Who is this research for? This research is relevant for audit firm leaders, accounting professionals, regulators, and corporate governance stakeholders.
Executive Summary
This research from Ashleigh Bakke and Stephen P. Rowe at the Sam M. Walton College of Business (Department of Accounting) examines how audit firms respond when engagement partners issue adverse internal control opinions (ICOs) under SOX 404(b). Using nationwide partner assignment data, the study analyzes how partners’ client portfolios change after they issue an adverse ICO to a U.S. public company.
The findings suggest that partners who issue adverse ICOs are more likely to be reassigned and tend to face less favorable portfolio changes—such as lower audit fees, fewer 404(b) clients, and reduced access to more prestigious engagements. These effects appear stronger when the adverse ICO involves an economically important client or occurs within a non–Big Four firm, highlighting the tension between regulatory expectations and client service incentives in internal control reporting.
Overall, the evidence indicates that audit firms may prioritize client service risk when reallocating partners after adverse ICOs, which may help explain broader concerns about underreporting of material weaknesses.
Action Items for Industry
- Support partners who issue warranted adverse ICOs: Ensure audit partners are not penalized for exercising appropriate professional judgment when identifying material weaknesses.
- Review partner reassignment policies: Evaluate whether current rotation practices may unintentionally discourage accurate internal control reporting.
- Enhance protections and incentives for conservative reporting: Clarify expectations and provide institutional support for partners who identify material weaknesses in high-pressure environments.
- Increase oversight of partner rotations: Regulators, audit committees, and boards may wish to monitor how partner assignments shift following adverse ICOs to ensure transparency and audit quality.
Quotes from the Researchers
"Our study highlights a potentially unintentional consequence of adverse ICOs that could discourage partners from issuing future adverse opinions when warranted. Audit firms and regulators should be aware of this possibility as they work to support the individual decision-makers responsible for performing public company audits." – Ashleigh Bakke
“To maintain high standards, audit firms should actively shield partners from the direct or indirect fallout of making difficult, but correct, decisions." – Stephen Rowe
Co-Authors & Affiliations
- Elizabeth N. Cowle — Colorado State University, College of Business
- Michael S. Wilkins — University of Kansas, School of Business
Link to the Original Research
Published in Journal of Accounting Research, available here.
📩 Interested in learning more?
If you’d like additional information about this research or to connect directly with
the researchers, please email us at research@walton.uark.edu.
