Investigation into investor information interest

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Master’s Thesis BA OCM

Investigation into investor information interest

An investigation into possible additions to the expanded auditor’s report

Jop Mulder (S2526921)

E-mail: j.mulder.30@student.rug.nl

Supervisor: prof. dr. D.A. (Dick) De Waard Co-assessor: Unkown

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Abstract

2014 saw the introduction of the expanded auditor’s report (EAR) in the Netherlands. This paper is an extension on earlier research done on the reading of the EAR. This research looked at what additional information a sample of members from the Vereniging van Effectenbezitters wanted to see being added to it. We found that most respondents wanted additional information, especially regarding the financial position and risk of the firm. Furthermore, internal control proved to be important to both finance professionals and older respondents. We looked at a preference for either an opinion from the auditor or information based on risk appetite and professionalism. We were unable to find such a relationship for either characteristic. Lastly, we looked at different types of industries that were invested in by the respondents. Although some industries saw a relationship with specific additions, no strong conclusions can be based on this.

Keywords: Expanded auditor’s report, auditing, risk appetite, professionalism, control, investor interest.

Acknowledgements:

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1. Introduction

1.1 Introduction

From financial year 2014 forward, Dutch public interest companies have been required to publish an expanded auditor’s report (EAR) in accordance with NBA 2014. This has been a drastic change in the way auditors make and present their findings in the annual report. Before we try to examine what the current situation is and how we can move forward we will begin with a look back in the past.

The profession of modern accounting was introduced in The Netherlands at the end of the nineteenth century through the establishment of the Nederlandsch Instituut van Accountants (NIVA - Dutch Institute of Accountants). Auditors now created an audit report that is

included in the annual report. For a long time this report included a simple pass or fail, where the auditor would issue either an unqualified (pass) or qualified (fail) opinion (Lennox, Schmidt, & Thompson, 2018). The wording used in this report was mostly standardised, thus resulting in companies mostly receiving the same unqualified report (Lennox, 2005; Gray, Turner, Coram, & Mock, 2011). This remained the standard for a substantial amount of time, until the introduction of new guidelines in 2002 by the Nederlands Instituut van

Registeraccountants (NIvRA - Dutch Institute of Registered Chartered Accountants). From this moment forward a small amount of information was also given regarding the

responsibility of the accountant and management with respect to the annual report and the activities undertaken by the accountant (NBA, 2002).

The early 2000’s saw a shift in public opinion on companies and the work done by auditors. Large accounting scandals plagued the news and 2008 saw the largest financial crisis in a long time. There was confusion among people, how was it possible for companies to receive an unqualified opinion, but still soon after that go bankrupt (Piersma, 2013)? The disconnect between the auditors and the users of the financial statements had long been known; however, this shift caused it to come into the public spotlight. The disconnect between the auditor and the users of the report is known as the “expectation gap” and has been around for as long as the audit report has been published (Humphrey, Moizer, & Turley, 1992). “It is widely felt that somebody should be made accountable for these financial disasters, and this somebody is perceived to be the auditors” (Chye Koh & Woo, 1998, p. 147).

Humphrey, Loft, and Woods (2009, p. 819) said that “the standard external audit report is not helpful in this regard, being full of general, standardized statements on the role and

limitations of the audit and containing little about the specific work undertaken and findings obtained by auditors”. Investors, institutions, and researchers agree with this and concluded that the auditor’s report was no longer sufficient (PCAOB, 2013; VEB, 2013; Mock et al., 2013; Gutierrez, Minutti-Meza, Tatum, & Vulcheva, 2018). “The [audit] reports have “symbolic value” possibly because of boilerplate language. Adding information about the audit can potentially add value to the audit report” (Mock et al., 2013, p. 345). This call for more information in the audit report was widespread from both researchers and institutions. The report should include additional information on the work of the auditor and how he came to his conclusion (Humphrey et al., 2009; PCAOB, 2013; NBA, 2014).

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to fulfil his role as representative of the communication between the public and the company (VEB, 2014).

In a response to this the Financial Reporting Council (FRC) in the United Kingdom

implemented the EAR in 2013. Reports from this moment forward were required to include matters such as key audit matters (KAM), the going concern principle, materiality, and scope of the group audit. As mentioned before, a year later the Netherlands followed. This new reporting style was already optional in 2013; however, full implementation would happen in 2014 when it became mandatory for all public interest entities. Since 2016 and 2017 the EAR has become part of the International Auditing and Assurance Standards Board (IAASB) and the Public Company Accounting Oversight Board (PCAOB) respectively. This means it must be used by all publicly listed companies worldwide (IAASB, 2015; PCAOB, 2017). Although most implementations are similar, they are not following each other to the letter, some

regional differences exist.

The NBA (2014) and IAASB (2015) mention these changes will help improve the

communication between companies, auditors, and other stakeholders. It should increase the confidence of users in the reports and statements, improve the transparency, audit quality, and enhanced information value, and further the financial reporting in the public interest (IAASB, 2015)

Dekker, Hoving, and De Waard (2018) found in preliminary research on the use of the EAR that accountants believe the new EAR gives more information. However, they unanimously said they would not consider it in their investments. Some investors mentioned that the new changes are not enough, they believe more could be added in the future to make them more informative (FRC, 2016). One of the reasons for why they might not be using this

information is explained by Lennox et al. (2018). They conclude that investors were already aware of the risks before they were published and thus the EAR does not contribute anything new on this front.

