Managerial Auditing Journal

Emerald Article: Corporate environmental responsibility and audit risk

Mary Mindak, Wendy Heltzer

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CER and
Corporate environmental audit risk
responsibility and audit risk
Mary Mindak and Wendy Heltzer
School of Accountancy and MIS, DePaul University, Chicago, Illinois, USA 697
Abstract Received 29 October 2010
Purpose – The purpose of this paper is to examine the relationship between and corporate Reviewed 2 February 2011
environmental responsibility (CER) and audit risk. Accepted 8 February 2011
Design/methodology/approach – A survey participation request was mailed to 5,008 US auditors
at random. The request provided a link to an electronic survey. The final sample consists of
anonymous responses from 163 auditors.
Findings – The authors find that auditors, on average, do not perceive a significant relationship
between corporate environmental strengths and audit risk; however, they do perceive an increase in
audit risk among firms with corporate environmental concerns. Use of CER in the risk assessment
process also varies across types of CER: 15 per cent of auditors use corporate environmental strengths
to assess audit risk, while 43 per cent of auditors use corporate environmental concerns to assess audit
risk. Perception of the CER/audit risk relationship is a significant determinant of CER use. Finally,
both types of CER are found to have average usefulness in the risk assessment process.
Research limitations/implications – The findings are limited to US auditors; results may not be
transferable to other countries.
Originality/value – Studies involving the impact of CER on earnings generally involve archival
data. By examining the impact of CER on audit risk, using a unique dataset, the authors present a
different and timely setting to study the CER/earnings relationship. To the best of the authors’
knowledge, this is the first paper to document the relationship between CER and audit risk.
Keywords United States of America, Auditors, Corporate environmental responsibility, Audit risk,
Earnings quality
Paper type Research paper

Corporations can and do use branding in the area of green technology to create an impression
that the corporation has [the] environment in mind with all its actions. This is what is called
lipstick on a pig. BP is the company who puts solar ads on TV and uses a green logo, etc.
yet the tone at the top did not filter to the people drilling in the gulf. It was lipstick on a pig.
Do I think that people who mess up the environment are the type to mess up the financials for
auditors [. . .] yes. Same goes for labor violators, fair trade violators, and EPA violators. If you
have no moral imperative to comply with other regulations what moral imperative do you
have to comply with IRS or IFRS or GAAP? (Survey Respondent No. 51, Anonymous Auditor,
Senior Manager).

1. Introduction
This study examines the relationship between corporate environmental responsibility
(CER) and audit risk. Our sample consists of anonymous survey responses from
163 US auditors. We do not impose a linear relationship between CER and audit risk; Managerial Auditing Journal
instead, we separately examine the relationships between: Vol. 26 No. 8, 2011
pp. 697-733
.
corporate environmental strengths (CES) and audit risk; and q Emerald Group Publishing Limited
0268-6902
.
corporate environmental concerns (CEC) and audit risk. DOI 10.1108/02686901111161340
MAJ We find that auditors do not perceive a significant relationship between CES and
26,8 audit risk; they do, however, perceive audit risk to increase with CEC. Additionally,
43 per cent of respondents use CEC in their risk assessment process, while only 15 per cent
of respondents use CES in their risk assessment process. Perception of the CER/audit
risk relationship is a significant determinant of CER use. In regards to auditors who use
CER to assess audit risk, both CES and CEC are deemed to be average in their usefulness.
698 Auditors who use CER to assess audit risk overwhelmingly believe that both CES and
CEC impact inherent audit risk, and that both forms of CER predominantly relate to
potential misstatements of contingent liabilities. Approximately 90 per cent of auditors
who do not use CEC to assess audit risk, would consider doing so, if made aware of the
positive relationship between CEC and earnings management documented by Heltzer
(2011) and expanded upon herein.
Our findings contribute to two steams of literature. First, our findings
contribute to the literature involving the impact of CER on accounting earnings.
Such studies predominantly use archival data to examine the impact of CER on earnings
management (discretionary accruals). We study the impact of CER on accounting data by
examining the relationship between CER and audit risk, rather than CER and earnings
management. There are certain benefits of using audit risk, rather than discretionary
accruals, to assess the impact of CER on earnings. First, audit risk encompasses
additional, often hard to measure qualities which may be related to CER’s impact on
earnings, such as managements’ integrity and the “tone at the top”. Additionally, earnings
management is calculated using post-audit numbers, which may contain audit
adjustments made to correct for attempted earnings management. Audit risk, on the other
hand, is determined pre-audit, thereby eliminating such selection bias. Further, through
their training, experience, and expertise, auditors have an intimate and unique knowledge
of earnings quality.
Our findings additionally contribute to the literature stream which examines specific
components of audit risk. Components of audit risk vary across firms and are largely
proprietary. Therefore, many papers reveal determinants of audit risk indirectly, via
variation in audit fees (Gul et al., 2003; Abbott et al., 2006) and audit committee expertise
(Krishnan and Visvanathan, 2009). Others take a more direct approach, providing audit
practices of specific firms, such as PricewaterhouseCoopers (PwC) (Winograd et al.,
2000) and KPMG (Bell et al., 2002). Our study adds to this research by unearthing an
additional component of audit risk: CEC. To our knowledge, this is the first paper to
document the relationship between CER and audit risk.
In additional to contributing to academic literature, our study is motivated by the
desire to improve audit quality. By revealing current practices in regards to CER and
audit risk, we hope to shed light on whether or not CER is actually used to assess audit
risk, and if it is, whether or not it is deemed useful. By exposing current practices and
results, we hope to inform others of the CER/audit risk relationship, which in turn may
help promote representative truthfulness in financial reporting.
The remainder of this paper is outlined as follows. Section 2 provides a literature
review. Section 3 develops our hypotheses and research questions. Section 4 describes
our sample. Section 5 presents our results. Section 6 concludes.
2. Literature review CER and
2.1 Corporate environmental responsibility audit risk
Academics question what affect, if any, CER has on reported earnings. One branch of
this literature involves the political cost hypothesis (PCH). The PCH predicts that firms
which are subject to increased political scrutiny will actively decrease earnings to
avoid fines and other potentially costly regulations. The PCH has been embraced in the
CER literature, as it predicts that heightened scrutiny surrounding CEC will lead to 699
discretionary income-reducing accruals. This prediction has been tested, and proven,
many times over in the CER literature. For example, Hall and Stammerjohan (1997)
examine earnings manipulation of oil firms undergoing a large litigation case. The
authors find evidence of reduced earnings during the litigation period. Cahan et al.
(1997) find that chemical firms engaged in income-reducing discretionary accruals
as the US Congress deliberated enactment of the Comprehensive Environmental
Response, Compensation, and Liability Act. Han and Wang (1998) study earnings of oil
companies during the 1990 Persian Gulf Crisis. The Persian Gulf Crisis led to increased
gas prices, which in turn caused heightened public scrutiny of oil firms. The authors
find that during the period of heightened scrutiny, oil firms engaged in greater
incidences of income-decreasing accruals. Magnan et al. (1999) find support for the
PCH outside of the USA. They examine discretionary accruals of Canadian firms
subject to antidumping investigations, and find that such firms do indeed engage in
income-decreasing discretionary accruals. Finally, Johnston and Rock (2005) find that
firms identified as “potentially responsible parties” per the Comprehensive
Environmental Response, Compensation, and Liability Act engaged in discretionary
income-decreasing accruals.
A contemporaneous study which examines the impact of CER on earnings is Heltzer
(2011). Heltzer’s study differs from those above as it does not involve a setting of
heightened political scrutiny. Instead, using 2007 KLD data, Heltzer studies earnings
management of firms across three subsamples: firms with CES, environmentally
neutral firms, and firms with CEC[1]. Heltzer finds that firms with CES (and
environmentally neutral firms) exhibit insignificant discretionary accruals, while firms
with CEC exhibit significantly positive discretionary accruals. These findings reveal
an asymmetric relationship between CER and earnings management.
Another branch of literature which examines the impact of CER on earnings is
encased in a wider spectrum of corporate responsibility. Such studies examine the
impact of corporate social responsibly (CSR) on earnings[2]. Two contemporaneous
studies which examine the impact of CSR on earnings are Chih et al. (2008) and
Prior et al. (2008). Both studies use international data and a continuous, blended
CSR measure. Chih et al. find mixed results regarding the relationship between CSR
and earnings quality. On one hand, the authors find a positive relationship between
CSR and earnings quality, as they find CSR reduces:
.
earnings smoothing; and
.
earnings losses and decrease avoidance.

