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Unformatted text preview: .’’ Where RMM is the
dependent variable, we expect the coefﬁcient on MI to be negative, indicating that higher
integrity assessments contribute to a lower preliminary risk assessment.
We include several controls to mitigate the potential for a correlated omitted variable
problem. We focus on known determinants of RMM. Prior literature has noted that the
length of the auditor-client relationship may affect risk assessments due to learning over
time (O’Keefe et al. 1994; Ashton 1991). We control for this by including the number of
years the auditor has been auditing the client (TENURE). As a result of the potential for
learning over time, we expect the coefﬁcient on TENURE to obtain a negative coefﬁcient.
There is no obvious association between TENURE and MI although we expect that the
auditor’s assessment of MI to be more accurate as TENURE increases.
To control for client size, we include the natural log of total client revenue (REVENUE)
for the year under audit. Risk and audit effort measures used in this study are revenue
cycle-speciﬁc, rendering the inclusion of REVENUE to be a ﬁtting size control. While larger
ﬁrms may have greater oversight leading to potentially lower control risk assessments, they
may have more complex control structures and greater decentralization, potentially increasing CR. Prior literature has shown that the relationship between auditor effort and client
size is nonlinear (O’Keefe et al. 1994). To address this issue, we utilize the natural log of
revenue. It is unclear how these effects will aggregate and affect the RMM-REVENUE
relationship or how size would inﬂuence MI. Accordingly, we do not have an expectation
of the sign on REVENUE.
Prior research documents a strong association between the discovery of prior-year errors
and current period errors (Kinney 1979), and between prior-year errors and current year
risk assessments (Mock and Wright 1999). We include a dummy variable labeled PYERR
that is coded as 1 if there was a documented prior year audit difference. PYERR also can
impact the assessment of management integrity (MI). This variable is a very simple risk
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- Spring '10