Research done earlier this year by Dorenbos (2019), on the usefulness of the EAR and whether people were reading it, showed there was still room for improvement. There are still a substantial number of investors who are not reading the EAR. One of the possible reasons for this could be that there is information they want, but that is not included in the current implantation of the EAR. The annual letters of the VEB have shown there are still numerous topics that could be included (VEB, 2015, 2016, 2018) Moreover, research has shown that despite reports becoming longer and more diverse when the changes were implemented, recently reports have once again begun to become more similar. This could be attributed to mimetic isomorphism; accounting companies are looking at each other and are trying to find a best practice (Van der Hoek & De Waard, 2017). This is contrary to the intentions of these changes. Problems with the previous way of reporting were that the report was the same for each company, instead of being tailored to the specific issues that are present within a company.

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1.2 Research Questions

What additional information would increase investor interest in the expanded auditor’s report?

In this research we will be using a survey developed by students from the Rijksuniveristeit Groningen (RUG) that has been used in earlier research into investor opinion on the expanded auditor’s report i.e. Bouwman (2019), Dorenbos (2019), and Dubblinga (2019). Their research was mainly focused on whether the EAR was read and what factors influenced the reading of the EAR. They developed a survey that was used to obtain information from members of the VEB about their interaction with the EAR. However, this survey was not set up with one specific research question in mind. One of the questions in this survey is

concerned about what investors would like to see in the EAR for it to become more useful to them. The possible answers relate to the financial position and risk of the firm, the quality of the internal control, the quality of automation, and about differences found during auditing. Therefore, when it comes to the additional information we speak of in the research question, we limit ourselves to these topics.

The information that is deemed to be useful by investors will depend on the personal traits and preferences of the investors. We can imagine that investors who also invest

professionally have different interests than investors who do not work in the financial

industry. Another factor that could play a role is the risk appetite of the investors, people that like to take more risk might be interested in additional information or maybe it is the opposite is true. This leads us to the first sub research question.

What is the role of professionalism and risk appetite of the investor on what additional information would be interesting to him?

In this question professionalism refers to whether they are working or have worked in the financial sector professionally or not.

Not all companies are equal, industry plays a large role in the type of information that is important to them. Investors might want different information from a company in the IT sector compared to a company in the oil industry. It is thus important to keep in mind the industries the investor is active in when researching their preferences. This leads to the second sub question.

Does industry play a role on what additional information would be interesting to investors?

1.3 Scientific contribution and practical relevance

This research will contribute to the current academic discussion on the audit process and the usefulness of its information. It will specifically help with the discussion on the role of the EAR and can create further interest in it. It will also contribute to the discussion in interest groups such as the VEB that are searching for ways to improve the auditor’s report. It can be used by governing bodies such as the NBA to determine what could be added to the EAR to improve its usefulness. Lastly it will also help accountants in knowing what factors their audience is interested in.

The remainder of this paper will be structured as follows. Chapter 2 will look at the

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2. Theoretical background

To explain the importance of the EAR we will be looking at three theories. Agency, signalling, and expectation gap theory. These will help in understanding why the auditor’s report exist and the reasons for a call for more information to be included within it.

2.1 Agency Theory

When discussing the auditor, it is impossible to neglect the agency theory. Coined by Jensen and Meckling in 1976, it is the fundamental theory that explains the need for an external auditor. They defined the agency relationship as “a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority” (Jensen & Meckling, 1976, p.308).

The relation between the shareholder and the management of a company is a prime example of a principal-agent relationship. This theory operates under the assumption that all economic agents are driven by self-interest and strive to maximise their own wealth (Deegan & Samkin, 2009). Both parties are interested only in what is best for themselves, when the interests of the two parties are not aligned this can result in conflict, this is the agency problem. When such a problem occurs costs can arise, these costs are the agency costs.

There can be multiple reasons for why such costs would occur. Firstly, they can be due to a decrease in firm value. There would be less trust in managers fulfilling the needs of the shareholders, this would cause a decrease in stock value and thus firm value. Secondly, to combat potential agency problems, shareholders can attempt to mitigate these by monitoring the behaviour of managers, or bonding with them to create a better alignment between their goals. This would consequently lead to associated costs (Morris, 1987).

One of the methods shareholders use to monitor, is the independent auditor and the EAR he writes. The EAR also serves the purpose of partially mitigating the information asymmetry that exists between shareholders and managers. Information asymmetry occurs when one of the parties has an information advantage compared to the other party. In our case the

management of a company has all the information about the company, whereas the investors have much more limited knowledge. The auditor’s report is a mechanism to close this information gap. Healy and Palepu (2001) argued that demand for financial information is a result of information asymmetry. They go on to argue there is a market demand for auditing services and thus having an increase in information from the auditor will aid investor decision making.

2.2 Signalling theory

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Whereas the agency theory is focused on moral hazards in the context of executive decision making, signalling theory concerns itself with the role that signalling plays in resolving information asymmetry between parties (Connelly, Certo, Ireland, & Reutzel, 2011). Although signalling theory was developed for the labour market, it can be applied to any situation where information asymmetry plays a role (Morris, 1987).

Signalling theory can be well explained by a figure presented by Connelly et al., (2011)

Figure 1: Signalling Timeline, Connelly et al., (2011, p. 44)

The signaller in our research is the firm who wants/must send a signal to the public about its financial position. They are the owners of the information which is not visible to outsiders (Ross, 1977). The signal sent is the auditor’s report, thus making the auditor the creator of the signal on behalf of the firm. The receivers are primarily shareholders, but as the annual report is a public document any interested party can read this report and is thus a receiver of the signal.

