribute in your auditor appointment decision; response scale is 2 3 (very unimportant), 2 2 (unimportant), 2 1 (somewhat unimportant), 0 (neutral), 1 (somewhat important), 2 (important), 3 (very important), not applicable; aattributes are ranked in decreasing order of importance for the total sample; ba positive (negative) t-statistic that is signicant ( p , 0.10, two-tailed) indicates that the variable is more important to rotators (retainers)

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Table AII.