Description
Complying with sections of the Sarbanes-Oxley Act that require internal reporting of data often requires implementing additional resources. Companies generally adopt methods such as the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework to aid in fulfilling compliance requirements. Please respond to the following question: How do the requirements of the Sarbanes-Oxley Act support or contradict the principles of the COSO Framework? Provide at least three specific examples.
Your 2- to 3-page paper should reflect the application of the Resources presented this week as well as knowledge gained from previous weeks’ Required or Optional Readings.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0268-6902.htm
Continuous online auditing
as a response to the
Sarbanes-Oxley Act
El-Hussein E. El-Masry
Continuous
online auditing
779
Department of Accounting, College of Business and Economics,
California State University, Los Angeles, California, USA, and
Jacqueline L. Reck
James E. Rooks Distinguished Professor in Accounting, School of Accountancy,
College of Business Administration, University of South Florida, Tampa,
California, USA
Abstract
Purpose – The purpose of this paper is to examine investors’ perceptions of the usefulness of
continuous online auditing (COA) prior to and after the Sarbanes-Oxley (SOX) Act and assesses the
current value relevance of continuous auditing. The paper examines two research questions: first,
whether continuous online audits significantly impact investors’ perceptions of firm risk and,
consequently, the value of a firm and second, whether continuous online audits have a greater impact
on investor assessment of a firm’s risk subsequent to SOX.
Design/methodology/approach – A 2 £ 2 £ 2 £ 2 between participants laboratory experiment
was conducted. Technology risk was manipulated at (e-commerce risks versus no e-commerce risks),
traditional financial risk was manipulated at (high financial leverage versus low financial leverage),
COA was manipulated at (traditional annual audit versus continuous online audits), and pre- and
post-SOX was tested (2002 sample versus 2005 sample). The primary dependent variables used were
investors’ assessment of firm risk and investors’ assessment of earnings per share estimates.
Additionally, investors’ confidence in their investing decision was captured.
Findings – Results indicate a demand for COA as reflected in investors’ reduced firm risk estimates,
and increased confidence in estimates. Comparative results from the 2005 sample and the 2002 sample
indicate that the value relevance of COA has increased after the introduction of SOX in July 2002.
We attribute this shift to investors’ perception that COA is a factor that helps mitigate firm risk and
relatedly boosts investor confidence in their investing decisions.
Research limitations/implications – Only a single proxy for traditional business risk (financial
leverage) is examined. Future studies need to examine the ability of continuous online audits to
mitigate other types of traditional business risks.
Originality/value – The study establishes the current economic feasibility of continuous online
audits. Additionally, the most insightful finding of the study is that the value relevance of COA has
increased after the introduction of SOX. This shift is due to investors’ perceptions of COA as a factor
that mitigates firm risk and helps boost confidence in their investing decisions. Implications for the
profession, the classroom and public policy are discussed.
Keywords Auditing, Legislation, Online reporting, Financial risk, United State of America
Paper type Research paper
The authors would like to thank Jim Hunton for his helpful comments and suggestions on
previous drafts of this paper. The authors also extend their thanks to two anonymous reviewers
and to the editorial team.
Managerial Auditing Journal
Vol. 23 No. 8, 2008
pp. 779-802
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900810899527
MAJ
23,8
780
1. Introduction
The impetus for the Sarbanes-Oxley (SOX) Act of 2002 was the large losses
experienced by shareholders in cases such as Enron and WorldCom. It was believed
that the passage of SOX would help mitigate some of the risk faced by shareholders.
To help reduce shareholder risk, SOX enhances the traditional audit function, and
tightens control over assurance service practices and processes. However, one area
SOX did not address was the frequency of assurance on firm provided financial
accounting information. Many studies that have addressed attempts to enhance
assurance services (Vasarhelyi et al., 2002; Daigle and Lampe, 2003) conclude that the
financial scandals that led to the introduction of SOX could have been avoided had a
paradigm of more frequent continuous online audits been adopted. Our study
addresses this proposition. Specifically, two research questions are examined. First, do
continuous online audits significantly impact investors’ perceptions of firm risk and,
consequently, the value of a firm? Second, do continuous online audits have a greater
impact on investor assessment of a firm’s risk subsequent to SOX? A pre-post SOX
study examining investors’ perceptions of the usefulness of continuous online audits
was conducted.
To answer our research questions we conducted a 2 £ 2 £ 2 £ 2 between
participants experiment, where technology risk was manipulated (e-commerce risks
versus no e-commerce risks), traditional financial risk was manipulated (high leverage
versus low leverage), continuous online auditing (COA) was manipulated (traditional
annual audit versus continuous online audits), and pre- and post-SOX was tested (2002
sample versus 2005 sample). The two primary dependent variables used to test the
manipulations were investors’ assessment of firm risk and investors’ assessment of
earnings per share (EPS) estimates. Additionally, we test for investors’ confidence in
their investing decision to see if confidence is impacted by any of our manipulations.
Findings of the study indicate that the current demand for COA as reflected in
investors’ reduced firm risk estimates and investors’ increased confidence estimates is
significant. Perhaps, the most interesting finding of the study is that the value
relevance of COA increased after the introduction of SOX in July 2002. Investors now
are more likely to demand continuous online audits. We attribute this shift in demand
to investors’ perception of continuous auditing as a factor that mitigates firm risk and
helps boost confidence in investing decisions. While we are unable to find that COA
mitigates the impact of specific firm risks we test (technology and leverage), COA does
impact participants’ overall assessment of firm risk. The findings have numerous
implications to the profession as the market for assurance services is becoming
more competitive and subject to external competition from various professions
(i.e. information systems).
The next section of the paper provides theory and the hypotheses. Sections on the
method, results and a discussion follow the theory and hypotheses.
2. Theory and hypotheses development
2.1 Economic demand for continuous online audits
One of the primary prerequisites for the success of any new service is economic
demand for this service. In the case of the newly introduced COA, if investor’s
favorable and value adding perception of COA can be established, then use of COA
becomes economically feasible.
In auditing, the independent assuror provides a service to the owners of the firm.
The independent assuror’s responsibility is to certify that, to the best of his/her
knowledge, and according to certain agreed upon criteria, management representations
are accurate and prepared according to the agreed upon rules. Such a certification
increases the reliability of management representations (Wells and Loudder, 1997);
thus, increasing the credibility of the information for the owner and decreasing the risk
of relying on management representations.