Morris (1987) looked at both agency and signalling theory and questioned the relation between the two theories. Research into agency theory was not concerned with signalling theory, and vice versa. He concluded that these two theories are not competing, but rather they are consistent with one another and show considerable overlap. Signalling theory can be implied in agency theory, but because information asymmetry is not a necessary part of agency theory the opposite is not true.

Because signalling is vital in mitigating agency costs and reducing information asymmetry it is important to have the best signal possible. By improving the EAR with additional

information, the signal can be enhanced and perform better.

2.3 Expectation Gap

The expectation gap is a phenomenon that has plagued the accounting industry almost since its inception a hundred years ago (Humphrey et al., 1992). The actual term was first used by Liggio (1974). He defined it as the difference between levels of expected performance as envisioned by the independent accountant and by the user of financial statements. The Cohen Commission (1978) further developed this definition by including: whether a gap exists between what the public expects and needs and what auditors can and should reasonably expect to accomplish. Subsequently, Porter (1993) split the theory into two separate

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performance gap, i.e. the gap between what society can reasonably expect auditors to accomplish and what auditors are perceived to achieve.

Research has shown that auditors have a very different view on how much and what is required of them compared to the public. Baron, Johnson, Searfoss and Smith (1977) found that the users of financial statements hold auditors more responsible for finding errors and illegal acts than auditors hold themselves responsible. This could be because people are under the impression that an unqualified opinion means fool proof financial reporting (Okafor & Otalor, 2013). Lowe (1994) also found a gap between the expectations of auditors and the judicial system. Judges systematically expected more from the auditing profession than auditors believed they provided.

The causes for this expectation gap have been researched and several factors were found that could contribute to the gap: the complicated nature of an audit function, conflicting role of auditors, retrospection evaluation of auditor’s performance, time lag in responding to

changing expectation, self-regulation process of the auditing profession, and the unawareness and unreasonable expectations (Lee & Ali, 2008)

The response to the existence of this gap can take two forms (Humphrey et al., 1992). Firstly, there is a group that takes a defensive approach, they want to focus on education of the public to align their idea of what an auditor should do with what is being done by auditors e.g. Okafor and Otalor (2013). Secondly, the other group take a constructive approach. They want to expand the auditor’s role to meet the concerns of the public e.g. Lee, Ali, and Kandasamy, (2008).

In this paper we will be taking a constructive approach. We attempt to find additional topics that could be included in the EAR that could close the current gap even further.

2.4 Prior literature and hypotheses

2.4.1 Expanded Auditor’s Report

The EAR was created with the intention to enhance the informational value of the audit report to the users of the financial statements. This is to be accomplished by increasing transparency about the judgements of the both the management and auditors in preparing and auditing financial statements (FRC, 2012)

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differently due to the extra information found in the KAM paragraphs (Christensen et al., 2014).

One of the reasons for the EAR has been introduced in the first place was to have a more personalised report for each company. As we mentioned the report was almost always the same before the changes and gave very little information on the specific firm. Due to isomorphic forces happening after the introduction of the EAR reports once again began to look similar (Van der Hoek & De Waard, 2017; De Waard, Boven, & Bolk, 2019). They suggest instead of publishing an audit report the accountant dossier is published and stakeholders can determine for themselves how an opinion on the company was formed. Other are suggesting iterating on the current EAR and find the aspects that can be added to further enhance the value (FRC, 2016; VEB, 2016; Gutierrez et al., 2018; VEB, 2018). The VEB has been publishing a letter to all the major accountancy firms in the Netherlands each year in which, among other things, they suggest ways to improve the EAR. Some of the points mentioned in these letters are the source for the questions in the survey used in this research. They suggest that IT risks should be considered, especially regarding cybersecurity (VEB, 2016). Another suggestion is to include the differences found during auditing that have been found, they can be an indication of the quality of the internal control. They also suggest providing more information on the internal control and about the financial position and risk of the company (VEB, 2018).

Based on these topics we will attempt to determine which of these factors are important to the users of the EAR.

2.4.2 Professionalism and Risk Appetite

In our research we will be looking at the preferences of both professionals working in the finance industry and those who are not. Differences between their behaviour and their preferences can be expected due to their different backgrounds.

Risk taking by professionals and overconfidence is a phenomenon that has been well defined and has been getting increased attention from both behavioural economics and financial literature (Menkhoff, Schemling, and Schmidt, 2013). Not all professionals act the same, age and experience can play a role in the amount of risk they are willing to take. Research has shown that in general younger professionals have more overconfidence than older

professionals, who are more experienced (Chevalier & Ellison, 1999; Menkhoff, Schmidt, & Bronzynski, 2006). However, professionals often tend to have more overconfidence than both students and other lay people in experiments (Heath & Tversky, 1991; Glaser, Weber, & Langer, 2007). Menkhoff et al. (2013) analysed whether the degree of overconfidence depends on experience and professionalism. In their study they found systematic differences in overconfidence between the groups analysed (investment advisors, institutional investors, and lay people). Investment advisors tended to be the most overconfident, while institutional investors were the least overconfident, however not consistently. They also found that although more experience led to better investment decisions, age tended to do the opposite. Because professionals are shown to have more overconfidence than their laymen

counterparts, we expect them to have a higher risk appetite.

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How high-risk appetite and the desire for more information is linked is unknown and will be interesting to see. There are multiple ways this connection could play out. The higher risk appetite could lead investors to have more overconfidence thus making decisions based on their own perceived knowledge and not wanting to rely on either information or an opinion of the auditor. It could also show a reversed effect, because when they have a higher risk

appetite, they may want to have additional information to offset this higher risk. We will therefore have two opposing hypotheses dealing with this connection between these factors. H2a: People with a higher risk appetite are less interested in additional information in the EAR compared to those with a lower risk appetite.