On the other hand, when earnings aggressiveness is used to measure earnings quality,
the authors find a negative relationship between CSR and earnings quality. In a related
paper, Prior et al. examine the relationship between CSR and earnings management
(discretionary accruals). They authors predict that managers resort to CSR practices
MAJ to alleviate the negative effects of earnings management on shareholder interests;
26,8 the authors find support for their prediction.
We hope to contribute to the literature above by providing a new environment to
evaluate the impact of CER on earnings. By collecting a unique dataset of auditor
responses, we are able to provide new insights into the effect of CER on earnings.
As outlined below, audit risk is directly related to the representative truthfulness of
700 earnings. Thus, by studying the relationship between CER and audit risk, we expand
upon our knowledge of how, if at all, CER impacts financial data. This in turn has
implications for users of financial statements, as well as policy makers interested in
increasing the quality of accounting data.

2.2 Audit risk

Audit risk refers to the risk of failure to identify material misstatements in financials,
leading to an incorrect audit opinion. In more technical terms, audit risk is the product of
three factors: inherent risk, control risk and detection risk. Inherent risk is the risk
that a material misstatement occurs before considering the internal control environment.
Control risk is the risk that the client’s internal controls will not detect material
misstatements on a timely basis. Finally, detection risk is the risk that a material error in
the financial statements will go undetected by the auditor.
Academics have long sought to identify specific determinants of the risk
assessment process. While there are mandated auditing standards which must be
followed, it is ultimately the responsibility of the audit team, lead by the engagement
partner, to design, and implement audits[3]. As such, determinants of audit risk vary
across and within audit firms, due to the nature of each client, varying levels of risk
aversion, as well as the ability of audit team members to infuse their unique knowledge
and skills into the planning process.
Studies regarding the determinants of audit risk use both archival and unique
data[4]. Archival studies focus on how, if at all, variations in measurable qualities, such
as earnings management, impact audit fees. For example, using Australian data,
Gul et al. (2003) document a positive association between discretionary accruals and
audit fees. In a related study using US data, Abbott et al. (2006) find that audit fees
increase among firms with income-increasing discretionary accruals. Similarly,
Krishnan and Visvanathan (2009) find that, conditional upon the strength of a firm’s
corporate governance, audit pricing decreases as accounting expertise of an audit
committee increases.
As mentioned above, not all studies involving the determinants of audit risk involve
archival data. Many studies involving audit risk determinants use unique data. These
studies gather data directly from audit firms, and/or obtain auditor data via a survey or
experiment. There are undeniable benefits to using archival data, such as decreased
cost and ease of accessibility/time. However, there are certain earnings qualities which
may not be measurable in terms of numeric tapes. Further, specifics regarding audit
planning are generally considered proprietary. As such, obtaining information directly
(and anonymously) from auditors may provide more insightful findings.
In regards to gathering data directly from audit firms, Winograd et al. (2000) and
Bell et al. (2002) are able to obtain information from PwC and KPMG, respectively.
Winograd et al. document information pertaining to the PwC Audit Approach (PwCAA).
The authors outline the eight principles of the PwCAA framework, as well as specifics
regarding PwC’s Financial Risk Assessment System. Similarly, Bell et al. disclose CER and
information about KPMG’s risk assessment tool (KRisk). The authors provide examples audit risk
of the different types of information gathered per KRisk (spanning seven categories) as
well as details regarding each category. Owing to the proprietary nature of audit risk
determinants, these papers are important bridges between practitioners and academics.
However, as Winograd et al. note: “It is difficult to know whether all factors have been
captured or whether certain factors listed are consistent with other firms due to the 701
limited public information available”.
In regards to unique data collected from auditor surveys and experiments, Bedard
and Johnstone (2004) collect data from engagement partners to study the relationship
between audit planning and earnings management risk. The authors find an increase
in planned audit effort and billing rates among firms with heightened earnings
management risk. In a related study, Bell et al. (2001) collect confidential data from
auditors at a single audit firm. The authors find a positive relationship between
perceived business risk and audit fees. Johnstone (2000) conducts an experiment using
137 audit partners. Johnstone develops and tests a model that describes how auditors
evaluate risk, as well as the role of risks in the client acceptance process. She finds that
experiment participants considered client-related risks in determining their audit
firm’s risk of loss on an engagement.
Our study contributes to the steam of literature outlined above by documenting a
source of audit risk which has not, to the best of our knowledge, previously been
documented. Specifically, we question what role, if any, CER plays in the risk
assessment process. We do so in what we believe is the most direct way possible:
surveying auditors. Our findings that auditors:
.
do not perceive CES to be related to audit risk; and
.
perceive an increase in audit risk among firms with CEC, further our knowledge
of audit risk determinants.

Additionally, our finding that almost half of our respondent population uses CEC to
assess audit risk further enhances our knowledge of the risk assessment process.

3. Hypotheses and research questions

3.1 Entire sample analyses
3.1.1 Auditors’ perceptions of CER and audit risk. As mentioned above, using a recent
sample of US firms, Heltzer (2011) finds discretionary accruals among firms with
CEC are insignificant, while firms with CES exhibit significantly positive discretionary
accruals. Because our study setting closely resembles that of Heltzer in terms of time
and geography, we use these empirical findings as a basis for our hypotheses.
However, before formulating our hypotheses we expand upon Heltzer’s findings,
to ensure that they hold outside the year 2007. In Table I, we present discretionary
accruals for CEC and CES firms across one-year (2009), five-year (2005-2009), and
ten-year (2000-2009) periods; across each period CES are not related to discretionary
accruals, while CEC are related to positive discretionary accruals.
As discussed above, Gul et al. (2003) and Abbott et al. (2006) document a positive
relationship between discretionary accruals and audit fees, suggesting that audit risk
increases with discretionary accruals. As Gul et al. (2003) note:
MAJ
Predictions per One-year study: Five-year study: Ten-year study:
26,8 Heltzer (2011) 2009 2005-2009 2000-2009

Strength
subsample m¼0 0.0071 20.0024 20.0007
Neutral
702 subsample m¼0 20.0022 20.0003 20.0004
Concern
subsample m.0 0.0129 * * * 0.0037 * 0.0040 * *
Notes: Statistically significant at: *90 per cent, * *95 per cent, and * * *99 per cent levels, respectively;
statistical significance of signed predictions are determined using one-sided p-values; statistical
significance of unsigned (insignificant) predictions are determined using two-sided p-values; this table
depicts average discretionary accruals per subsample; discretionary accruals are determined using the
Table I. modified Jones Model; subsamples are created using KLD data; see Heltzer (2011) for details
Archival data concerning calculations of discretionary accruals, as well as CER subsamples