For a new assurance service, such as COA, to be successfully introduced the owners
of the firm (and potential owners) have to perceive this new assurance service as value
adding. If such a perception exists, owners of the firm will demand that management
acquire this new assurance service. The demand for the service is conveyed to
management through the valuing of the firm. That is, those firms not providing the
service will be charged a premium in the form of lower stock prices.
2.2 Using continuous online auditing to reduce investors’ risk perceptions
Even prior to the introduction of SOX in July 2002, COA was thought to be effective in
reducing firm risks. In the following sections a discussion of the various risks that
COA helps mitigate is introduced. However, first, the definition of COA and discussion
of its characteristics is addressed.
2.2.1 Basic concepts of COA. One of the most agreed upon and frequently used
definitions of COA is auditing that produces audit results simultaneously with the
relevant events, or a short time period thereafter (Kogan et al., 1999). These events are
not necessarily related to financial statement transactions and many involve a variety
of subject matters ranging from daily business transactions to long-term strategic
projects that impact the long-term financial condition of the company.
As the workplace and accounting systems have become more computerized[1], it has
become increasingly feasible to produce a set of financial reports in narrower time
frames, paving the way for the introduction of continuous reporting (Li et al., 2007).
The need for timelier reporting was first documented and recommended in the report of
the AICPA Special Committee on Assurance Services (1995). The report emphasized
that decision-makers increasingly need more frequent (other than just at the end of the
year or quarter) reporting and that decision-makers are not likely to base their
decisions on unreliable (unaudited) data.
Prior research (Pany and Smith, 1982; Bamber and Stratton, 1997; Blackwell et al.,
1998; Wright, 2002) supports the finding that the independent auditor’s assurance
increases the reliability of the financial statements. Thus, it is expected that the
demand for more timely and reliable information will increase the demand for COA. In
1995, the AICPA Special Committee on Assurance Services pointed to “continuous
testing” as one of the promising new services that CPA firms should consider
introducing. Although the AICPA’s initiative was the first to introduce this new
product, it was not the first to address the need for such a product. Groomer and
Murthy (1989) studied the control and security issues in a database environment. They
suggested the use of embedded audit modules that would capture information on a
real-time basis. Subsequently, Vasarhelyi and Halper (1991) introduced the concept of
continuous testing of real-time systems in an internal auditing context. Later studies
(Kogan et al., 1999) extended this concept to external auditing and defined external
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continuous auditing as an auditing process that produces audit results to outside
stakeholders a short time after, or at the same time as the occurrence of the event.
It is important to note that continuous auditing (or testing) can be conducted either
online or offline depending on the subject matter and on whether an internal or external
audit is in question. The current study assumes that continuous audits are conducted
and their results are published online. The basis for this assumption is Kogan et al.
(1999), who concluded that continuous auditing can only be feasible when implemented
in an online system. They argued that external as well as internal continuous audits
are technologically feasible only if the process is fully automated and implemented
using an online computer system, which they defined as a system permanently linking
the auditor and the auditee via a computerized network. Specifically, if this permanent
link is not established it will not be possible for the auditor to access the auditee’s
system on a real time basis to perform the necessary audit work. Hence, for the purpose
of this study, COA is defined as the type of external or internal auditing that produces
audit results that are published online almost simultaneously with the occurrence of
the relevant events.
In light of the previous definition, some of the main differences between traditional
audits and COA are the shortened time to the release of reports, the highly automated
audit procedures needed to provide the required audit evidence, the significant
dependence on automated systems, and the need for auditors to receive the results of
the automatic audit procedures almost immediately after their occurrence[2].
Another difference between traditional audits and COA is that the internal control
systems of the firm will be examined more frequently to ensure an understanding of
these systems. Such increased examination has the potential to improve internal
controls that are not related to financial reporting (e.g. inventory access related
controls) and enhance the efficiency and effectiveness of the internal control structure
in general. Since the reliability of any firm report or representation is affected by the
underlying internal control system, such continuous examination of the internal
control system, and its disclosure to investors has the potential to increase investors’
confidence in the data being generated. This potential to increase confidence fits with
one of the primary objectives of SOX, which is to boost investor confidence.
Finally, continuous audits will allow auditors to increase the magnitude of
substantive tests for some transactions. Specifically, since substantive tests will be
conducted on a weekly or daily basis, as opposed to once a year, it is expected that the
total amount of evidence examined during the series of substantive tests will exceed
the amount of evidence gathered during a traditional audit. The reason is that the total
number of transactions available for testing per audit (weekly, daily, etc.) will be
smaller, which permits a relatively larger percentage of testing. This increase in
substantive tests can lower audit risk. Over the years, such a drop in audit risk
increases investors’ confidence in the audited information (AICPA and CICA, 1999).
As can be seen, there is a potential for COA to reduce investor perceptions of firm
risk, which can translate into increased firm value. However, the economic feasibility of
COA has not been fully researched (Vasarhelyi, 1998; Li et al., 2007). Several prior COA
studies (Kogan et al., 1999; Rezaee et al., 2002; Wright, 2002) suggest that more research
be directed to verify whether COA does have an economic impact on the firm. The
current study looks at one aspect of the economic feasibility of COA. Specifically, this
study examines whether COA, as a new assurance service, is value relevant to
investors, where value relevance is defined as the ability of COA to reduce investors’
risk perceptions and increase investors’ EPS estimates. The two components of overall
firm risk studied, technology related risks and traditional financial risks, are discussed
in the next two sections.
2.2.2 Technology risks and COA. Electronic transactions-related risks include losses
associated with any intentional attacks by hackers and attackers, or possible
transmission failures during the transmission of data. Online electronic transaction
risks also include the risks of dealing with the wrong party and the risks associated
with the loss of trust inherent in the electronic (less personal) nature of e-commerce.
Additionally, it is always feared that some of the control features provided by
e-commerce vendors may not be seriously implemented. For example, there is a need to
assure that claimed security and control features are seriously provided, especially for
the sites of smaller firms who do not guarantee security of their online transactions.
Other risks associated with electronic processing of transactions include the risks
associated with inappropriate use of individual and organizational profiles, and risks
of liability for links attached to the firm web-site (AICPA, 1996). Additionally, other
risks that surfaced over the last decade and that need to be considered by firms include
spyware and network security breaches, especially when data is transmitted by
wireless devices.
The previously mentioned technology risks represent threats to investors who are
unable to estimate the magnitude of the cost (losses) associated with these risks. In
1996 alone, the cost of security breaches to corporations was $136 million (Hann, 1998).