H2b: People with a higher risk appetite are more interested in additional information in the EAR compared to those with a lower risk appetite.

Because both age plays a role in the quality of decision making, we expect them to also influence the interest in new and more information in the EAR. We expect people who are older to be less interested in extra information, as they are more likely to assume that they have enough experience to make decisions.

H3: People who are older are less interested in additional information in the EAR compared to those who are younger.

We assume people working or those that have worked in the financial sector have a higher degree of financial knowledge than people who have not. They will be able to better comprehend information provided by the auditor and distil what is important to them. Therefore, we expect them to value information more than the opinion of someone else. H4a: People working in the financial sector are more interested in additional information rather than an opinion.

Because the people who do not work in the financial sector would have more difficulty

understanding the information, we assume they will favour a professionalopinion on matters

compared to additional information.

H4b: People not working in the financial sector are more interested in an opinion rather than additional information.

As was mentioned before, the type of industry a company is active in could influence what people would like to see in their EAR. Therefore, we assume that people who are investing in a particular industry might want to see different topics added in the EAR than those who are active in another industry.

H5: The type of information investors wants to see will depend and differ based on the types of industry they are investing in.

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3. Methodology

This research is of an explorative nature, the research will take the form of a descriptive survey research. The survey (Appendix A) that will be used in this research was developed by three students of the RUG. Their research was focused on whether and why people read the EAR. However, this topic was not the only one that the survey had been designed for. It was not set up with a specific research in mind, but rather to obtain information from investors about their thoughts and opinions on the EAR. This research will build upon their earlier research and investigates what extra aspects investors want to see in the EAR.

The survey was held among members from the VEB. This was done because students do not necessarily behave the same way as investors would do (Glaser, Weber, & Langer, 2007). Having actual nonprofessional and institutional investors participate will enhance the validity of this research. The survey was embedded within the weekly newsletter in the last week of October 2018. This newsletter was sent to all members of the VEB. The survey was also published on the website of the VEB on the 25th_{of October 2018. It was available for all} members for five weeks, during this period two reminders were also included in the digital newsletter.

3.1 Population and Sample

The annual report of the VEB in 2017 shows us the number of members is 41.841, which should be our population. However, we cannot be sure that each of those members are reading the newsletter or visiting the website regularly enough to have seen the survey. The total number of responses to the survey was 132, this was later corrected to 115 after a completeness check. To check whether this sample is large enough despite not knowing the exact population size we will have to determine the necessary sample size. For this we will be using the following formula:

𝑁𝑒𝑐𝑒𝑠𝑠𝑎𝑟𝑦 𝑆𝑎𝑚𝑝𝑙𝑒 𝑆𝑖𝑧𝑒 = (𝑍 − 𝑠𝑐𝑜𝑟𝑒) ∗ 𝑆𝑡𝑑𝐷𝑒𝑣 ∗ (1 − 𝑆𝑡𝑑𝐷𝑒𝑣)/𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑒𝑟𝑟𝑜𝑟 Taking a confidence interval of 90 percent, a standard deviation of 0.5 and an error margin of 9 percent we find that we need a population of 83,51. As we have a population of 115 we deem this to be enough for our further analyses.

3.2 Dependent Variables

The dependent variables in this research consists out of the possible additions to the EAR, which correspond to the answers for question 18. These will be categorized as EARA1 (EAR addition) through EARA6. Opposite to wanting any sort of new information, it is also

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3.3 Independent Variables

Risk appetite (RISKAPP)

Risk appetite is measured by the answer given to the question 9 in the survey. This question asks for the respondent to rate themselves on a 9-point scale, going from ‘not willing to take any risk’ to ‘very willing to take risk’. The question raised is: “to what extent are you willing to take risk for an increase returns”. This question was found to be a good indicator of a person’s risk profile (Dohlmen et al., 2005).

Professionalism (PROF)

This variable is measured by using the responses from question 5 and question 6 in the survey. These questions are in regard to whether the respondent is or was active in the financial industry and whether they also invest professionally respectively. This variable is a binary variable, if the respondent answers in the affirmatory to any of these two questions a 1 is assigned. When the answer is no to both question a 0 will be assigned.

Industry

We will group the industries using the Global Industry Classification Standard (GICS). This industry grouping was used due it modernity and provides homogenous categorisation of forecast-related application (Chung, Hrazdil, & Li, 2016). This means we will be using the following classifications:  Energy (10)  Materials (15)  Industrials (20)  Consumer Discretionary (25)  Consumer Staples (30)  Health Care (35)  Financials (40)  Information Technology (45)  Communication Services (50)  Utilities (55)  Real Estate (60)

The question corresponding to this variable is question 13 in the survey. Here most answers correspond directly to one of these sectors, the others will be placed in their corresponding sector. The same will be done for answers that have been given in the ‘other’ section. The variables are named IND10, IND15, etc. a 0 meaning they do not invest in this industry and a 1 meaning they are investing in this industry.

3.4 Control variables

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4. Results

4.1 Descriptive statistics

Of the 133 respondents to the survey only 106 fully completed the survey. However, as we are not using every single question in this research, we are able to use the answers of 115 respondents (table 2). This sample consists of 110 males and 5 females (MEAN= 0,96), the average age is somewhere between 50 and 60 years old (MEAN=4.90). On average people have been investing for 10 to twenty years (MEAN=3,78) and around 44 percent are or have worked in the finance industry (MEAN=0,44). The risk appetite of the respondent is on average 6,25 on a scale from 1 to 9. Over 91 percent of the people are in either full or partial control of their own investments and almost 9 percent is not in control. Table 3 shows the descriptive statistics for the dependent variables. EARNA (MEAN=0,15) shows us that most people do want to see additions to be made to the EAR. Of the possible addition most people are interested in EARA1 (MEAN=0,65) and EARA2 (MEAN=0.63). Finally, table 5 shows us that Energy, IND10 (MEAN=0,59), and Financials, IND40 (MEAN=0.57), are the two industries that people invest the most in.

