Summary

3.4.4.1 Findings

The pattern of association between those responsible for financial reporting quality and

restatements differs for restatements that correct unintentional error and restatements that correct

intentional misstatement. CFO expertise and influence, rather than audit committee expertise or

auditor quality, are related to restatements that correct unintentional error. The odds of such

restatements are more than one half (one third) less for companies with CFOs with greater

financial expertise (influence). However, this difference in the odds of restatement is only

observable when the model used to test associations with restatements that correct unintentional

errors includes the interactions of major organizational change (e.g., restructuring or merger and

acquisition activity) with CFO financial expertise and CFO influence. In the absence of major

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in CFO financial expertise and influence. This relationship is consistent with CFOs with greater

expertise and influence having greater strategic management responsibilities and concentrating

their efforts on those responsibilities rather than financial reporting. However, in the presence of

organizational change, the odds of restatement to correct unintentional error increases (does not

increase) for companies without CFOs with financial expertise. This finding suggests that CFOs

with greater financial expertise and influence are better able than CFOs with lesser financial

expertise and influence to change financial reporting systems as required in response to change.

While both CFO financial expertise and influence are associated with restatement to

correct unintentional error, it is CFO financial expertise and not CFO influence that is associated

with restatements that correct unintentional error more strongly than with restatements that

correct intentional misstatement. This is consistent with CFOs with greater power not only being

better able to influence the personnel, system and business process changes so as to prevent

unintentional financial reporting error, but also being better able to stand up to CEOs and resist

intentional misstatement.

In contrast, I find that restatements that correct intentional misstatement are decreasing in

audit committee financial expertise. This finding is consistent with Keune and Johnstone’s

(2012, 1641) finding that “that audit committees with greater financial expertise are less likely to

allow managers to waive material misstatements compared to audit committees with less

expertise”. While Keune and Johnstone (2012) investigate negotiations to resolve already

detected misstatements, my study is not so restricted. I find no support for my prediction that

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correct unintentional error43. I conclude from my findings that while audit committees with greater financial expertise may ask more probing questions and play a bigger role in negotiations

between management and external auditors, that greater financial expertise is not necessarily

related to securing greater resourcing for financial reporting systems and personnel.

The relationships between restatements that correct unintentional error and CFO financial

expertise, CFO influence, and organizational change observed with Model 2 tests are not

mimicked by associations between internal control quality and CFO characteristics and

organizational change in Model 1 tests. This would be surprising had Rice and Weber (2012,

811) not found that “only a minority of … firms acknowledge their existing control weaknesses

during their misstatement periods, and that this proportion has declined over time”. Hence, I do

not conclude that CFO characteristics are not associated with internal control quality but rather

that Model 1 results are affected by internal control quality measurement error. In this study,

auditors report ineffective control in SOX 404 reports as originally filed or amended for only 20

companies of the 121 (16.5%) that restate to correct unintentional error.

Finally, in tests of a theoretical model that includes CFO financial expertise and influence

and audit committee financial expertise, I find no evidence that auditor quality, measured by both

firm and engagement office size, is associated with either restatement to correct unintentional

error or restatement to correct intentional misstatement. This finding adds to the mixed results of

the small number of recent restatement studies that include auditor quality as either a test or

control variable (Cohen et al. 2014, Ettredge et al. 2014, Francis and Michas 2013, Francis et al.

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In their study of the interaction of audit committee financial expertise and status, Badolato et al. (2014, 12) test the association of audit committee financial expertise and restatements coded by Audit Analytics as errors as a “Falsification test” to “rule out the potential for false positives”. While they do not find an association between restatement to correct error and audit committee financial expertise and, it is not clear if their sample includes quarterly restatements,Badolato et al. (2014) also find no association between audit committee financial expertise and irregularities unless the audit committee also has high status relative to management.

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2013, Newton et al. 2013). Most of these studies find restatements decreasing in auditor quality,

at least for the more severe restatements. However, consistent with the results of this study,

Cohen et al. (2014) (the only one of these studies that includes audit committee expertise in tests)

predict, but do not find, a negative association between auditor quality (included as a control

variable and proxied by auditor size) and restatement.

3.4.4.2 Limitations and opportunities for future research

This study of determinants of unintentional error in audited financial statements of public

companies has several limitations. First, interpreting the moderating effects of CFO financial

expertise and CFO influence on the association between organizational change and restatements

that correct unintentional error is challenging when using logistic and mediated logistic models.

Structural equation modeling (SEM) may lead to additional insights in future research. Secondly,

either the measure of auditor quality or the correlation between the various audit control

variables may explain the failure to find evidence to support the hypotheses of association

between auditor quality and restatements. In future studies, results of PCAOB inspections and

audit firms’ internal engagement quality reviews (Bell et al. 2013, Epps and Messier 2007), and

self-regulated peer reviews (Casterella et al. 2009), where data is available, may better proxy for

auditor quality. Using an audit fee model to predict abnormal audit fees may permit a more

nuanced exploration of auditor measure associations. Finally, this is a small sample study. The

decision to include in the sample only companies with auditor’s SOX 404 reports for the first

year of their restated period and no prior restatements, limited the sample size. Less the one fifth

of the companies that restate to correct unintentional error report ineffective control in auditor’s

SOX 404 reports (as amended). Given I did not find the predicted associations between the

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control quality (i.e., auditors’ SOX 404 reports), there is an opportunity to expand the sample in

the future by including non-accelerated filers not required to obtain an auditor’s opinion on the

effectiveness of internal control over financial reporting. The sample could also be expanded by

including quarterly restatements, albeit auditors’ responsibilities with respect to annual and

quarterly financial statements differ. Similarly, there is an opportunity to expand the sample of

restatements that correct intentional misstatements in future years as the number of AAERs

increase and by including restatements related to SEC, Department of Justice, or other

investigations. Expanded samples would increase the power of tests that compare the

associations between restatements that correct intentional misstatements and restatements that

correct unintentional error.

3.4.4.3 Contributions

In spite of these limitations, this study’s development and testing of a theoretical model

of the determinants of unintentional error in audited financial statements of public companies

makes several contributions. The model that is developed in this chapter is more complete than

models used to date. In particular, it includes the interaction of CFO characteristics and

organizational change. When these interactions are not included, the effects of CFO

characteristics may not be observed in archival research in tests. This study’s investigation of

these interactions has shown that the association between unintentional error and CFO financial

expertise and influence depends on whether or not companies are undergoing major

organizational change. This study has also shown that restatements that correct unintentional

error and internal control measures based on auditor’s SOX 404 reports are not substitute

proxies. Finally, this study has shown that the determinants of unintentional error differ from

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expertise is more likely to be associated with restatements that correct unintentional error, an

increase in audit committee financial expertise is more likely to reduce restatements that correct

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