In 2002, the estimated cost surged to $20.2 billion (Garg, 2003). It is feared that with the
increase in the volume of online retailing, from $8 billion in 1997 (Gray and Debreceny,
1998; Green, 1999) to $172 billion in 2005 and to almost $329 billion in 2010 (Lin and
Yu, 2006), costs associated with the identified risk factors will also increase
dramatically. Moreover, the potential liability associated with online retailing is
staggering given that virtually any computer user, anywhere in the world, can access a
business web-site. Thus, firms’ exposure to potential liability is considered to be global,
which increases the need for some type of continuous monitoring of online transactions
(i.e. COA).
It has been widely accepted that risk is an important dimension of the investment
decision and that investors are generally risk averse (Mear and Firth, 1988). In other
words, once aware of risks, investors will incorporate the risks into their assessment of
overall firm risk. The purpose of assurance services is to lessen investors’ concerns
about the accuracy of management assertions; a fact documented in the statement of
basic auditing concepts (AAA, 1973). The statement cites four situations where
assurance services can be useful in reducing investors’ risk concerns. These situations
are: the presence of a conflict of interest between the information provider and users;
the significance of the consequences of information provided; the remoteness of users
from the subject matter covered by the information provided; and the complexity of the
subject matter. Given the frequency and the magnitude of losses associated with online
transactions, the second situation (significant consequences of information) applies to
firms engaged in online activities. The huge potential liability related to electronic
transactions is highly significant; therefore, COA can be useful in providing reliable
information so investors can more readily assess the risks associated with electronic
transactions. The liability associated with online electronic transactions is particularly
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significant for online retailing, online security trading, and online procurement
activities (Kogan et al., 1999).
The ability of e-commerce assurance services to reduce information asymmetry and
relieve investors’ risk perceptions is supported by many prior studies that have been
conducted over a long period of time (Fama and Laffer, 1971; Wallace, 1980; Hunton
et al., 2000). COA, however, provides a different level of service than the researched
e-commerce assurances, which generally seek to assure online users that the data they
are providing to the firm are secure. In a COA environment, constant up-to-date reports
about the firm’s financial condition are provided. If the reports contain no negative
information about the financial condition of the firm that can be associated with online
electronic transactions investors’ fears about any dramatic and sudden losses that may
be generated from the engagement of the firm in online activities will be lessened. More
specifically, with the traditional annual audit, investors have to wait until the end of
the year to get a dependable and reliable (certified by independent auditors) update
about any costs or losses associated with online electronic transactions. With COA,
investors get a reliable update about these costs or losses on a more frequent basis.
Thus, while COA is not able to mitigate the risk associated with online transactions, it
is able to provide reliable and timely information concerning risk exposure, allowing
investors to make more informed decisions.
Several studies (Vasarhelyi and Halper, 1991; Gray and Debreceny, 1998; Kogan
et al., 1999) have addressed three areas where the use of COA can be helpful in
mitigating investors’ perceptions of a firms’ e-commerce technology risks: online
retailing, online procurement systems and online trading. Additionally, we argue that
providing COA increases the reliability and timeliness (relevance) of firm provided
information, which should reduce investors’ risk perceptions of the firm. Therefore, we
provide following hypothesis stated in alternative form:
H1. Investors’ assessment of investing risk associated with a firm’s e-commerce
technology will be lower for firms using COA than for firms using a
traditional annual audit.
2.2.3 Traditional risks and COA. In accounting, the study of traditional business risks
and their impact on various accounting measures and indicators is a frequently visited
research topic (Huss and Jacobs, 1991; Chen and Church, 1992; Pratt and Stice, 1994;
Johnstone, 2000). In accounting research, different proxies for a firm’s business risk
have been used. Some of the most widely used proxies are firm size, industry,
composite measures of various firm risks, and financial leverage.
Leverage, defined as total debt divided by total equity of a firm, is a traditional
measure of the overall risk of the firm. Generally, the greater the debt, the greater the
risk that the firm will be forced by its creditors to liquidate and go out of business
(Lewis, 1993). However, leverage can also result in greater profitability since a
company is generating profits from projects without having to invest any of its own
funds to get that return. Moreover, interest expense proceeds are tax-deductible. Thus,
the greater an entity’s financial leverage, the greater the opportunity for high returns.
The risk/rewards payoff is what investors consider when analyzing the risk associated
with a firm’s leverage.
Many studies have documented the “superiority” of leverage as a proxy for firm risk
(Hamada, 1972; Bhandari, 1988; Artz and Neihengen, 1995). Ben-zion and Shalit (1975)
considered leverage one of the most relevant proxies for firm risk. Bhandari (1988)
noted that the debt/equity ratio is a natural proxy for risk after he found that a firm’s
debt/equity ratio is significantly associated with stock returns. Barbee et al. (1996)
noted that during the period 1979-1991, studies have consistently found that leverage
and the sales/price ratio have greater explanatory power for stock returns than either
the book-to-market ratio or the market value of equity. Other studies (Holmes et al.,
1994; Johnstone, 2000) have also used leverage as a “traditional” measure of firm risk.
Palmrose (1987) and O’Keefe et al. (1994) linked leverage directly to the probability
of misstatement of the financial statements. They argue that leverage also measures
the prior (to the audit) likelihood of material misstatement in the financial statements.
They conclude that the greater the risk of bankruptcy (due to high financial leverage),
the greater the risk that management may attempt to manipulate the firm’s financial
statements.
Our study examines whether COA has the potential to help lessen investors’
concerns about the risk of default and the risk of material misstatement of the financial
statements for highly leveraged firms. As previously pointed out, it is expected that
COA could reassure the investor in a timelier manner about management activities
relating to high financial leverage. COA will also reassure the investor that the risk of
firm default due to high leverage is continuously reviewed by the auditors to ensure
that the firm’s financial leverage does not become a going concern issue. In other
words, one of the major advantages of COA over traditional annual audits is that it
ensures that the firm’s traditional business risks (e.g. loan default risks) are more
promptly disclosed to investors. This disclosure is valuable to investors who make
investment decisions on a daily or in some cases on a minute-by-minute basis. These
investors, as previously pointed out, value more timely reporting (AICPA, 1994).
However, because audited information is perceived as being more reliable, investors
are expected to highly value timelier audited reports. The ability of COA to impact
investor risk perceptions associated with leverage is stated in the second hypothesis of
this study in alternate form:
H2. Investors’ assessment of investing risk associated with a firm’s financial
leverage will be lower for firms receiving COA than for firms receiving a
traditional annual audit.