VARIABLE OBS MEAN STD. DEV. MIN MAX

EXPERIENCE 115 3,782609 1,160631 1 5 PROF 115 0,443478 0,498969 0 1 RISKAPP 115 6,252174 1,746392 1 9 GENDER 115 0,956522 0,204824 0 1 AGE 115 4,895652 1,266117 1 6 CONTRL 115 .9130435 .2830045 0 1

Table 2: descriptive statistics for independent and control variables

EARNA 115 0,1478261 0,3564808 0 1 EARA1 115 0,6521739 0,4783649 0 1 EARA2 115 0,6347826 0,4835983 0 1 EARA3 115 0,4956522 0,5021692 0 1 EARA4 115 0,4434783 0,4989692 0 1 EARA5 115 0,2956522 0,4583325 0 1 EARA6 115 0,4869565 0,5020173 0 1

Table 3: Descriptive statistics dependent variables

INDNS 115 0,1913043 0,3950495 0 1 IND10 115 0,5913043 0,4937442 0 1 IND15 115 0,3913043 0,4901781 0 1 IND20 115 0,3217391 0,4691879 0 1 IND25 115 0,3652174 0,4835983 0 1 IND30 115 0,4260870 0,4966708 0 1 IND35 115 0,3130435 0,4657614 0 1 IND40 115 0,5652174 0,4978979 0 1 IND45 115 0,4086957 0,4937442 0 1 IND50 115 0,2521739 0,4361610 0 1 IND55 115 0,1391304 0,3475972 0 1 IND60 115 0,3652174 0,4835983 0 1

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After normality tests it was found that not all variables follow a normal distribution, for this reason we will not be using the pearson correlation, but instead the spearman correlation.

4.2 Correlation Matrix

Table 5 shows us the Spearman correlation matrix, due to its large size it has been split up in four different parts. A star indicates significance at the 95% confidence level. We see some interesting significant correlations, but none of them are above 0,700. This indicates there is likely no multicollinearity. We find here that both experience and professionalism are significantly correlated to EAR3 and EAR4, both concerned with information about the internal control. We also find a significant correlation between age and EARA1. We also see that relation with wanting EARA1 and IND20, or Industrials.

EXPERIENCE PROF RISKAPP GENDER AGE CONTROL

EXPERIENCE 1 PROF 0.2046* 1 RISKAPP 0.2027* 0.1527 1 GENDER 0.1829 0.1903* 0.1003 1 AGE 0.2517* -0.1646 -0.2199* -0.0623 1 CONTROL 0.2953* 0.1512 0.3571* 0.2369* 0.1088 1 EARNA -0.0797 -0.0759 0.0796 -0.1515 -0.1128 -0.0454 EARA1 0.0947 0.0272 -0.0664 0.1129 0.2143* 0.0338 EARA2 0.1464 0.0228 -0.0626 0.0154 0.1233 0.0864 EARA3 0.3408* 0.2353* -0.0242 0.1261 0.1185 0.1825 EARA4 0.2291* 0.1896* -0.0225 0.1045 -0.0962 0.0270 EARA5 0.1171 0.1121 -0.0377 0.0447 0.0636 0.0647 EARA6 0.0987 0.1108 0.0170 0.2077* -0.1006 -0.0081 INDNS -0.0834 -0.0337 -0.0263 -0.2215* -0.1584 -0.3207* IND10 0.2902* 0.1012 0.1765 0.1697 0.2320* 0.3712* IND15 0.1840* 0.0016 0.0733 0.0836 0.2190* 0.1842* IND20 0.0377 0.2470* 0.1992* 0.1468 -0.0293 0.2125* IND25 0.1078 -0.0591 0.1662 0.0732 -0.0009 0.1059 IND30 0.0638 0.0095 0.1831 0.0975 0.1209 0.1411 IND35 0.1317 0.1145 0.0931 0.0520 0.1328 0.0752 IND40 0.1050 0.2533* 0.1416 0.2431* 0.0429 0.2896* IND45 0.1643 0.2192* 0.3097* 0.0905 0.0846 0.2566* IND50 0.0787 0.0056 0.1917* 0.1238 0.0744 0.1081 IND55 -0.0115 -0.1060 0.1539 0.0857 0.0231 0.0349 IND60 0.1161 -0.0591 0.1062 0.1617 0.2111* 0.1700

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EARNA EARA1 EARA2 EARA3 EARA4 EARA5 EARA6