[. . .] the determination of discretionary accruals requires subjective estimates and

discretionary accruals are, by nature, inherently more uncertain than other items in the
financial statements and more difficult to audit. They are also more prone to manipulation.
This leads to an upward revision of auditors’ inherent risk assessments in the course of the
audit which will be associated with higher audit effort and thus higher audit fees.
Additionally, as Heninger (2001) notes, auditors have incentives to avoid discretionary
positive accruals as such artificial increases may lead to increased litigation risk and/or
reputational loss. Barron et al. (2001) extend this concept in their experimental study of
audit partners and managers. They find that planned audit investments are larger with
earnings overstatements, relative to understatements[5].
Owing to the empirical findings in Table I, coupled with the positive association
between discretionary accruals and audit risk, along with auditors’ increased
sensitivity to positive accruals, we hypothesize that auditors, on average, will perceive
no relationship between CES and audit risk. We further hypothesize that auditors will,
on average, perceive a positive relationship between CEC and audit risk:
H1a. Auditors, on average, do not perceive a significant relationship between CES
and audit risk.
H1b. Auditors, on average, perceive a positive relationship between CEC and audit
risk.
Perceptions of the CER/audit risk relationship are determined on a nine-point scale,
ranging from 24.0 (decreased audit risk) to 4.0 (increased audit risk), with 0.0 being the
middle value (no impact on audit risk). We test H1a by ascertaining whether the mean
perception of CES/audit risk is insignificant; we test H1b by ascertaining whether the
mean perception of CEC/audit risk is positive. Inability to accept our first set of hypotheses
may be due to factors other than earnings management impacting perceptions and/or
auditors’ lack of awareness regarding the relationship between CER on earnings
management. We attempt to decipher between these alternatives in Sections 3.2 and 3.3.
3.1.2 Auditors’ use of CER in the risk assessment process. In this section, we build
upon our predictions regarding auditors’ perceptions of CER and audit risk. Specifically,
we investigate the use of CER in the risk assessment process. Empirical evidence
suggests that discretionary accruals are not related to CES; however, discretionary CER and
accruals appear to increase with CEC. Further, as discussed in Section 2, audit risk audit risk
involves the risk of material misstatements of accounting data; past studies suggest that
discretionary positive accruals increase that risk. As such, we hypothesize that CES
(CEC) are (are not) used in the risk assessment process with our second set of hypotheses:
H2a. Auditors, on average, do not use CES to assess audit risk.
703
H2b. Auditors, on average, use CEC to assess audit risk.
We test H2a by ascertaining whether the proportion of auditors who use CES to assess
audit risk is equal to zero; we test H2b by ascertaining whether the proportion of
auditors who use CEC to assess audit risk is positive.
We expand upon our study of CER use in the risk assessment process by
investigating the determinants of such use, with our first research question:
RQ1. What are the determinants of auditors’ use of CER in the risk assessment
process?
CER use is a binary measure, and thus we conduct probit regressions to examine
RQ1[6]:

USEi;t ¼ a0 þ a1 BIGFOURi þ a2 EXPERIENCEi þ a3 SECi þ a4 INDUSTRYi

þ a5 CER_FIRMi þ a6 CER_DEPTi þ a7 PERCEPTIONi;t
ð1Þ
þ a8 POL_AWAREi þ a9 ENV_IMPTi þ a10 ENV_ACTi
þ a11 CER_BELIEFi þ a12 CER_INDICATIONi þ a13 PCHi

In equation (1) we question whether CER use (USEi,t) is driven by institutional factors,
such as working for a big-four audit firm (BIGFOURi), number of years of public
accounting experience (EXPERIENCEi), percentage of clients registered with the
SEC (SECi), industry specialization (INDUSTRYi), CER practices of the accounting firm
(CER_FIRMi), and known existence of a specialized CER department (CER_DEPTi).
We allow for the possibility that use of CER in the risk assessment process additionally
(or alternatively) is determined by personal convictions and practices. As such,
we include political awareness (POL_AWAREi), importance of environmental issues
(ENV_IMPTi), maintenance of the environment (ENV_ACTi), beliefs regarding
CER and overall corporate responsibility (CER_BELIEFi), beliefs regarding CER and
its indication about managements’ integrity regarding financial reporting
(CER_INDICATIONi), beliefs about the PCH (PCHi), and unique perceptions of the
CER/audit risk relationship (PERCEPTIONi,t). In-depth descriptions regarding all of
the above variables may be found in Appendix 1.

3.2 Analyses of auditors who use CER to assess audit risk

In this section, we examine the subsample of auditors who use CER to assess audit risk.
We begin by studying the usefulness of CER in the risk assessment process. Based upon
the documented insignificant relationship between CES and discretionary accruals,
we predict that CES will not be useful in regards to risk assessment. However, because of
the documented significant relationship between CEC and discretionary accruals,
MAJ coupled with auditors’ increased sensitivity to overstating earnings, we predict
26,8 that CEC will be useful in the risk assessment process. As such, our third set of
hypotheses is:
H3a. CES are not useful in the risk assessment process.
H3b. CEC are useful in the risk assessment process.
704 The usefulness of CER in assessing audit risk is determined on a nine-point scale,
ranging from 1.0 (not useful) to 9.0 (extremely useful), with 5.0 being the middle value
(moderately useful). In regards to H3a we anticipate that the mean usefulness of
CES will not be significantly different from 1.0, while in H3b we anticipate that the
mean usefulness of CEC will be significantly greater than 1.0.
We further examine CER use with our second and third research questions:
RQ2. Where does CER fit in the audit risk equation?
RQ3. What types of accounts are believed to be impacted by CER?
By examining where CER fits in the risk equation, as well as the types of accounts
CER is used to assess, we hope to paint a more complete picture regarding why CER is
used in the risk assessment process.

3.3 Analyses of auditors’ who do not use CER to assess audit risk
Our final examination involves those auditors who do not use CER to assess audit risk.
We do not anticipate CES will be used in the risk assessment process (see H2a);
as such, we focus on auditors who do not use CEC to assess audit risk. Specifically,
we question the willingness of auditors to use CEC in their assessment of risk if they
are made aware of the empirical relationship between CEC and discretionary accruals:
RQ4. Are auditors who do not use CEC to assess audit risk willing to do so if they
are made aware of the relationship between CEC and earnings management?
By better understanding auditor’s wiliness to use CECs in the risk assessment process,
we hope to not only unveil why auditors do not use CEC to assess audit risk, but also
gauge potential successes of educational endeavors regarding the findings in Table I.

4. Sample
4.1 Survey design and responses
We collected our data electronically, via an online survey[7]. Letters requesting survey
participation were mailed to 5,008 auditors, all of whom were current members of the
Auditing Section of the American Institute of Certified Public Accountants (AICPA)[8].
Names and mailing addresses were received from Lake Group Media[9].
The survey first asks for institutional and personal data[10]. Next, we separately
ask questions regarding CES and CEC. On top of each page we define the relevant
terms[11]. We define CES as actions taken by the company to protect the environment,
such as: pollution prevention, recycling, the use of clean energy, maintaining PP&E
with above average environmental performance, and production of environmentally
beneficial products and services. We define CEC as actions taken by the company
that harm the environment, such as: creating hazardous waste, emitting ozone
depleting chemicals or toxic chemicals, producing substantial amounts of agricultural
chemicals (i.e. pesticides) and generating revenues from products linked to climate CER and
change. Further, we define audit risk as the risk that an auditor fails to properly audit risk
identify material misstatements in the financials and fails to modify their audit opinion
accordingly.
We mailed two requests for participation. The original was mailed on 19 August
2010. Survey responses were anonymous, preventing participants from feeling
restricted when providing their firm’s methodology or their personal risk assessment 705
processes. Because responses could not be linked to respondents, a follow-up request
for participation was sent to all auditors on 13 September 2010.
Of the 5,008 initial requests, 210 (4.2 per cent) were returned, reducing our pool of
viable respondents to 4,798[12]. Of those viable respondents, 216 auditors started the
survey. In determining our final sample, we eliminated responses from non-auditors
(seven auditors), as well as responses missing pertinent data and/or completed
under five minutes (46 auditors)[13]. Our final sample is comprised of 163 auditors.
See Table II for details.
At first blush our response rate may appear low; however, our response rate and final
sample compare to those in contemporaneous studies. For example, in a recent US study
involving the impact of the Sarbanes Oxley Act of 2002 on small business firms,
Michelson et al. (2009) mail 5,479 surveys and receive 117 completed surveys, for a
response rate of 2.1 per cent. We acknowledge that our response rate may have been
negatively impacted by two factors. First, studies tend to be consistent in their methods
of communication, using written requests and written surveys, or electronic requests
and electronic surveys. To the best of our knowledge, AICPA data are available only as
mailing addresses. We did not want to unnecessarily use paper (this is, after all, a study
about CER). Thus, we sent written requests to participate in an electronic survey. By
conducting the survey electronically we saved approximately 50,000 pages across two
mailings. We believe that the disconnect between the method of participation request
(paper) and the survey (electronic) reduced our response rate, as it required an additional
step. Second, authors are often able to obtain direct access into an audit firm,