2.2.4 Overall, relevance of COA. Based on the first and second hypotheses, we believe it
is possible for COA to mitigate the impact of the identified components of firm risk.
However, given the overall impact COA has on a business it is possible that a main
effect for COA exists that cannot be found in the individual interactions identified. The
overall demand is due to investors’ perceptions that COA reduces total firm risk, which
includes risks such as technology risk and traditional business risk. In other words, an
overall decrease in the riskiness attributed to firms receiving COA can occur without a
significant impact being seen on the individual components of firm risk. In turn, the
decrease in overall risk associated with COA will be reflected in firm value. Therefore,
we hypothesize a main effect for COA, which stated in alternative form is:
H3. Investors’ assessment of firms’ overall investing risk will be lower for firms
receiving COA than for firms receiving traditional annual audits.
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2.3 Continuous online auditing as a response to the Sarbanes-Oxley (SOX) Act
Many studies addressing the feasibility of continuous auditing (Vasarhelyi et al., 2002;
Daigle and Lampe, 2003) suggested the deployment of COA as a response to the SOX
Act of 2002. These studies into the effectiveness of COA and its ability to red flag
discrepancies addressed the issue of whether COA could have prevented some of the
financial scandals of the early twenty-first century. Vasarhelyi et al. (2002) concluded
that COA could have detected many of Enron’s operational issues and red flagged
them much sooner. Specifically, Enron’s abnormal transactions involving its special
purpose entities would have been detected, or at least led to further investigation by the
investing community if COA had been used.
Daigle and Lampe (2003) concluded that SOX has increased demand for COA.
Specifically, they pointed to four reasons why SOX contributed to increased COA
demand:
(1) the newly required certification by the CEO and CFO;
(2) the new internal control requirement under section 404, which makes it
mandatory for management to report on the adequacy of internal control with
respect to financial reporting, and for the external auditor to certify this report;
(3) the demand under sections 409 and 411 to increase the speed of reporting on
substantial changes with respect to the financial condition of the companies;
and
(4) the new disclosures on year-end adjusting entries.
Moreover, the US government in the aftermath of Enron, specifically in 2002, proposed
quarterly or a more frequent type of external reporting for use by investors. Thus, COA
is gaining momentum in both the accounting and regulatory communities (Searcy and
Woodroof, 2003).
COA can be viewed as an effective response to SOX since it is designed to be a
strategic system lens audit. Strategic system lens audits focus the auditor’s assessment
of risk through a lens that directs the auditor’s attention to the client’s system
dynamics rather than to the traditional balance sheet accounts and the likelihood of
their misstatement (Chen, 2004). This characteristic of COA fits with the SOX goal of
helping prevent future financial frauds and scandals by improving audit practices and
helping auditors focus more on the underlying dynamics that lead to these
discrepancies and misstatements rather than on traditional balance sheet accounts
risks. Thus, it is justifiable that economic demand for COA after the introduction of
SOX is because of the perception that COA is effectively reducing risk. Therefore, in
the fourth hypothesis of this study we state in alternate form:
H4. Investors’ perception of firm risk will be lower for firms receiving COA after
the introduction of SOX than for firms receiving COA prior to the introduction
of SOX.
3. Method
3.1 Variables
A 2 £ 2 £ 2 £ 2 between participants full factorial design experiment was conducted.
The first factor, firm involvement in online retailing, a measure of new technology
risks, was manipulated at two levels (involved and not involved in online retailing).
For the purpose of the current study, a firm was considered “involved in online
retailing” if it conducted more than 50 per cent of its retailing activity online. The
second factor is firm financial leverage, which was measured as the ratio of total debt
to total assets. Leverage was manipulated at two levels – high leverage (0.96) and low
leverage (0.20). This division was based on the results of a study (Safieddine and
Titman, 1999) that found that the average debt to equity ratio across the various
industries is around 0.6. The frequency of audits (COA versus traditional annual
audits) was the third factor in this study. In the experimental material, COA was
defined as the “type of auditing that produces audit results simultaneously with, or a
short time period after, the occurrence of relevant events”. The fourth factor was the
introduction of the SOX Act in July 2002. Participants were involved in the study either
prior to SOX or subsequent to the enactment of SOX.
Two primary dependent variables were captured. The first dependent variable was
investors’ estimate of firm risk, which was measured using a scale ranging from 0
(very low likelihood that the investor will lose his or her initial investment) to 100
(extremely risky investment). Using a rating of perception of firm risk is consistent
with many studies in the accounting and auditing literature including Gooding (1975),
Farrelly et al. (1985), Farrelly and Reichenstein (1984) and Mear and Firth (1988). The
second dependent variable used was investors’ EPS estimates. EPS estimates, as a
measure of firm risk, are frequently used in accounting and auditing research (Mear
and Firth, 1988, Hunton et al., 2000). An additional dependent variable was investors’
confidence in their investing decision. Participants rated their confidence in their
investing decision on a scale ranging from 0 (very unconfident) to 100 (very confident).
Information was also gathered for several covariates: the number of years of work
experience, age of participants, and years of investing experience. Because these
covariates have been used in similar studies on financial analysts and individual
investors’ earnings forecasts (Hunton and McEwen, 1997; Hunton et al., 2000), we
ensured these factors were tested, and controlled if necessary, in our study.
3.2 Experiment[3]
The experiment was conduced in a monitored laboratory setting. Students were
randomly assigned to a treatment and provided with a paper version of the experiment.
Participants first read background information about a hypothetical company. This
information included economic information followed by industry information, two
years of dividends and share price information, and a three-year summary of key
financial ratios. After receiving background information, current year summary
information was provided in the form of three key ratios. The ratios provided were
leverage, current ratio and return on equity. Leverage was the only ratio manipulated
(high ¼ 0.96 and low ¼ 0.20). A moderate current ratio of 2.0 (Horngren et al., 1999)
and a moderate return on equity ratio of 14 per cent (Eaker et al., 2000) were provided.
For the online retailing activities treatment, participants received either a paragraph
about technology risks associated with involvement in online retailing activities or a
paragraph about the traditional retailing activities of the case firm (Appendix 1).
Participants in the continuous audits (COA) treatment group received a paragraph
disclosing management’s intention to submit to continuous (weekly) online audits in
the coming year; whereas, the traditional audits group read a paragraph indicating that
the company’s financial statements were audited once a year (Appendix 1).