EARNA 1 EARA1 -0.4160* 1 EARA2 -0.4473* 0.3561* 1 EARA3 -0.3639* 0.2858* 0.2824* 1 EARA4 -0.2732* 0.2109* 0.3136* 0.2703* 1 EARA5 -0.2698* 0.1931* 0.2144* 0.3486* 0.1888* 1 EARA6 -0.4058* 0.0540 0.1609 0.1825 0.3210* 0.2456* 1 INDNS 0.1089 -0.0626 -0.1361 -0.0400 -0.0782 -0.0244 -0.0758 IND10 -0.0524 0.1356 0.1409 0.0458 0.1012 0.0347 0.0668 IND15 0.0175 0.1740 0.0901 -0.0108 0.0374 0.1443 0.0387 IND20 -0.1295 0.1903* 0.1745 0.0246 -0.0153 0.0433 0.0366 IND25 0.0911 -0.0528 0.0127 -0.1379 -0.0228 -0.1748 -0.0163 IND30 -0.0121 0.1124 0.1788 -0.1156 0.0449 0.0198 0.1456 IND35 0.0358 0.0993 -0.0332 -0.0691 0.1523 0.0146 0.0176 IND40 0.0193 0.0961 0.1362 0.1327 0.0414 -0.0468 0.0122 IND45 0.0026 0.1615 0.0795 0.0249 0.0412 0.0816 -0.0314 IND50 0.0966 0.1298 0.1078 -0.0150 0.0056 -0.0252 -0.0449 IND55 -0.0259 0.0298 -0.0082 -0.0468 -0.0048 -0.0402 -0.0398 IND60 -0.0106 0.0610 0.1628 0.0066 0.0499 -0.0561 -0.0163

Table 5b: Spearman Correlation Matrix (*=significant at a 5% level)

INDNS IND10 IND15 IND20 IND25 IND30

INDNS 1 IND10 -0.4951* 1 IND15 -0.2994* 0.4129* 1 IND20 -0.2403* 0.2697* 0.2869* 1 IND25 -0.3230* 0.2632* 0.1689 0.1735 1 IND30 -0.3297* 0.3944* 0.3180* 0.3100* 0.2229* 1 IND35 -0.3283* 0.3324* 0.2656* 0.0970 0.3058* 0.3284* IND40 -0.3762* 0.3770* 0.2719* 0.2286* 0.1552 0.3655* IND45 -0.3144* 0.5472* 0.4207* 0.2605* 0.2511* 0.3210* IND50 -0.2315* 0.4013* 0.3960* 0.1573 0.1418 0.2690* IND55 -0.1316 0.1298 0.1925* 0.1534 0.2169* 0.1617 IND60 -0.3230* 0.4469* 0.5020* 0.1735 0.0998 0.2595*

Table 5c: Spearman Correlation Matrix (*=significant at a 5% level)

IND35 IND40 IND45 IND50 IND55 IND60

IND35 1 IND40 0.2516* 1 IND45 0.3161* 0.2296* 1 IND50 0.2125* 0.3477* 0.4541* 1 IND55 0.2163* 0.1499 0.2280* 0.4030* 1 IND60 0.1890* 0.4831* 0.3246* 0.3497* 0.2169* 1

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4.3 Results for H1

The first hypothesis states that those who are working or have worked professionally in the financial sector will be showing a higher risk appetite than those who have not. To test this, we ran an independent t-test on our sample to determine whether there are differences in risk appetite based on professionalism. Group 0 are those without professional experience (N=64) and those with professional experience are group 1 (N=51). The results show that those without professional experience have a significantly lower risk appetite (5.953 ± 0.233) than those who did have professional experience (6.627 ± 0.163), t (113) = -2.087, p = 0.039.

GROUP OBS MEAN STD.

ERR. STD. DEV. [95% CONF. INTERVAL] 0 64 5.953.125 .232982 1.863.856 5.487.548 6.418.702 1 51 6.627.451 .2132122 152.264 6.199.202 70.557 COMBINED 115 6.252.174 .1628519 1.746.392 5.929.566 6.574.782 DIFF -.674326 .3158165 -130.002 -.0486318

diff = mean(0) - mean(1) t = -2.1352

Ho: diff = 0 Satterthwaite's degrees of freedom = 112.919

Ha: diff < 0 Ha: diff != 0 Ha: diff > 0 Pr(T < t) = 0.0175 Pr(|T| > |t|) = 0.0349 Pr(T > t) = 0.9825 Table 6, statistical output for Independent T-Test H1

4.4 Results for H2, H3, and H4

Hypotheses H2, H3, and H4 are concerned with the want for more information or an opinion. This was based on the three independent variables risk appetite (RISKAPP), professionalism (PROF), and age (AGE). To test these hypotheses, we performed a logistic regression analysis on all of the dependent variables which measure the interest in each EAR addition. Model 1 includes the control variables; this is including the variable age. Model 2 adds the independent variable RISKAPP. Lastly model 3 adds the final independent variable PROF. We were unable to find any significant relation between risk appetite and the want for any specific type of addition. We found a significant relation between age and the want for EARA3 (β=0.283), but only at a 90% confidence level (p=0.097). This means that older people will be more interested in an opinion about the internal control of a company. Regarding professionalism, we were able to find a significant relation between

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Model 1 Model 2 Model 3

CONSTANT -2.244883 -1.900119 -1.927961 GENDER 1.330249 1.319175 1.237381 AGE 0.351221 0.333731 0.350430 CONTROL -0.098690 0.040697 -0.002083 RISKAPP -0.059750 -0.066313 PROF 0.240204 R2 0.0434 0.0448 0.0469 N 115 115 115

Table 7: Logistic regression coefficient wanting information about EARA1 (*,**, and *** =significant on respectively a 10%, 5%, and 1% level)

EARA2

CONSTANT -1.072594 -0.376843 -0.396246 GENDER 0.094426 0.070694 -0.001455 AGE 0.216582 0.181864 0.195267 CONTROL 0.532398 0.810745 0.778487 RISKAPP -0.120063 -0.126187 PROF 0.206375 R2 0.0187 0.0245 0.0261 N 115 115 115

