Question 1 (18 points)
Consider the paper “Shredded reputation: the cost of audit failure” (2002) written by Chaney and
Philipich from the required reading list.
a. What are the two ways in which auditing adds value to a share? Explain. (4 points)
b. Which if these two ways is studied in Chaney & Philipich (2002)? (2 points)
c. Explain the logic of Hypothesis 3. (4 points)
d. What do the authors conclude with respect to this hypothesis based on the results presented in
Table 9 (see next page)? [Also explain which numbers and statistics you use to draw your
conclusion.] (4 points)
e. Salesgrow is incorporated as a control variable ‘to capture potential aggressive revenue
recognition procedures by firms’. Is the resulting negative sign for this coefficient in line with
this variable capturing this effect? Explain your answer. (4 points)
Answer
a. Assurance – adding credibility so that investors rely on the numbers which could lower information
asymmetry; Insurance – the possibility to be compensated for loss in value when the auditor is found liable
for providing wrong information. (2 points each)
b. Assurance: whether investors lose their trust in figures audited by AA; (there was no threat of default at
that time so insurance is less likely)
c. If this ratio is higher, the benefit apart from audit services for AA is larger and the independence may be
questioned. If there is a higher probability that AA is not independent, the loss in trust due to the incidents
is expected to be greater.
d. It is not confirmed. The coefficients for NAfee are not significantly different from 0 so that the spillover loss
(Cumulative Abnormal Return) is not larger in case there are higher non-audit fees.
e. Yes. If it signals aggressive revenue recognition, it would imply that the firms with higher Salesgrow are
more likely to have overestimated results, so the financial statements are likely to be perceived less
reliable yielding more negative abnormal returns in case reliability of the auditor is damaged by incidents.
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, of Anderson clients
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Consider the paper “Shredded reputation: the cost of audit failure” (2002) written by Chaney and
Philipich from the required reading list.
a. What are the two ways in which auditing adds value to a share? Explain. (4 points)
b. Which if these two ways is studied in Chaney & Philipich (2002)? (2 points)
c. Explain the logic of Hypothesis 3. (4 points)
d. What do the authors conclude with respect to this hypothesis based on the results presented in
Table 9 (see next page)? [Also explain which numbers and statistics you use to draw your
conclusion.] (4 points)
e. Salesgrow is incorporated as a control variable ‘to capture potential aggressive revenue
recognition procedures by firms’. Is the resulting negative sign for this coefficient in line with
this variable capturing this effect? Explain your answer. (4 points)
Answer
a. Assurance – adding credibility so that investors rely on the numbers which could lower information
asymmetry; Insurance – the possibility to be compensated for loss in value when the auditor is found liable
for providing wrong information. (2 points each)
b. Assurance: whether investors lose their trust in figures audited by AA; (there was no threat of default at
that time so insurance is less likely)
c. If this ratio is higher, the benefit apart from audit services for AA is larger and the independence may be
questioned. If there is a higher probability that AA is not independent, the loss in trust due to the incidents
is expected to be greater.
d. It is not confirmed. The coefficients for NAfee are not significantly different from 0 so that the spillover loss
(Cumulative Abnormal Return) is not larger in case there are higher non-audit fees.
e. Yes. If it signals aggressive revenue recognition, it would imply that the firms with higher Salesgrow are
more likely to have overestimated results, so the financial statements are likely to be perceived less
reliable yielding more negative abnormal returns in case reliability of the auditor is damaged by incidents.
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, of Anderson clients
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