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After reading the experimental materials, participants rated the perceived risk of
the firm and estimated its EPS for the current year. They also rated their confidence in
their investing decision. After returning the experimental instrument, participants
received a post-experimenta
www.emeraldinsight.com/0268-6902.htm
Continuous online auditing
as a response to the
Sarbanes-Oxley Act
El-Hussein E. El-Masry
Continuous
online auditing
779
Department of Accounting, College of Business and Economics,
California State University, Los Angeles, California, USA, and
Jacqueline L. Reck
James E. Rooks Distinguished Professor in Accounting, School of Accountancy,
College of Business Administration, University of South Florida, Tampa,
California, USA
Abstract
Purpose – The purpose of this paper is to examine investors’ perceptions of the usefulness of
continuous online auditing (COA) prior to and after the Sarbanes-Oxley (SOX) Act and assesses the
current value relevance of continuous auditing. The paper examines two research questions: first,
whether continuous online audits significantly impact investors’ perceptions of firm risk and,
consequently, the value of a firm and second, whether continuous online audits have a greater impact
on investor assessment of a firm’s risk subsequent to SOX.
Design/methodology/approach – A 2 £ 2 £ 2 £ 2 between participants laboratory experiment
was conducted. Technology risk was manipulated at (e-commerce risks versus no e-commerce risks),
traditional financial risk was manipulated at (high financial leverage versus low financial leverage),
COA was manipulated at (traditional annual audit versus continuous online audits), and pre- and
post-SOX was tested (2002 sample versus 2005 sample). The primary dependent variables used were
investors’ assessment of firm risk and investors’ assessment of earnings per share estimates.
Additionally, investors’ confidence in their investing decision was captured.
Findings – Results indicate a demand for COA as reflected in investors’ reduced firm risk estimates,
and increased confidence in estimates. Comparative results from the 2005 sample and the 2002 sample
indicate that the value relevance of COA has increased after the introduction of SOX in July 2002.
We attribute this shift to investors’ perception that COA is a factor that helps mitigate firm risk and
relatedly boosts investor confidence in their investing decisions.
Research limitations/implications – Only a single proxy for traditional business risk (financial
leverage) is examined. Future studies need to examine the ability of continuous online audits to
mitigate other types of traditional business risks.
Originality/value – The study establishes the current economic feasibility of continuous online
audits. Additionally, the most insightful finding of the study is that the value relevance of COA has
increased after the introduction of SOX. This shift is due to investors’ perceptions of COA as a factor
that mitigates firm risk and helps boost confidence in their investing decisions. Implications for the
profession, the classroom and public policy are discussed.
Keywords Auditing, Legislation, Online reporting, Financial risk, United State of America
Paper type Research paper
The authors would like to thank Jim Hunton for his helpful comments and suggestions on
previous drafts of this paper. The authors also extend their thanks to two anonymous reviewers
and to the editorial team.
Managerial Auditing Journal
Vol. 23 No. 8, 2008
pp. 779-802
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900810899527
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1. Introduction
The impetus for the Sarbanes-Oxley (SOX) Act of 2002 was the large losses
experienced by shareholders in cases such as Enron and WorldCom. It was believed
that the passage of SOX would help mitigate some of the risk faced by shareholders.
To help reduce shareholder risk, SOX enhances the traditional audit function, and
tightens control over assurance service practices and processes. However, one area
SOX did not address was the frequency of assurance on firm provided financial
accounting information. Many studies that have addressed attempts to enhance
assurance services (Vasarhelyi et al., 2002; Daigle and Lampe, 2003) conclude that the
financial scandals that led to the introduction of SOX could have been avoided had a
paradigm of more frequent continuous online audits been adopted. Our study
addresses this proposition. Specifically, two research questions are examined. First, do
continuous online audits significantly impact investors’ perceptions of firm risk and,
consequently, the value of a firm? Second, do continuous online audits have a greater
impact on investor assessment of a firm’s risk subsequent to SOX? A pre-post SOX
study examining investors’ perceptions of the usefulness of continuous online audits
was conducted.
To answer our research questions we conducted a 2 £ 2 £ 2 £ 2 between
participants experiment, where technology risk was manipulated (e-commerce risks
versus no e-commerce risks), traditional financial risk was manipulated (high leverage
versus low leverage), continuous online auditing (COA) was manipulated (traditional
annual audit versus continuous online audits), and pre- and post-SOX was tested (2002
sample versus 2005 sample). The two primary dependent variables used to test the
manipulations were investors’ assessment of firm risk and investors’ assessment of
earnings per share (EPS) estimates. Additionally, we test for investors’ confidence in
their investing decision to see if confidence is impacted by any of our manipulations.
Findings of the study indicate that the current demand for COA as reflected in
investors’ reduced firm risk estimates and investors’ increased confidence estimates is
significant. Perhaps, the most interesting finding of the study is that the value
relevance of COA increased after the introduction of SOX in July 2002. Investors now
are more likely to demand continuous online audits. We attribute this shift in demand
to investors’ perception of continuous auditing as a factor that mitigates firm risk and
helps boost confidence in investing decisions. While we are unable to find that COA
mitigates the impact of specific firm risks we test (technology and leverage), COA does
impact participants’ overall assessment of firm risk. The findings have numerous
implications to the profession as the market for assurance services is becoming
more competitive and subject to external competition from various professions
(i.e. information systems).
The next section of the paper provides theory and the hypotheses. Sections on the
method, results and a discussion follow the theory and hypotheses.
2. Theory and hypotheses development
2.1 Economic demand for continuous online audits
One of the primary prerequisites for the success of any new service is economic
demand for this service. In the case of the newly introduced COA, if investor’s
favorable and value adding perception of COA can be established, then use of COA
becomes economically feasible.
In auditing, the independent assuror provides a service to the owners of the firm.
The independent assuror’s responsibility is to certify that, to the best of his/her
knowledge, and according to certain agreed upon criteria, management representations
are accurate and prepared according to the agreed upon rules. Such a certification
increases the reliability of management representations (Wells and Loudder, 1997);
thus, increasing the credibility of the information for the owner and decreasing the risk
of relying on management representations.
For a new assurance service, such as COA, to be successfully introduced the owners
of the firm (and potential owners) have to perceive this new assurance service as value
adding. If such a perception exists, owners of the firm will demand that management
acquire this new assurance service. The demand for the service is conveyed to
management through the valuing of the firm. That is, those firms not providing the
service will be charged a premium in the form of lower stock prices.