EARA3

CONSTANT -3.502590 -2.940283 -3.133652 GENDER 1.258442 1.245295 0.828865 AGE 0.224221 0.193832 0.282993* CONTROL 1.269774 1.486883* 1.381654 RISKAPP -0.095584 -0.132730 PROF 1.095293*** R2 0.0455 0.0494 0.0930 N 115 115 115

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21 EARA4

CONSTANT -0.6983427 -0.2125544 -0.2101436 GENDER 1.1072170 1.0873100 0.8229419 AGE -0.1359990 -0.1626227 -0.1213707 CONTROL 0.0761459 0.2628532 0.1514090 RISKAPP -0.0811685 -0.1097556 PROF 0.7305482* R2 0.0138 0.0168 0.0378 N 115 115 115

EARA5

CONSTANT -2.193374 -1.755708 -1.786668 GENDER 0.451502 0.434625 0.217384 AGE 0.094540 0.070203 0.107386 CONTROL 0.460870 0.624348 0.544526 RISKAPP -0.072615 -0.093454 PROF 0.554702 R2 0.0069 0.0092 0.0209 N 115 115 115

EARA6

CONSTANT 1.073767 1.196042 3.485146 GENDER N/A N/A N/A AGE -0.1244235 -0.1313211 -0.1129140 CONTROL -0.4634606 -0.4143996 -0.4673369 RISKAPP -0.0213470 -0.0316471 PROF 0.2980732 R2 0.0075 0.0078 0.0115 N 115 115 115

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4.5 Results for H5

Hypothesis 5 questions whether the industries the respondent invests in, influence his interest in specific additions to the EAR. To determine this, we once again used logistic regression. The table below shows the coefficients for all industries on the six different possible additions. For EARA3 we find a significant negative relationship between investing in IND30 (β= -0.860) and not being interested in EARA3 at a 90% confidence level (p=0.76). This shows that the respondents who are investing in Consumer Staples are less interested in an opinion about the internal control. For EARA5 we find two significant relationships IND10 (β=0.173) and IND25 (β= -1.276), both at the 95% confidence level (p=0.040) and (p=0.021) respectively. This means that those who invest in energy are more interested in the quality of automation in a firm. We also find that those who invest in Consumer

Discretionary are less interested in the quality of automation in a firm. To test for goodness of fit we again performed a Hosmer-Lemeshow goodness-of-fit test on the two regressions that showed significant results. Both models show a good fit with EARA3 (p=0.954) and EARA5 (p=0.856).

EARA1 EARA2 EARA3 EARA4 EARA5 EARA6

_CONS 0.171146 0.076032 -0.17373 -0.45371 -0.92343 -0.23452 IND10 0.142065 0.179721 0.455665 0.435273 0.172959** 0.463205 IND15 0.5194 -0.19505 0.055688 -0.01879 1.180063 0.248701 IND20 0.809504 0.6291 0.180652 -0.14095 0.110312 -0.00406 IND25 -0.70441 -0.08937 -0.70291 -0.35621 -1.27605** -0.18362 IND30 -0.02582 0.624042 -0.85956* -0.01744 0.044509 0.727462 IND35 0.349448 -0.53641 -0.24766 0.721502 0.244798 -0.05757 IND40 0.15443 0.076431 1.082379 -0.00926 -0.0618 -0.07958 IND45 0.348389 -0.09842 0.378627 -0.0681 0.520861 -0.40744 IND50 0.30622 0.358484 -0.38529 -0.20747 -0.50906 -0.34345 IND55 -0.19824 -0.45425 0.000985 -0.06719 0.022105 -0.08343 IND60 -0.37374 0.56623 -0.43412 0.059883 -0.93815 -0.27957 R2 0.0686 0.064 0.0656 0.0272 0.0875 0.0315 N 115 115 115 115 115 115

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4.6 Additional analysis

Figure 2: Interest in each EAR addition

Finally, we want to have a look at the raw interest in each of the additions. This clearly shows that most interest is in the financial information 65 and 63 percent for EARA1 and EARA2 respectively, with no clear winner regarding information or an opinion. EARA4, EARA4, and EARA6 show similar levels of interest among the sample, only EARA5 shows considerably less interest of the respondents. Also interesting is that only just under 15 percent is not interested in any sort of new additional information. A reason for this could have been that most of these people are not in control of their own portfolio. To check this, we performed a chi squared test between EARNA and CONTROL. However, this shows that the assumption is incorrect, only 2 out of 10 people who are not in control of their portfolio mention they do not need additional information in the EAR. This test is insignificant (p=0.627) and we thus must reject this hypothesis.

CONTROL EARNA 0 1 Total 0 8 90 98 1 2 15 17 TOTAL 10 105 115 PEARSON chi2(1) = 0.2367 Pr = 0.627

Table 14: Chi2 _{Test between EARNA and CONTROL}

0 10 20 30 40 50 60 70 80

EARA0 EARA1 EARA2 EARA3 EARA4 EARA5 EARA6

re sp on de nt s EAR addition

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5. Discussion and conclusion

5.1 Discussion and conclusion

This research began as an extension on the work of Bouwman (2019), Dorenbos (2019), and Dubblinga (2019). Their research into the reading of the EAR showed there was still room for improvement. Research has shown that the EAR is an important signalling tool for a firm (Morris, 1987). The relationship between investors and management is plagued with agency problems and the EAR can mitigate some of these costs. Despite this, many stakeholders and auditors have different ideas on what the job of the auditor entails and what the function of the EAR should be. This expectation gap has long been around, although some researchers believe the stakeholders should adjust their views on what an auditor delivers (Okafor and Otalor, 2013). Contrary to this, we subscribe to the idea that improving the EAR can narrow down the gap.