Panel A
Number of requests
Total requests mailed 5,008
Returned requests (210)
Viable respondents 4,798
Panel B
Initial request Follow-up request Total
Surveys started 150 66 216
Non-auditor responses (5) (2) (7)
Survey completions time is less than five minutes
and/or missing pertinent answers (32) (14) (46)
Final sample 113 50 163
Response rate (based upon surveys started) (%) 3.13 1.37 4.50
Response rate (based upon final sample) (%) 2.36 1.04 3.40
Notes: This table summarizes our surveyed population (Panel A) and response rates (Panel B); the
initial request was mailed on 19 August, and the follow-up request was mailed on 13 September; the Table II.
survey was taken off-line on Monday, 4 October Sample determination
MAJ or use “connections” to obtain respondents. Our study is completely blind; we used
26,8 random contacts generated by Lake Group Media. We believe the benefits of this
approach (privacy, greater demographic and firm variation) outweigh the costs of
reduced responses. In anticipation of the lower response rate due to the factors outlined
above, we purchased a large number of auditor contacts (5,008) so that our final sample
size would be robust.
706
4.2 Summary statistics
Summary statistics for our sample may be found in Table III. In regards to institutional
variables (Panel A), approximately 45 per cent of our sample work for big-four audit
firms. Thus, we have an approximately even split between big-four auditors and
auditors from other firms. Experience level among survey participants is relatively
high: average years of public accounting work (EXPERIENCE) is just over 17.
In untabulated statistics we find that approximately 38.7 per cent of our sample is
comprised of partners, while an additional 8.0 per cent is comprised of directors[14].
This composition bodes well for our analyses, as partners and directors are intimately
involved in the risk assessment process. Regarding the remaining institutional
variables, approximately one-third of our respondents’ clients are SEC registrants
(SEC), most respondents view the environmental practices of their audit firms as above
average (CER_FIRM), and approximately 65 per cent of respondents work for firms
with known internal CER departments (CER_DEPT).
In regards to personal variables (Panel B), our sample comprises auditors with
above average convictions regarding political and environmental responsibilities.
Specifically, on scales of 1.0-9.0, respondents exhibit mean political awareness
(POL_AWARE) of 6.9, value environmental issues (ENV_IMPT) with a mean of 6.4,
and are active in protecting the environment in their personal lives (ENV_ACT), also
with a mean of 6.4. Respondents’ mean belief regarding CER (CER_BELIEF) is 6.4;
however, their mean interpretation of CER and its indication regarding integrity of
financial reporting (CER_INDICATION) is only 4.8. Finally, our survey participants
are not strong believers in the PCH outlined in Section 2, as the mean of PCH is 3.3.
Panel C of Table III provides details regarding industry specialization in our sample.
Industry specialization is a dummy variable equal to one if the auditor has clients in a
particular industry; zero otherwise. The most heavily represented industry in our
sample is manufacturing, as just over half our sample have clients in the manufacturing
industry. After manufacturing, technology is the next most represented industry in our
sample, with 33 per cent representation. In addition, over 18 per cent of our sample
consists of generalists, while 27.6 per cent consists of “other” specialties[15]. Overall,
our sample provides a wide-range of industrial expertise across industries which
are impacted by CER.

5. Results
5.1 Entire sample analyses
5.1.1 Auditors’ perceptions of CER and audit risk. Results regarding auditors’
perceptions of the CER/audit risk relationship may be found in Table IV. The findings in
Panel A relate to our first set of hypotheses. In H1a we predict that auditors, on average,
perceive no relationship between CES and audit risk, while in H1b we predict that
auditors, on average, perceive a positive relationship between CEC and audit risk.
 Scale N Mean SD Min. 25% Median 75% Max.
Panel A. Institutional variables
BIGFOUR Binary 163 0.45 0.50 0.0 0.0 0.0 1.0 1.0
EXPERIENCE No. of years 163 17.39 10.17 0.50 9.00 15.00 25.00 46.00
SEC Percentage of clients 162 33.36 37.36 0.00 0.00 15.00 75.00 100.00%
CER_FIRM 1.0-9.0 163 6.65 1.36 2.00 6.00 7.00 8.00 9.00
CER_DEPT Binary 163 0.65 0.48 0.00 0.00 1.00 1.00 1.00
Panel B. Personal variables
POL_AWARE 1.0-9.0 163 6.90 1.43 2.00 6.00 7.00 8.00 9.00
ENV_IMPT 1.0-9.0 163 6.39 1.58 1.00 5.00 7.00 7.00 9.00
ENV_ACT 1.0-9.0 163 6.43 1.14 2.00 6.00 7.00 7.00 9.00
CER_BELIEF 1.0-9.0 163 6.38 1.09 3.00 6.00 7.00 7.00 9.00
CER_INDICATION 1.0-9.0 162 4.80 2.34 1.00 3.00 5.00 7.00 9.00
PCH 1.0-9.0 163 3.26 2.02 1.00 1.00 3.00 5.00 9.00
Panel C: Industry representation
(1) (2) (3)
Greatest time spent in the Over 50% of time spent in the
Any time spent in the specific industry specific industry specific industry
(1a) (1b) (2a) (2b) (3a) (3b)
n % of sample n % of sample n % of sample
Banking 37 22.7 18 11.0 15 9.2
Government/public administration 22 13.5 7 4.3 6 3.7
Healthcare 34 20.9 6 3.7 6 3.7
Hospitality/tourism 11 6.7 1 0.6 0 0.0
(continued)

Summary statistics
audit risk
CER and

Table III.
707
 26,8

708
MAJ

Table III.
Insurance 18 11.0 4 2.5 3 1.8
Manufacturing 83 50.9 32 19.6 20 12.3
Media and entertainment 13 8.0 1 0.6 0 0.0
Oil, gas and other natural resources 22 13.5 7 4.3 5 3.1
Public utilities 15 9.2 3 1.8 2 1.2
Real estate 35 21.5 11 6.7 11 6.7
Retail trade 33 20.2 4 2.5 2 1.2
Technology 54 33.1 16 9.8 9 5.5
Transportation 10 6.1 1 0.6 1 0.6
Generalist/no specialty 30 18.4 7 4.3 6 3.7
Other 45 27.6 20 12.3 14 8.6
Total 462 283.4 163 100.0 100 61.3
Notes: This table outlines sample summary statistics; all variables presented in Panels A (institutional variables) and Panel B (personal variables) are
defined in Appendix 1; in Panel C we present industry specialization of sample auditors; Column (1) of Panel C presents the number and percentage of
auditors who spend any time in the specific industries; note that percentages in Column (1b) sum to greater than 100 per cent, as many auditors specialize
in more than one industry; Column (2) of Panel C presents the number of auditors who spend more time in the specific industry, relative to the auditors
other industry specializations; as such, each sample auditor is represented once in Column (2a), allowing Column (2b) to sum to 100 per cent; finally,
Column (3) of Panel C presents the number of auditors who spend over 50 per cent of their time in the specific industry; as such, not every auditor is
represented in Column (3a), and the percentages in Column (3b) sum to less than 100 per cent
 CER and
Variable Hypothesis Prediction N Mean SD t-value p-value
Panel A a audit risk
PERCEPTIONi,CES H1a m¼0 163 0.147 1.287 1.46 0.1462
PERCEPTIONi,CEC H1b m.0 163 1.172 1.341 11.16 * * * , 0.001
Panel B. Frequency of responses b
Perceptions of the CES/audit risk relationship
80 709