2.2 Using continuous online auditing to reduce investors’ risk perceptions
Even prior to the introduction of SOX in July 2002, COA was thought to be effective in
reducing firm risks. In the following sections a discussion of the various risks that
COA helps mitigate is introduced. However, first, the definition of COA and discussion
of its characteristics is addressed.
2.2.1 Basic concepts of COA. One of the most agreed upon and frequently used
definitions of COA is auditing that produces audit results simultaneously with the
relevant events, or a short time period thereafter (Kogan et al., 1999). These events are
not necessarily related to financial statement transactions and many involve a variety
of subject matters ranging from daily business transactions to long-term strategic
projects that impact the long-term financial condition of the company.
As the workplace and accounting systems have become more computerized[1], it has
become increasingly feasible to produce a set of financial reports in narrower time
frames, paving the way for the introduction of continuous reporting (Li et al., 2007).
The need for timelier reporting was first documented and recommended in the report of
the AICPA Special Committee on Assurance Services (1995). The report emphasized
that decision-makers increasingly need more frequent (other than just at the end of the
year or quarter) reporting and that decision-makers are not likely to base their
decisions on unreliable (unaudited) data.
Prior research (Pany and Smith, 1982; Bamber and Stratton, 1997; Blackwell et al.,
1998; Wright, 2002) supports the finding that the independent auditor’s assurance
increases the reliability of the financial statements. Thus, it is expected that the
demand for more timely and reliable information will increase the demand for COA. In
1995, the AICPA Special Committee on Assurance Services pointed to “continuous
testing” as one of the promising new services that CPA firms should consider
introducing. Although the AICPA’s initiative was the first to introduce this new
product, it was not the first to address the need for such a product. Groomer and
Murthy (1989) studied the control and security issues in a database environment. They
suggested the use of embedded audit modules that would capture information on a
real-time basis. Subsequently, Vasarhelyi and Halper (1991) introduced the concept of
continuous testing of real-time systems in an internal auditing context. Later studies
(Kogan et al., 1999) extended this concept to external auditing and defined external
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continuous auditing as an auditing process that produces audit results to outside
stakeholders a short time after, or at the same time as the occurrence of the event.
It is important to note that continuous auditing (or testing) can be conducted either
online or offline depending on the subject matter and on whether an internal or external
audit is in question. The current study assumes that continuous audits are conducted
and their results are published online. The basis for this assumption is Kogan et al.
(1999), who concluded that continuous auditing can only be feasible when implemented
in an online system. They argued that external as well as internal continuous audits
are technologically feasible only if the process is fully automated and implemented
using an online computer system, which they defined as a system permanently linking
the auditor and the auditee via a computerized network. Specifically, if this permanent
link is not established it will not be possible for the auditor to access the auditee’s
system on a real time basis to perform the necessary audit work. Hence, for the purpose
of this study, COA is defined as the type of external or internal auditing that produces
audit results that are published online almost simultaneously with the occurrence of
the relevant events.
In light of the previous definition, some of the main differences between traditional
audits and COA are the shortened time to the release of reports, the highly automated
audit procedures needed to provide the required audit evidence, the significant
dependence on automated systems, and the need for auditors to receive the results of
the automatic audit procedures almost immediately after their occurrence[2].
Another difference between traditional audits and COA is that the internal control
systems of the firm will be examined more frequently to ensure an understanding of
these systems. Such increased examination has the potential to improve internal
controls that are not related to financial reporting (e.g. inventory access related
controls) and enhance the efficiency and effectiveness of the internal control structure
in general. Since the reliability of any firm report or representation is affected by the
underlying internal control system, such continuous examination of the internal
control system, and its disclosure to investors has the potential to increase investors’
confidence in the data being generated. This potential to increase confidence fits with
one of the primary objectives of SOX, which is to boost investor confidence.
Finally, continuous audits will allow auditors to increase the magnitude of
substantive tests for some transactions. Specifically, since substantive tests will be
conducted on a weekly or daily basis, as opposed to once a year, it is expected that the
total amount of evidence examined during the series of substantive tests will exceed
the amount of evidence gathered during a traditional audit. The reason is that the total
number of transactions available for testing per audit (weekly, daily, etc.) will be
smaller, which permits a relatively larger percentage of testing. This increase in
substantive tests can lower audit risk. Over the years, such a drop in audit risk
increases investors’ confidence in the audited information (AICPA and CICA, 1999).
As can be seen, there is a potential for COA to reduce investor perceptions of firm
risk, which can translate into increased firm value. However, the economic feasibility of
COA has not been fully researched (Vasarhelyi, 1998; Li et al., 2007). Several prior COA
studies (Kogan et al., 1999; Rezaee et al., 2002; Wright, 2002) suggest that more research
be directed to verify whether COA does have an economic impact on the firm. The
current study looks at one aspect of the economic feasibility of COA. Specifically, this
study examines whether COA, as a new assurance service, is value relevant to
investors, where value relevance is defined as the ability of COA to reduce investors’
risk perceptions and increase investors’ EPS estimates. The two components of overall
firm risk studied, technology related risks and traditional financial risks, are discussed
in the next two sections.
2.2.2 Technology risks and COA. Electronic transactions-related risks include losses
associated with any intentional attacks by hackers and attackers, or possible
transmission failures during the transmission of data. Online electronic transaction
risks also include the risks of dealing with the wrong party and the risks associated
with the loss of trust inherent in the electronic (less personal) nature of e-commerce.
Additionally, it is always feared that some of the control features provided by
e-commerce vendors may not be seriously implemented. For example, there is a need to
assure that claimed security and control features are seriously provided, especially for
the sites of smaller firms who do not guarantee security of their online transactions.
Other risks associated with electronic processing of transactions include the risks
associated with inappropriate use of individual and organizational profiles, and risks
of liability for links attached to the firm web-site (AICPA, 1996). Additionally, other
risks that surfaced over the last decade and that need to be considered by firms include
spyware and network security breaches, especially when data is transmitted by
wireless devices.
The previously mentioned technology risks represent threats to investors who are
unable to estimate the magnitude of the cost (losses) associated with these risks. In
1996 alone, the cost of security breaches to corporations was $136 million (Hann, 1998).