This led us to our research question:

What additional information would increase investor interest in the expanded auditor’s report?

In this research we looked at the interest in six different potential additions to the EAR. These additions were inspired by the annual VEB letters to accounting firms in the Netherlands. The same survey that was used in the earlier research into reading the EAR was used here.

Despite a low response rate (0.3 percent) our sample was large enough to test our hypotheses. To find out what drives people to be interested in certain information we asked:

What is the role of professionalism and risk appetite of the investor on what additional information would be interesting to him?

Research showed that those who are investing professionally tend to favour more risky investments than lay people. For H1 we expected to find a positive relationship between professionalism and risk appetite. We were able to confirm this, those with professional financial experience showed a higher risk appetite than those who did not have professional experience. This is in line with earlier research (Heath & Tversky, 1991; Glaser, Weber, & Langer, 2007).

We hypothesised that there could be a difference in the want for information and the want for an opinion. The relationship between risk appetite and the interest in information or an

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Age has been known to influence risk taking and the quality of decision-making regarding investing (Chevalier & Ellison, 1999; Menkhoff, Schmidt, & Bronzynski, 2006). H4 deals with this and that older people will be more interested an opinion than additional information. We were able to find a significant relationship between age and wanting an opinion on the internal control, however this was the only significant result we were able to find. This is not enough to confirm the hypothesis and we thus must reject H4. It does once again show the importance of internal control to not only those with professional experience, but also older investors.

Finally, we wanted to know whether industry investment choice influences the types of additions investors want to see. This led us to the second sub question:

Does industry play a role on what additional information would be interesting to investors? For H5 we looked at the choice of investment industries and the want for specific types of additional information. The conclusions that can be based on the results are limited. However, the negative relationship that was found between investing in Consumer

Discretionary (25) and wanting information about the quality of internal control is interesting. Consumer discretionary is a sector with a lot of automation e.g. the car industry and has the potential to see a lot more automation over the coming years e.g. retail (Begley, Hancock, Kilroy & Kohli, 2019). The reason for this low interest in quality of automation can be due to differing factors. The respondents might feel the reporting on this is already of adequate quality and thus there is no need for the auditor to report on this any further. It could also be due to underestimation of the effect of automation in this sector, further research could investigate whether this result is found in other samples and the reasoning for it. This also shows there is a possibility for companies to create an EAR that better fits their demographic and go to more personalised EAR.

Lastly, we had look at raw interest in the different additions, it showed a large support for information and an opinion about the financial position and risks of a company. We saw very few people not interested in any addition at all, one could assume this is due to those people being not in charge of their own investment portfolio. However, this relation did not exist, even those who have outsourced their investment portfolio generally want to see additional information being added to the EAR.

To sum up we found that there is significant interest in additions being made to the EAR, these come mostly in the form of information and/or an opinion about the financial position and risks. We found that that professional and older investors want information about the internal control of a company. Although professionalism did cause a higher risk appetite, risk appetite did not lead to a need for any specific EAR addition.

5.2 Limitations, Future research & Implication

The response rate of this research was only 0.3 percent, we would have rather seen a higher response rate to strengthen the external validity, This does not make this research not

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of reminders will not significantly increase the response rate. What could have helped was sending out a physical survey as well, this has the potential to garner more responses. Although we have seen a lot of support for the additions that were suggested in the survey, there are many other things that could be added. Future research could look at what other factors are of interest. It would also be interesting to find out about investor opinion on the proposed idea by Van der Hoek & De Waard, 2017. Would it be better to have the whole accountant’s dossier published where investors can find any information they might want? Another limitation is the low number of female respondents. Research has shown that risk appetite is generally lower for women than for men. It would have been interesting to see whether women want more information because of this. Future research could look at this. Internal control has shown to be of particular interest by both professionals and older people. Future research could find out why they find internal control so important and specifics of what they expect from the auditor in this regard.

Lastly the average age of the respondents was high, a younger sample might show different behaviour, especially as their risk taking is known to be higher (Chevalier & Ellison, 1999; Menkhoff, Schmidt, & Bronzynski, 2006).

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Appendix B: Variables and abbreviations

Abbreviation Description

EAR Expanded auditor’s report

VEB Vereniging van Effectenbezitters

FRC Financial Reporting Council

NBA Nederlandse Beroepsorganisatie van Accountants

IAASB International Auditing and Assurance Standards Board

PCAOB Public Company Accounting Oversight Board

KAM Key audit matters

Variables

EARNA Not interested in additional information. 1 if true, 0 if not true (Q18)

EARA… Interested in addition, the number indicates the specific addition. 1 if

true, 0 if not true. (Q18)

RISKAPP Risk appetite measured from 1 to 9. (Q9)

PROF Professionalism measured based on both Q5 and Q6. When either was

answered with yes, a 1 was assigned, if both were answered with no a 0 was assigned.

EXPERIENCE Experience with investing, measured from 1 to 5 based on Q3

CONTROL Being in control of your own investments. Measured based on Q14. If

they wholly or partially control their own investments a 1 was assigned, if they had their investments fully outsourced a 0 was assigned.

AGE The age of the respondent. Measured from 1 to 6. (Q2)

GENDER The gender of the respondent. If answered with male a 1 was assigned, if

answered with female a 0 was assigned. (Q1)

INDNS Whether the respondent does not invest in any specific industry. If

answered with yes, a 1 is assigned, if not answered a 0 is assigned.

IND… Whether the respondent invests in this industry, number indicates the

Investigation into investor information interest

Master’s Thesis BA OCM