28
19
15
9
3 6 3
0

–4 –3 –2 –1 0 1 2 3 4
Perceived Perceived Perceived
decrease no impact increase
in audit risk in audit risk in audit risk

Perceptions of the CEC/audit risk relationship

56

42

33

15
10
4 3
0 0

–4 –3 –2 –1 0 1 2 3 4
Perceived Perceived Perceived
decrease no impact increase
in audit risk in audit risk in audit risk

Notes: a Statistical significance (statistically different from zero) at the *90, * *95, and * * *99 per cent
levels, respectively; Panel A summarizes auditors’ perceptions of the relationship between CER audit
risk; values in the table below represent subsample averages (standard deviation in parentheses); the
scale ranges from 24.0 (perceived decrease in audit risk) to 4.0 (perceived increase in audit risk) with
zero being the middle value (perceived no impact on audit risk); bPanel B presents the frequency of Table IV.
responses in regard to the auditors’ perceptions of the relations between the various types of CER and Auditors’ perceptions
audit risk of CER and audit risk
MAJ We find support for both H1a and H1b in Panel A of Table IV. Specifically,
26,8 the mean perception of the impact of CES on audit risk is not statistically significant,
while the mean perception of the impact of CEC on audit risk is statistically positive.
Thus, CES is not perceived to impact audit risk, while CEC is perceived to increase
audit risk. These findings provide new evidence towards the impact of CER on
earnings quality: they suggest that CEC, but not CES, are related to an increased risk of
710 material misstatements, and therefore lower earnings quality.
We provide further insights into auditors’ perceptions of the CER/audit risk
relationship in Panel B of Table IV. These frequency tables provide visual explanations
for the distinct and asymmetric differences in perceptions. In regards to perceptions of
CES/audit risk, responses generally follow a normal distribution: approximately
50 per cent of auditors perceive no relationship between CES and audit risk; this
distribution decreases in frequency in both directions from the mean. Responses
regarding perceptions of CEC/audit risk are quite different: only 4 per cent of auditors
believe CEC leads to a decrease in audit risk, 34 per cent of auditors perceive no
relationship between CEC and audit risk, and 61 per cent perceive CEC as leading to an
increase in audit risk.
5.1.2 Auditors’ use of CER in the risk assessment process. Results regarding
auditors’ use of CER in the risk assessment process may be found in Table V.
The findings in Panel A relate to our second set of hypotheses. In H2a we predict there
will not be a significant percentage of auditors who use CES to assess audit risk, while
in H2b we predict that a significant proportion of auditors will use CEC to assess
audit risk.
We find that approximately 15 per cent or our sample use CES to assess audit risk,
while 43 per cent of our samples use CEC to assess audit risk. Both proportions are
significant, providing support for H2b but not H2a. Thus, despite empirical evidence
that CES are unrelated to discretionary accruals, a significant percentage of auditors
use CES to assess audit risk. This suggests that CES may contain information related
to audit risk which is unrelated to discretionary accruals (such as “tone at the top”)
and/or auditors may not be aware of the insignificant relationship between CES
and discretionary accruals. We attempt to decipher between these possibilities in
Section 5.3.
Regarding our RQ1, in Panel B we shed light on the determinants of auditors’ use of
CER in the risk assessment process[16]. Our model provides relatively good and
similar fits across use of CES and CEC, with pseudo-R[2] values of 37.36 per cent and
39.05 per cent, respectively. We find that the dominant determinant of both types
of CER is perception (PERCEPTION). Thus, it is an auditor’s unique perception of
the CER/audit risk relationship, which universally determines whether an auditor will
use CER to assess audit risk. Additionally, use of CES is marginally increased by
auditors’ beliefs concerning the relationship between CER and management’s integrity
regarding financial accounting and reporting decisions (CER_INDICATION),
suggesting that CES are used to assess audit risk when they are believed to reveal
information about the “tone at the top”. Further, CEC use is increased by the
presence of a CER department (CER_DEPT), implying that audit firms which hire
environmental specialists are successful in utilizing their knowledge during audits.
None of the other independent variables prove to be significant determinants of
auditors’ use of CER in the risk assessment process.
 CER and
Variable Hypothesis Prediction n Mean (%) SE p-value
audit risk
Panel A a
USEi,CES H2a %¼0 163 15.3 0.03 , 0.001
USEi,CEC H2b %.0 163 42.9 0.04 , 0.001
Panel B: Probit regressions b
USEi,CES USEi,CEC 711
n 144 161
Intercept 2 2.68 22.63 * *
(2 1.57) (21.96)
Institutional variables
BIGFOUR 2 0.37 20.38
(2 0.80) (21.05)
EXPERIENCE 0.01 0.00
(0.54) (0.14)
SEC 2 0.00 0.00
(2 0.74) (0.45)
CER_FIRM 2 0.01 20.10
(2 0.03) (20.81)
CER_DEPT 0.51 1.07 * * *
(1.05) (2.88)
Personal variables
PERCEPTION 0.35 * * 0.72 * * *
(2.35) (5.71)
POL_AWARE 0.08 0.10
(0.58) (0.91)
ENV_IMPT 0.00 0.12
(0.03) (0.98)
ENV_ACT 2 0.23 20.09
(2 1.08) (20.61)
CER_BELIEF 0.15 20.00
(0.86) (20.02)
CER_INDICATION 0.16 * 0.09
(1.65) (1.29)
PCH 2 0.01 0.07
(2 0.12) (0.89)
Adjusted-R 2 36.90% 37.66%
Notes: Statistically significant (statistically different from zero) at *90 per cent, * *95 per cent, and
* * *99 per cent levels, respectively; athis panel summarizes the proportion of auditors in our sample
that use environmental concerns and strengths to assess audit risk; values in the table below represent
subsample percentages (standard errors in parentheses); bbelow are regression results from estimating
the following probit regression:
USEi;t ¼ a0 þ a1 BIGFOURi þ a2 EXPERIENCEi þ a3 SECi þ a4 INDUSTRYi þ a5 CER_FIRMi
þ a6 CER_DEPTi þ a7 PERCEPTIONi;t þ a8 POL_AWAREi þ a9 ENV_IMPTi
þ a10 ENV_ACTi þ a11 CER_BELIEFi þ a12 CER_INDICATIONi þ a13 PCHi ð1Þ
where the dependant variable USEi,t is a binary variable equal to one if the auditor (i ) uses the specific Table V.
type of CER (t) to asset audit risk; zero otherwise, and the independent variables are described in Panel Auditors’ use of CER
A; values represent coefficient estimates, followed by z-values to assess audit risk
MAJ 5.2 Analyses of auditors who use CER to assess audit risk
26,8 This section focuses exclusively on the subsample of auditors who use CER, in either
capacity, to assess audit risk[17]. Results regarding the usefulness of both CES and CEC
in the risk assessment process may be found in Table VI. In H3a we predict CES will not
be useful in the assessment of audit risk, while in H3b we predict CEC will be useful in
the assessment of audit risk. As outlined in Table VI, we find support for H3b, but not
712 H3a. Specifically, we capture usefulness on a scale of 1.0 (not useful) to 9.0 (extremely
useful), with 5.0 being the middle value (moderately useful). The mean usefulness of both
CES and CEC in the risk assessment process is 5.68 and 5.67, respectively. Thus, despite
evidence that CES are unrelated to discretionary income-increasing accruals, CES
appear to contain useful information regarding audit risk; we investigate this further
below.
We next examine our second and third research questions by studying:
.
where CER falls in the audit risk equation; and
.
which part(s) of an audit are impacted by CER, respectively, in Table VII.