In 2002, the estimated cost surged to $20.2 billion (Garg, 2003). It is feared that with the
increase in the volume of online retailing, from $8 billion in 1997 (Gray and Debreceny,
1998; Green, 1999) to $172 billion in 2005 and to almost $329 billion in 2010 (Lin and
Yu, 2006), costs associated with the identified risk factors will also increase
dramatically. Moreover, the potential liability associated with online retailing is
staggering given that virtually any computer user, anywhere in the world, can access a
business web-site. Thus, firms’ exposure to potential liability is considered to be global,
which increases the need for some type of continuous monitoring of online transactions
(i.e. COA).
It has been widely accepted that risk is an important dimension of the investment
decision and that investors are generally risk averse (Mear and Firth, 1988). In other
words, once aware of risks, investors will incorporate the risks into their assessment of
overall firm risk. The purpose of assurance services is to lessen investors’ concerns
about the accuracy of management assertions; a fact documented in the statement of
basic auditing concepts (AAA, 1973). The statement cites four situations where
assurance services can be useful in reducing investors’ risk concerns. These situations
are: the presence of a conflict of interest between the information provider and users;
the significance of the consequences of information provided; the remoteness of users
from the subject matter covered by the information provided; and the complexity of the
subject matter. Given the frequency and the magnitude of losses associated with online
transactions, the second situation (significant consequences of information) applies to
firms engaged in online activities. The huge potential liability related to electronic
transactions is highly significant; therefore, COA can be useful in providing reliable
information so investors can more readily assess the risks associated with electronic
transactions. The liability associated with online electronic transactions is particularly
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significant for online retailing, online security trading, and online procurement
activities (Kogan et al., 1999).
The ability of e-commerce assurance services to reduce information asymmetry and
relieve investors’ risk perceptions is supported by many prior studies that have been
conducted over a long period of time (Fama and Laffer, 1971; Wallace, 1980; Hunton
et al., 2000). COA, however, provides a different level of service than the researched
e-commerce assurances, which generally seek to assure online users that the data they
are providing to the firm are secure. In a COA environment, constant up-to-date reports
about the firm’s financial condition are provided. If the reports contain no negative
information about the financial condition of the firm that can be associated with online
electronic transactions investors’ fears about any dramatic and sudden losses that may
be generated from the engagement of the firm in online activities will be lessened. More
specifically, with the traditional annual audit, investors have to wait until the end of
the year to get a dependable and reliable (certified by independent auditors) update
about any costs or losses associated with online electronic transactions. With COA,
investors get a reliable update about these costs or losses on a more frequent basis.
Thus, while COA is not able to mitigate the risk associated with online transactions, it
is able to provide reliable and timely information concerning risk exposure, allowing
investors to make more informed decisions.
Several studies (Vasarhelyi and Halper, 1991; Gray and Debreceny, 1998; Kogan
et al., 1999) have addressed three areas where the use of COA can be helpful in
mitigating investors’ perceptions of a firms’ e-commerce technology risks: online
retailing, online procurement systems and online trading. Additionally, we argue that
providing COA increases the reliability and timeliness (relevance) of firm provided
information, which should reduce investors’ risk perceptions of the firm. Therefore, we
provide following hypothesis stated in alternative form:
H1. Investors’ assessment of investing risk associated with a firm’s e-commerce
technology will be lower for firms using COA than for firms using a
traditional annual audit.
2.2.3 Traditional risks and COA. In accounting, the study of traditional business risks
and their impact on various accounting measures and indicators is a frequently visited
research topic (Huss and Jacobs, 1991; Chen and Church, 1992; Pratt and Stice, 1994;
Johnstone, 2000). In accounting research, different proxies for a firm’s business risk
have been used. Some of the most widely used proxies are firm size, industry,
composite measures of various firm risks, and financial leverage.
Leverage, defined as total debt divided by total equity of a firm, is a traditional
measure of the overall risk of the firm. Generally, the greater the debt, the greater the
risk that the firm will be forced by its creditors to liquidate and go out of business
(Lewis, 1993). However, leverage can also result in greater profitability since a
company is generating profits from projects without having to invest any of its own
funds to get that return. Moreover, interest expense proceeds are tax-deductible. Thus,
the greater an entity’s financial leverage, the greater the opportunity for high returns.
The risk/rewards payoff is what investors consider when analyzing the risk associated
with a firm’s leverage.
Many studies have documented the “superiority” of leverage as a proxy for firm risk
(Hamada, 1972; Bhandari, 1988; Artz and Neihengen, 1995). Ben-zion and Shalit (1975)
considered leverage one of the most relevant proxies for firm risk. Bhandari (1988)
noted that the debt/equity ratio is a natural proxy for risk after he found that a firm’s
debt/equity ratio is significantly associated with stock returns. Barbee et al. (1996)
noted that during the period 1979-1991, studies have consistently found that leverage
and the sales/price ratio have greater explanatory power for stock returns than either
the book-to-market ratio or the market value of equity. Other studies (Holmes et al.,
1994; Johnstone, 2000) have also used leverage as a “traditional” measure of firm risk.
Palmrose (1987) and O’Keefe et al. (1994) linked leverage directly to the probability
of misstatement of the financial statements. They argue that leverage also measures
the prior (to the audit) likelihood of material misstatement in the financial statements.
They conclude that the greater the risk of bankruptcy (due to high financial leverage),
the greater the risk that management may attempt to manipulate the firm’s financial
statements.
Our study examines whether COA has the potential to help lessen investors’
concerns about the risk of default and the risk of material misstatement of the financial
statements for highly leveraged firms. As previously pointed out, it is expected that
COA could reassure the investor in a timelier manner about management activities
relating to high financial leverage. COA will also reassure the investor that the risk of
firm default due to high leverage is continuously reviewed by the auditors to ensure
that the firm’s financial leverage does not become a going concern issue. In other
words, one of the major advantages of COA over traditional annual audits is that it
ensures that the firm’s traditional business risks (e.g. loan default risks) are more
promptly disclosed to investors. This disclosure is valuable to investors who make
investment decisions on a daily or in some cases on a minute-by-minute basis. These
investors, as previously pointed out, value more timely reporting (AICPA, 1994).
However, because audited information is perceived as being more reliable, investors
are expected to highly value timelier audited reports. The ability of COA to impact
investor risk perceptions associated with leverage is stated in the second hypothesis of
this study in alternate form:
H2. Investors’ assessment of investing risk associated with a firm’s financial
leverage will be lower for firms receiving COA than for firms receiving a
traditional annual audit.
2.2.4 Overall, relevance of COA. Based on the first and second hypotheses, we believe it
is possible for COA to mitigate the impact of the identified components of firm risk.
