The impact of CEO characteristics on audit quality

Abstract

Audited financial statements have gained considerable attention in the accounting literature. According to the upper echelons theory, a firm is a reflection of its top management team (TMT). Among several decisions, financial decisions are mainly set by CEOs and CFOs. Therefore, audit quality indirectly reflects the characteristics of CEOs/CFOs. The first paper provides an up-to-date and comprehensive systematic literature review (SLR) of the existing research on CEO/CFO and audit quality. This paper aims to synthesise, appraise and extend the current knowledge on (i) theoretical (i.e. i.e. economic, accounting/corporate governance, sociological and socio-psychological) perspectives and (ii) empirical evidence on the influence of the CEO/CFO characteristics— experience, personality, power, demographics, connections and compensation—on audit quality. Using the SLR method, 93 papers from 37 journals in the fields of accounting, finance, economics, ethics, CSR and management that were published between January 1999 and December 2020 are reviewed. The main findings are as follows. First, although agency theory is the most dominant applied theory, most studies omit to apply any theory at all. Secondly, the existing empirical audit quality literature focuses excessively on (i) the CEO characteristics, yet there is marginal attention to the CFO characteristics in general characteristics and (ii) the CEO’s power and compensation dominant characteristics. Thirdly, there is a lack of mixed-methods, qualitative and cross-cultural/country studies.

The second paper paper provides UK-based evidence on how CEO narcissism influences the sceptical judgment of external auditors’ in determining the Key Audit Matters (KAM) and materiality. This paper emploies a panel dataset of 611 observations from 2013 to 2020. The findings find auditors perceive a greater audit risk of clients with narcissistic CEOs, thus performing additional audit procedures. The paper also finds that the perceived risks associated with auditors become more pronounced when a narcissistic CEO has financial experience. This result indicates that familiarity with financial policies and disclosure is perceived by auditors as a potential risk as the CEO is more aware of financial manipulation. This is the first paper to provide evidence on the influence of clients with narcissistic CEOs on auditors’ professional sceptical judgment and highlights the importance of considering CEO personalities and experience together in improving the understanding of the external audit plan and the auditor’s judgment process. The third paper examines whether industry tournament incentives of CEOs, measured as the gap between the CEO's total pay and other executives' total pay, are associated with auditors’ sceptical judgements in determining key audit matters (KAM) and materiality level. Based on a panel dataset of 1040 observations from 2013 to 2020, the findings show that when the tournament gap is large, auditors are less sceptical in their judgments. The findings also show that auditors perceive a higher CEO industry pay gap to pose greater business and fraud risks when a CEO has financial background; thus, auditors respond to such risks by increasing the depth of their audit plan (i.e., lowering the materiality level). These findings are robust to several alternative specifications and control for potential endogeneity issues.