In regards to the risk equation (RQ2, Panel A), we find that both CES and CEC are
believed to impact inherent risk by over 90 per cent of each respective subsample. This
sheds light on the usefulness of CER, as it suggests a “tone at the top” is pervasive
throughout a corporation’s management and its financial reporting. Control risk is
believed to be impacted by approximately one-third of each subsample, suggesting that
CER additionally impacts a company’s internal controls. Finally, it is believed that CER
impacts detection risk by 16.0 per cent (27.5 per cent) of the users of CES (CEC). Auditors
try to restrict detection risk through the performance of substantive auditing
procedures. Therefore, these auditors may consider that, in the presence of CES and/or
CEC, they can design their audit procedures to reduce the risk of material misstatements.
In regards to location of audit risk (RQ3, Panel B), over 90 per cent of CER users state
that CER impacts misstatements of contingent liabilities, while over half CER users
state that CER impacts client acceptance and continuance. Additionally, 40 per cent
(30 per cent) of auditors use CES (CEC) in earnings management assessments.
Thus, despite the findings in Table I, use of CER in the risk assessment process is
comprised of factors other than earnings management assessment. We investigate
this discrepancy via the written answers below. This finding also highlights the
importance of using unique data to capture audit risk determinants.
In reviewing the written responses regarding why auditors use CER to assess audit
risk, it appears auditors CES is believed to be an indication of the “tone at the top”

Variable Hypothesis Prediction n Mean SD t-Stat. p-value

USEFULNESSi,CES H3a m¼1 25 5.680 * * * 1.282 18.25 , 0.001

USEFULNESSi,CEC H3b m.1 69 5.667 * * * 1.746 22.20 , 0.001
Notes: Statistically significant (statistically different from 1.0) at *90 per cent, * *95 per cent, and
* * *99 per cent levels, respectively; this table summarizes the usefulness of CER in assessing audit
Table VI. risk; values in the table represent subsample averages (standard deviation in parentheses); the possible
Usefulness of CER in scale ranges from 1.0 (not useful) to 9.0 (extremely useful) with 5.0 being the middle value (moderately
assessing audit risk useful)
 CER and
Type of
CER audit risk
used

Panel A. Types of audit risk

Inherent (%) Control (%) Detection (%)
CES 713
(n ¼ 25) 96.0 32.0 16
CEC
(n ¼ 69) 91.3 31.9 27.5
Panel B. Specific location audit risk
Client acceptance Misstatement of Misstatement of Earnings
and continuance contingent accounts other than management Other
(%) liabilities (%) contingent liabilities (%) assessments (%) (%)
CES
(n ¼ 25) 56.0 92.0 4.0 40.0 4.0
CEC
(n ¼ 69) 50.7 92.8 13.0 30.4 2.9
Notes: This table provides information regarding where and how CER is used in the audit process; in
Panel A respondents selected each area of the audit risk model where they believe that knowing and Table VII.
understanding a company’s CER is most useful; in Panel B respondents selected where they believe Details regarding use of
CER is most useful in assessing audit risk during the audit planning and procedures processes; in each CER in the risk
panel, the participants could select more than one option assessment process

and “management integrity”, which are important parts of the audit risk assessment
process related to understanding the client and its environment. For example, a partner
at a top-ten audit firm states that he uses CES in the risk assessment process because
“they are indicative of a very positive tone at the top which often translates into a lower
assessment of audit risk”.
In regards to why auditors use CEC to assess audit risk, there is also a lot of talk
about “tone at the top” and “managerial integrity”, however, these answers tend to be
more concrete in terms of the impact on financial reporting, primarily in relationship to
estimates regarding contingent liabilities. For example, a partner at a big-four firm
wrote: “If a company is knowingly causing a potential environmental liability than
those risks should be considered for potential financial statement impact”. Similarly,
a senior at a big-four firm wrote, “Seems reasonable there would be a risk of the
company trying to ‘hide’ the amount of environment harm they do and the liability/cost
of it”.

5.3 Analyses of auditors who do not use CER to assess audit risk
The final part of our study involves the subsample of auditors who do not currently
use CER to assess audit risk. The predominant reason for not using CES in the risk
assessment process (from the written responses) is the lack of a perceived correlation
between CER and financial reporting[18]. Other auditors simply “haven’t thought of it”
or “never really gave it a thought”[19]. A Senior at a big-four firm expanded upon the
idea that CES and audit risk are not related:
MAJ [. . .] I do not see any impact on audit risks just because of a focus on the environment. I do not
think that there is an increase in audit risk because one company is not diverting time, energy
26,8 and resources to developing, implementing and maintaining corporate responsibility
programs. My view is that these changes are really great for the environment, provides good
PR for companies and possible ways to save the company money. I do not believe that those
companies that choose to do this are in any way more honest (decreasing audit risk) nor
divert resources away from proper management (increasing audit risk). I believe it has no
714 audit risk impact.
In regards to why auditors to not use CEC to assess audit risk, lack of perceived
correlation is again the main reason, along with lack of consideration. As a big-four
Senior Manager notes: “It never crossed my mind. If I was provided evidence that
companies with environmental concerns were more likely to manipulate earning
I would consider [using them]”.
Expanding upon this notion, we present the results of our fourth research question in
Table VIII. In RQ4 we research whether auditors’ knowledge of the relationship between
earnings management and CEC, as replicated in Table I, would change their behaviors.
Responses were gauged on a nine point scale, ranging from “No” at 1.0, to “Yes” at 9.0,
with “Maybe” being the middle response at 5.0. As Panel A illustrates, only 5 per cent of
this subsample would not consider using CEC to assess risk if made aware of the

n Mean SD Min. 25% Median 75% Max. t-Stat. p-value

Panel A. Summary statistics

93 6.032 1.997 1.0 5.0 6.0 7.0 9.0 4.98 , 0.0001
Panel B. Frequency distribution
Auditors' willingness to use
CEC to assess audit risk

