PhD-FDEF-2015-17 The Faculty of Law, Economics and Finance DISSERTATION Defense held on 17/12/2016 in Luxembourg to obtain the degree of DOCTEUR DE L’UNIVERSITÉ DU LUXEMBOURG EN SCIENCES ECONOMIQUES by LUKAS LÖHLEIN Born on 27 October 1986 in Künzelsau (Germany) GUARDING THE GUARDIANS ESSAYS ON AUDIT REGULATION Dissertation defense committee Dr Denise Elaine Fletcher, Chairman Professor, University of Luxembourg Dr Sebastian Botzem, Vice Chairman Professor, University of Bremen Dr Anke Müßig, Dissertation supervisor Professor, University of Luxembourg Dr Andrea Mennicken Professor, London School of Economics and Political Science Dr Robert Day Professor, University of Chichester GUARDING THE GUARDIANS ESSAYS ON AUDIT REGULATION Lukas Löhlein III Declaration I declare that the thesis I have presented for examination for the PhD degree conferred by the University of Luxembourg is solely my own work, other than where I have clearly indicated that it is the work of others. The copyright for this thesis rests with the author. Quotation from it is permitted, provided that full acknowledgement is made. This thesis may not be reproduced without my prior written consent. I warrant that this authorisation does not, to the best of my belief, infringe the rights of any third party. I declare that my thesis consists of 95.286 words. Statement of conjoint work I confirm that Anke Müßig contributed to Chapter 3 by developing the general research proposal and applying for research funding, by helping to conduct one interview and by providing written comments on the version of July 2015. I confirm that Hansrudi Lenz and Markus Grottke contributed to chapter 4. Hansrudi Lenz contributed to this chapter by providing written comments on the versions of June 2015, August 2015 and November 2015, by conducting linguistic changes to the versions of August 2015 and November 2015 to enhance their readability and by revising the paragraph on the comparison of the regulatory trends in the U.K., Canada and the US. Markus Grottke contributed to this chapter by developing and writing the theoretical framework, by conducting and analysing seven interviews, by revising the introductory section and writing the discussion sector, by providing written comments on the versions of April 2015, June 2015, August 2015 and November 2015, and by implementing linguistic changes to the versions of August 2015 and November 2015 to enhance their readability. Statement of use of third party for editorial help I confirm that the thesis was proof-read by Andrew Cartwright and Neil Jackson to correct language, spelling and grammar mistakes. IV V To Adele, who has always been there. VI VII Acknowledgements The work for this thesis has been sustained by the generosity of several institutions and people, and I wish to thank them here. I would like to thank my supervisor Anke Müßig for the confidence that she has placed in me throughout this project and for her generous support, which enabled me to further develop my ideas by attending conferences and summer schools and by joining the London School of Economics and Political Science as a visiting PhD student. I am also very grateful to Robert Day and Sebastian Botzem for their intellectual support and stimulating debates, for valuable feedback in discussing my first drafts and for the help they gave me in structuring and clarifying my thoughts. For their genuine teamwork and passionate research, I wish to thank the co-authors of one of my chapters, Markus Grottke and Hansrudi Lenz. For their invaluable advice, guidance, and enthusiastic encouragement during my PhD, I would especially like to thank Andrea Mennicken, Yvey Gendron, Emmanouil Dedoulis, and Christopher Humphrey. I would also like to thank Belen Fernandez and Valdone Darskuviene, who enabled me to enrich my teaching experience in Spain and Lithuania and who have supported me both professionally and personally. I would also like to thank my fellow PhD students at the Centre for Research in Economics and Management at the University of Luxembourg, particularly my colleagues Anne and Rocky, with whom I was fortunate to share my office time. As travelling was an inherent part of this journey, I would like to thank Katerina, Amer, Tobias, Daniel, Hans, and Christopher for always offering shelter, food, and wonderful moments. I would like to thank Christian and Maristella for the good times we had in and outside the Grand Duchy. I am particularly grateful to the Department of Accounting at the London School of Economics and Political Science, which I will always remember as an outstanding, unique place of higher learning and critical thinking. I would also like to thank the students whom I had the privilege to teach and who were, and remain, a daily motivation to me in pursuing a career in academia. Last, but not least, I would also like to thank both my grandparents and, in particular, my parents, Frank Löhlein and Anna-Maria Madirazza-Löhlein, for their unwavering and unconditional support during this journey. Lukas Löhlein London, November 2015 VIII IX Table of Contents Introduction: The Politics of Auditing ................................................................................ 2 Chapter 1: Changing from self-regulation to public oversight: a literature review of 30 years of research on external quality assurance in the U.S. .............................................. 15 1.1 Introduction .................................................................................................................................. 16 1.2 Organising framework ................................................................................................................ 18 1.3 Background: development of U.S. audit regulation ............................................................... 21 1.3.1 The emergence of external quality controls ................................................................. 21 1.3.2 The voluntary peer-review system from 1977 to 1988 .............................................. 22 1.3.3 The mandatory peer review system from 1988 to 2002 ............................................ 23 1.3.4 Governmental inspections under the PCAOB regime .............................................. 25 1.4 Analysis of the AICPA Peer-Review System .......................................................................... 27 1.4.1 Outcome validity of peer reviews ................................................................................. 27 1.4.2 Recognition of peer reviews by the financial market ................................................. 30 1.4.3 Impact of peer reviews on audit quality ....................................................................... 33 1.5 Analysis of the PCAOB Inspection system ............................................................................. 36 1.5.1 Outcome validity of PCAOB inspections.................................................................... 36 1.5.2 Recognition of PCAOB inspections by the financial market ................................... 38 1.5.3 Impact of PCAOB inspections on audit quality ......................................................... 41 1.6 Comparison .................................................................................................................................. 43 1.7 Research gaps ............................................................................................................................... 46 1.8 Conclusion .................................................................................................................................... 49 1.9 References ..................................................................................................................................... 51 Chapter 2: (In)dependent audit oversight: an interdisciplinary approach to comparing audit regulation.................................................................................................................. 57 2.1 Introduction .................................................................................................................................. 58 2.2 Methodology ................................................................................................................................. 61 2.2.1 Notion of independence ................................................................................................. 61 2.2.2 Variables of independence ............................................................................................. 62 2.2.3 Analysis and visualisation of independence ................................................................. 68 2.3 Results............................................................................................................................................ 69 2.3.1 Organisational Independence ........................................................................................ 69 2.3.2 Functional Independence ............................................................................................... 73 2.3.3 Material Independence .................................................................................................... 74 2.4 Conclusion and future research ................................................................................................. 77 2.5 Appendices ................................................................................................................................... 79 2.6 References ....................................................................................................................................