However, given the overall impact COA has on a business it is possible that a main
effect for COA exists that cannot be found in the individual interactions identified. The
overall demand is due to investors’ perceptions that COA reduces total firm risk, which
includes risks such as technology risk and traditional business risk. In other words, an
overall decrease in the riskiness attributed to firms receiving COA can occur without a
significant impact being seen on the individual components of firm risk. In turn, the
decrease in overall risk associated with COA will be reflected in firm value. Therefore,
we hypothesize a main effect for COA, which stated in alternative form is:
H3. Investors’ assessment of firms’ overall investing risk will be lower for firms
receiving COA than for firms receiving traditional annual audits.
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2.3 Continuous online auditing as a response to the Sarbanes-Oxley (SOX) Act
Many studies addressing the feasibility of continuous auditing (Vasarhelyi et al., 2002;
Daigle and Lampe, 2003) suggested the deployment of COA as a response to the SOX
Act of 2002. These studies into the effectiveness of COA and its ability to red flag
discrepancies addressed the issue of whether COA could have prevented some of the
financial scandals of the early twenty-first century. Vasarhelyi et al. (2002) concluded
that COA could have detected many of Enron’s operational issues and red flagged
them much sooner. Specifically, Enron’s abnormal transactions involving its special
purpose entities would have been detected, or at least led to further investigation by the
investing community if COA had been used.
Daigle and Lampe (2003) concluded that SOX has increased demand for COA.
Specifically, they pointed to four reasons why SOX contributed to increased COA
demand:
(1) the newly required certification by the CEO and CFO;
(2) the new internal control requirement under section 404, which makes it
mandatory for management to report on the adequacy of internal control with
respect to financial reporting, and for the external auditor to certify this report;
(3) the demand under sections 409 and 411 to increase the speed of reporting on
substantial changes with respect to the financial condition of the companies;
and
(4) the new disclosures on year-end adjusting entries.
Moreover, the US government in the aftermath of Enron, specifically in 2002, proposed
quarterly or a more frequent type of external reporting for use by investors. Thus, COA
is gaining momentum in both the accounting and regulatory communities (Searcy and
Woodroof, 2003).
COA can be viewed as an effective response to SOX since it is designed to be a
strategic system lens audit. Strategic system lens audits focus the auditor’s assessment
of risk through a lens that directs the auditor’s attention to the client’s system
dynamics rather than to the traditional balance sheet accounts and the likelihood of
their misstatement (Chen, 2004). This characteristic of COA fits with the SOX goal of
helping prevent future financial frauds and scandals by improving audit practices and
helping auditors focus more on the underlying dynamics that lead to these
discrepancies and misstatements rather than on traditional balance sheet accounts
risks. Thus, it is justifiable that economic demand for COA after the introduction of
SOX is because of the perception that COA is effectively reducing risk. Therefore, in
the fourth hypothesis of this study we state in alternate form:
H4. Investors’ perception of firm risk will be lower for firms receiving COA after
the introduction of SOX than for firms receiving COA prior to the introduction
of SOX.
3. Method
3.1 Variables
A 2 £ 2 £ 2 £ 2 between participants full factorial design experiment was conducted.
The first factor, firm involvement in online retailing, a measure of new technology
risks, was manipulated at two levels (involved and not involved in online retailing).
For the purpose of the current study, a firm was considered “involved in online
retailing” if it conducted more than 50 per cent of its retailing activity online. The
second factor is firm financial leverage, which was measured as the ratio of total debt
to total assets. Leverage was manipulated at two levels – high leverage (0.96) and low
leverage (0.20). This division was based on the results of a study (Safieddine and
Titman, 1999) that found that the average debt to equity ratio across the various
industries is around 0.6. The frequency of audits (COA versus traditional annual
audits) was the third factor in this study. In the experimental material, COA was
defined as the “type of auditing that produces audit results simultaneously with, or a
short time period after, the occurrence of relevant events”. The fourth factor was the
introduction of the SOX Act in July 2002. Participants were involved in the study either
prior to SOX or subsequent to the enactment of SOX.
Two primary dependent variables were captured. The first dependent variable was
investors’ estimate of firm risk, which was measured using a scale ranging from 0
(very low likelihood that the investor will lose his or her initial investment) to 100
(extremely risky investment). Using a rating of perception of firm risk is consistent
with many studies in the accounting and auditing literature including Gooding (1975),
Farrelly et al. (1985), Farrelly and Reichenstein (1984) and Mear and Firth (1988). The
second dependent variable used was investors’ EPS estimates. EPS estimates, as a
measure of firm risk, are frequently used in accounting and auditing research (Mear
and Firth, 1988, Hunton et al., 2000). An additional dependent variable was investors’
confidence in their investing decision. Participants rated their confidence in their
investing decision on a scale ranging from 0 (very unconfident) to 100 (very confident).
Information was also gathered for several covariates: the number of years of work
experience, age of participants, and years of investing experience. Because these
covariates have been used in similar studies on financial analysts and individual
investors’ earnings forecasts (Hunton and McEwen, 1997; Hunton et al., 2000), we
ensured these factors were tested, and controlled if necessary, in our study.
3.2 Experiment[3]
The experiment was conduced in a monitored laboratory setting. Students were
randomly assigned to a treatment and provided with a paper version of the experiment.
Participants first read background information about a hypothetical company. This
information included economic information followed by industry information, two
years of dividends and share price information, and a three-year summary of key
financial ratios. After receiving background information, current year summary
information was provided in the form of three key ratios. The ratios provided were
leverage, current ratio and return on equity. Leverage was the only ratio manipulated
(high ¼ 0.96 and low ¼ 0.20). A moderate current ratio of 2.0 (Horngren et al., 1999)
and a moderate return on equity ratio of 14 per cent (Eaker et al., 2000) were provided.
For the online retailing activities treatment, participants received either a paragraph
about technology risks associated with involvement in online retailing activities or a
paragraph about the traditional retailing activities of the case firm (Appendix 1).
Participants in the continuous audits (COA) treatment group received a paragraph
disclosing management’s intention to submit to continuous (weekly) online audits in
the coming year; whereas, the traditional audits group read a paragraph indicating that
the company’s financial statements were audited once a year (Appendix 1).
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After reading the experimental materials, participants rated the perceived risk of
the firm and estimated its EPS for the current year. They also rated their confidence in
their investing decision. After returning the experimental instrument, participants
received a post-experimenta
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