30

23

10 11
9
5
2 2
1

1 2 3 4 5 6 7 8 9
No Maybe Yes

Notes: This table presents our results from the following survey question: would you consider using
CEC to assess audit risk if you were provided evidence that corporations with one or more
Table VIII. environmental concerns exhibit greater earnings management, relative to other sample corporations?
Auditors’ willingness to Responses were based upon a nine-point scale, ranging from 1.0 (“No”) to 9.0 (“Yes”) with the middle
use CER in assessing value of “Maybe” at 5.0; Panel A summarizes numeric responses, while Panel B presents frequency of
audit risk responses
relationship between CEC and earnings management. The mean willingness of this CER and
population to use CEC to assess audit risk given the findings in Table I is 6.0, which is audit risk
statistically above average. The frequency graph in Panel B of Table VIII provides a
visual depiction of the willingness of auditors to use CEC in their risk assessment
process if provided the findings in Table I. This revelation has implications for auditors,
educators and policy-makers interested in detecting and preventing earnings
management in financial statements. 715
5.4 Robustness tests
5.4.1 Wave technique. We perform a “wave technique” analysis between the first and
second “wave” of responses to test for late and non-response biases (Kanuk and
Berenson, 1975; Hawkins, 1975). In addition to testing an early versus late response
bias, the different waves can also be used to predict a non-response bias assuming that
“subjects who respond less readily are more like those who do not respond at all than
those who do respond readily” (Kanuk and Berenson, 1975, p. 449).
In regards to our first set of hypotheses (involving CER/audit risk perceptions),
the mean of PERCEPTIONi,CES is not statistically different across waves, while
PERCEPTIONi,CEC is statistically greater in the first wave (mean of 1.3), relative to the
second wave (mean of 0.9). However, the mean of PERCEPTIONi,CEC is statistically
positive in both waves, suggesting that the difference in averages across perceptions does
not alter our findings. In regards to our second set of hypotheses (involving CER use), we
do not find differences in means of either USEi,CES or USEi,CEC across waves. Similarly, in
regards to our set of third hypotheses (involving CER usefulness), we do not find
differences in means of either USEFULNESSi,CES or USEFULNESSi,CEC across waves.
5.4.2 Sample requirements. One benefit of using an electronic survey is receiving
completion time, allowing us to eliminate respondents who did not take due care in
determining their answers. We chose five minutes as our cutoff, based on an
assumption of the reasonable time it would take to complete the survey with proper
thought. We examine the sensitivity of our findings to this cutoff herein. Responses of
auditors who completed our sample in-between 5 and 4 minutes (16 auditors) are
similar to those who completed our survey in-between 4 and 3 minutes (eight auditors).
As such, we discuss the results of these “quick” responders together.
Quick responders perceive CES (CEC) to lead to greater (less) audit risk, relative to our
main sample. The same pattern follows for use of CER: more (fewer) auditors among
the quick responders use CES (CEC) to assess audit risk, relative to our main sample.
These differences are significantly more pronounced in terms of CES, relative to CEC:
mean PERCEPTIONi,CEC and USEi,CEC among the quick responders are approximately
double those among our main sample. Usefulness of CER in the risk assessment
process does not appear to be influenced by quick respondents.
Because the number of quick responders is small, inclusion of these auditors has no
impact on our conclusions, except in the case of H1a. When we include quick responders
in our sample, PERCEPTIONi,CEC becomes marginally significant (positive) at the
90 per cent level. We review written responses of these auditors to better understand
if quick respondents (a) truly believe CES are more indicative of greater audit risk,
relative to our main sample (possibly by “masking” earnings management) or (b) did not
fully take time to properly answer the questions. We found no support for (a). Instead,
we find the auditors who perceive/use CES to assess audit risk in the “quick” sample do
MAJ so because they believe it speaks to the “tone at the top” (similar to our main sample)
26,8 suggesting that, in their haste, quick responders misinterpreted decreased audit risk
(2 4) with increased audit risk (þ 4)[20]. As such, we feel that our decision to eliminate
auditors who took less than five minutes to complete our survey is justified, as they are
indeed outliers.
5.4.3 Gender. We next evaluate whether females view the relationship between CER
716 and audit risk differently than males. Past research finds that females tend to utilize
more of the available information in their decision making process (the selectivity
hypothesis per Meyers-Levy (1989)) and tend to have a higher risk aversion than
males (Byrnes et al., 1999). Further, research has examined the effect of gender-bias on
decision making, and has found that female students incorporate more disconfirming
information cues in their analysis (Chung and Monroe, 1998), females’ analytical
procedures evaluate more decision cues when financial statement balances were in
line with the client’s business activity (O’Donnell and Johnson, 1999), and females
make more accurate audit judgments in more complex audit tasks (Chung and
Monroe, 2001). Because female decision makers have been found to be more risk
averse, such as in their investing decisions around mutual funds (Dwyer et al., 2002),
they may evaluate a greater amount of information in their risk assessment process to
reduce their risk of missing a material misstatement in the financial statements.
Approximately 22 per cent of our sample is comprised of female auditors.
We do not find statistically significant differences across gender in regards to the
variables used in our second set of hypotheses (USEi,t) and our third set of hypotheses
(USEFULNESSi,t). Following the research outlined above, we do find statistically
significant differences across gender in regards to perceptions of CER/audit risk.
Specifically, we do not find differences in PERCEPTIONi,CES across genders; however,
PERCEPTIONi,CEC among female auditors (mean of 1.51) is statistically greater than
PERCEPTIONi,CEC among male auditors (mean of 1.07). However, this difference does not
impact our conclusions regarding H1b, as both 1.51 and 1.07 are statistically positive.
5.4.4 Institutional variables. In this section, we examine the sensitivity of this our
finding regarding RQ1 to intuitional proxies used in equation (1). Specifically,
we examine whether proxies for experience, firm size, and industry specialization
impact our results concerning determinants of CER use.
In regards to auditor experience, in our main analyses we use years of public
accounting as a proxy for experience (EXPERIENCE). We examine the sensitivity of our
findings to this proxy by replacing EXPERIENCE with TOTAL_EXPERIENCE.
TOTAL_EXPERIENCE includes years of work in public accounting, industry
accounting, and “other” accounting. Additionally, we estimate equation (1) with
HIPOSITION in place of EXPERIENCE. HIPOSITION is a dummy variable equal to one
if the auditor is a Partner or Director; zero otherwise. We find determinants of both model
are mostly unchanged by the experience variable[21].
In our main analyses we use BIGFOUR to proxy for firm size. We do so because
studies have linked big-four audits to increased audit quality (DeAngelo, 1981).
In this robustness check we allow for the possibility that audit risk impacts the CER/audit
risk relationship in a linear, rather than binary manner. As such, we include REVENUES
in our model in place of BIGFOUR, a variable representing national revenues of the audit
firm. Similar to BIGFOUR, REVENUES is insignificant on both models, and other
determinants of CER use remain virtually unchanged.
 Finally, we examine the impact of industry dummy variables in our CER and
model. We re-estimate our model without the 15 dummy variables. PERCEPTION and audit risk
CER_INDICTAION remain the only significant determinants of CES use,
while PERCEPTION and CER_DEPT remain the only significant determinants of CEC
use. Finally, many auditors in our sample cross-specialize. Thus, their industry-specific
knowledge may not be as sharp, relative to auditors who specialize in only one industry.
As such, we re-estimate our model including an indicator variable for industry 717
specialization; industry specialization is insignificant, and as no impact on the significance
of the remaining determinants.

6. Conclusion
The impact of CER on financial statement data is studied extensively in the academic
arena. Such studies primarily use archival data, and tend to focus on CEC rather than
CES, or use a blended CER measure. We extend such studies by presenting unique data
from auditors, thereby capturing the private perceptions and uses of CER among those
most intimate with the preparation and review of financial statements.
In regards to our complete sample, we find that auditors do not perceive CES to be
related to audit risk, but they do perceive CEC to be related to an increase in audit risk.
These findings suggest that CEC, but not CES, are related to an increased risk of material
misstatements, and therefore lower earnings quality. We additionally find that 15 per
cent of our sample use CES to assess audit risk, while 43 per cent of our sample uses CEC
to assess audit risk. The difference across proportions is statistically significant,
highlighting the non-linear relationship between CER and earnings.
In regards to the subsample of auditors who use CER to assess audit risk, we find
that both CES and CECs are indeed useful. We attempt to understand why CES are
deemed useful, despite insignificant discretionary accruals in this subsample. Through
written responses we find that CES are considered to possess harder to measure
qualities related to earnings, such as “tone at the top” and “management integrity”.
In regards to the subsample of auditors who do not use CEC to assess audit risk,
we find that the vast majority of these auditors may consider using CEC to assess audit
risk if provided information regarding the relationship between CEC and earnings
management. Audit firms and accounting educators may wish to impart this
information to current and future auditors.
In sum, the findings herein advance the debates concerning the impact of CER on
accounting data. Similar to Heltzer (2011), our findings are asymmetric, highlighting
the importance of not imposing a linear relationship on CER/earnings. This study also
enhances our understanding of specific, often proprietary determinants of risk
assessment process. As such, the findings herein may aid auditors in determining
whether to include CER in their future risk assessment processes. Future studies may
wish to expand upon the findings herein by conducting a study outside of the US
and/or across countries with varying levels of regulation regarding CER.

Notes
1. See www.KDL.com
2. As noted by Wood (1991), CSR is hard to define. Wood’s Table I outlines a corporate social
performance model, in which the three principles of CSR are considered to be: institutional:
legitimacy; organizational: public responsibility; and individual: managerial discretion.
MAJ Additionally, the three processes of CSP are defined as: environmental assessment;
stakeholder management; and issues management. Finally, the three outcomes of corporate
26,8 behavior are stated to be: social impacts; social programs; and social policies.
3. Such mandated auditing standards are those outlined in Generally Accepted Auditing
Standards for US audits, and International Auditing Standards for international clients.
The audits of US public (issuer) companies must be performed in accordance with the
718 standards set by the Public Company Accounting Oversight Board.
4. Additionally, studies of audit risk involve theoretical models; see, for example, Newman et al.
(2001). Because our study involves data, we focus on the various methods of data collection
herein.
5. Barron et al. address unintentional over/under statements of earnings, rather than
discretionary actions.
6. We re-estimate equation (1) using logit instead of probit models, and our findings are not
significantly altered.
7. We used Qualtrics survey software to perform our study; see www.qualtrics.com
8. The minimum purchase was 5,000 contacts; however, we received 5,008.
9. See www.lakegroupmedia.com
10. Many of our questions are subjective in nature, which may induce bias. In order to reduce
personal bias, we provide auditors with discrete numeric scales for responses, coupled with
written descriptions. See Appendixes 1 and 2 for more detail.
11. Terminology is derived from KLD STATS. See www.kld.com
12. Because the survey was electronic, it was possible for auditors to forward the link to
co-workers. Six auditors obtained a forwarded survey link and started the survey; five of
these remain in our final sample.
13. We believe that completion under 5 minutes indicates lack of due care, especially because we
offered prizes for completion. We examine the sensitively of our results to this elimination in
Section 5.4.
14. The remaining 53.3 per cent of our sample is comprised of staff (3.0 per cent); seniors
(11.7 per cent); managers (12.3 per cent); senior managers (22.7 per cent); sole proprietors
(1.8 per cent), and “other” (1.8 per cent). These additional measurements of experience are
used in robustness tests in Section 5.4.
15. The three most represented categories of “other” specializations include not-for-profit,
construction, and employee benefit plans.
16. For the sake of readability we exclude the impact of industry dummy variables from
Panel B; results are instead discussed herein. Use of CES is increasing among auditors in
the hospitality/tourism and public utilities industries, and marginally among those in the
transportation industry. Additionally, STATA drops the insurance dummy from our
CES model (resulting in a sample of 144) as it predicts failure perfectly. Use of CEC is
marginally decreasing among auditors in the insurance industry, and marginally increasing
among those in the manufacturing industry.
17. There is substantial overlap among auditors who use each subtype of CER: of the 25 auditors
who use CES to assess audit risk, 22 (88 per cent) also use CEC. In total, 70 auditors use CEC
to assess audit risk; however, only 69 answered the questions for this section. As such, the
unique subsample for this section is 72 auditors.
18. For example, a partner at a mid-sized firm stated: “I don’t see the correlation between an CER and
entity’s position as it relates to the environment and audit risk”. This type of response is
echoed throughout our findings. audit risk
19. Quotes from a big-four director and a big-four senior manager, respectively.
20. Additionally, 15 quick responders (out of 24) gave the same answer regarding perceptions of
CES and CEC, including one answer of “9” for both, one answer of “7” for both, and two
answers of “6” for both. We believe this further suggests that quick responders did not 719
properly read/interpret survey questions.
21. In the CES model, both TOTAL_EXPERIENCE and HIPOSITION cause the specialization in
the retail industry to become a marginally significant positive indicator of CES use. This is
the only change due to the experience proxy.

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Variable Survey question Measurement/scale

PERCEPTIONi,t Regardless of whether or not you use CES/CEC to Scale of 24.0 to þ 4.0
Appendix 1
assess audit risk, how do you perceive the 2 4 ¼ Decrease in audit risk
relationship between CES/CEC and audit risk? 0 ¼ No impact on audit risk
þ 4 ¼ Increase in audit risk
USEi,t Do you use CEC/CES to assess audit risk? Binary measurement
1 ¼ Yes
0 ¼ No
USEFULNESSi,t How useful are measures of CES/CEC, in general, in Scale of 1.0 to 9.0
assessing audit risk? 1 ¼ Not useful
5 ¼ Moderately useful
9 ¼ Extremely useful
BIGFOURi In terms of national revenues, how would you rank Binary measurement
the size of the audit firm with which you are/were 1 ¼ One of the fourth largest
associated? 0 ¼ All other responses
EXPERIENCEi Please list the number of years that you have had Continuous variable
experience in public accounting 1 ¼ Spend any time in the industry
0 ¼ Spend no time in the industry
SECi Approximately what percentage of your total audits Continuous variable
are for companies that are registered with the SEC?
INDUSTRYi What percentage of your time is spent in each Binary measurement (converted from continuous
industry? variable)
1 ¼ Spend any time in the industry
0 ¼ Spend no time in the industry
CER_FIRMi How would you rate the environmental consciences Scale of 1.0 to 9.0
of the accounting firm where you currently work? 1 ¼ Poor
5 ¼ Average
9 ¼ Exceptional
CER_DEPTi Does the accounting firm where you currently work Binary measurement
have a CER or sustainability program? 1 ¼ Yes
0 ¼ No/do not know
(continued)

Variable definitions
audit risk
CER and

Table AI.
721
 26,8

722
MAJ

Table AI.
Variable Survey question Measurement/scale

POL_AWAREi How would you rate your political awareness? Scale of 1.0 to 9.0
1 ¼ Not aware
5 ¼ Somewhat aware
9 ¼ Extremely aware
ENV_IMPTi How important are environmental issues to you? Scale of 1.0 to 9.0
1 ¼ Do not care
5 ¼ Mildly important
9 ¼ Extremely important
ENV_ACTi How active are you in protecting the environment in Scale of 1.0 to 9.0
your personal life? 1 ¼ Knowingly hurt the environment
5 ¼ Neutral
9 ¼ Actively help the environment
CER_BELIEFi In regards to a corporation’s environmental Scale of 1.0 to 9.0
responsibility, do you believe that corporations 1 ¼ Maximize profits at all costs
should [. . .] 5 ¼ Meet minimum regulations
9 ¼ Protect the environment at all costs
CER_INDICATIONi Do you believe that a corporation’s actions around Scale of 1.0 to 9.0
CER are an indication about management’s integrity 1 ¼ No indication
around financial accounting and reporting decisions? ¼ Moderate indication
9 ¼ High indication
PCHi In the wake of an environmental disaster within one Scale of 1.0 to 9.01 ¼ No
industry, do you believe that other firms within that 5 ¼ Possibly
same industry will intentionally report lower 9 ¼ Yes
earnings, to avoid political scrutiny? For example, in
the reporting period following the BP oil spill, do you
believe that firms in the oil industry will
intentionally report lower earnings, in order to
appear less profitable, and thus avoid unfavorable
regulations or legislation?
Notes: This table contains definitions for all variables used herein; subscript (i ) represents the individual auditor, and subscript (t) represents the
type of CER in question (CES or CEC)
Appendix 2. Full survey CER and
audit risk

723
MAJ
26,8

724
 CER and
audit risk

725
MAJ
26,8

726
 CER and
audit risk

727
MAJ
26,8

728
 CER and
audit risk

729
MAJ
26,8

730
 CER and
audit risk

731
MAJ
26,8

732
 CER and
audit risk

733

About the authors

Mary Mindak is an Assistant Professor at DePaul University. She graduated from Miami
University with a BS in Accountancy in 1999 and a Master’s of Accountancy in 2000. After
working for Ernst & Young as an Auditor and Western and Southern Life Insurance Company
as a Strategic GAAP Analyst, she attended the University of Cincinnati and achieved her PhD in
2009. She has published in the CMA Magazine and is working on various research projects in the
areas of audit risk, earnings management, and corporate environmental responsibility.
Wendy Heltzer is an Assistant Professor at DePaul University. She received her BS in
Economics from the Wharton School at the University of Pennsylvania, and her MBA and PhD
from the Booth School of Business at the University of Chicago. She has published papers in
the Journal of Accounting, Auditing & Finance, Advances in Accounting, and Managerial
Auditing Journal. Wendy Heltzer is the corresponding author and can be contacted at:
wheltzer@depaul.edu

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