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    The Impact on Auditor Judgments of CEO Influence on Audit...
    research summary posted May 25, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 09.0 Auditor Judgment, 13.0 Governance, 13.01 Board/Audit Committee Composition 
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    Title:
    The Impact on Auditor Judgments of CEO Influence on Audit Committee Independence
    Practical Implications:

    The results of this study show that auditors consider the influence that the CEO has over the audit committee in determining whether the audit committee is likely to support the audit team when resolving issues with management. To the extent that auditors feel that CEO influence decreases audit committee support of the external auditor this undermines the independent reporting line that the audit committee should provide. Current audit standards do not address this situation.

    Citation:

    Cohen, J.R., L.M. Gaynor, G. Krishnamoorthy, and A.M. Wright. 2011. The Impact on Auditors Judgments of CEO Influence on Audit Committee Independence. Auditing: A Journal of Practice and Theory 30 (4): 129-147.

    Keywords:
    Audit committee; audit judgments; independence corporate governance; CEO influence; management incentives
    Purpose of the Study:

    Although an audit committee meets regulatory requirements of independence, it is still possible that the CEO of a company has influenced the appointment of its members. This study investigates whether knowledge of the CEO’s prior relationships with audit committee members, either professional or personal, influences the magnitude of an audit adjustment that they anticipate will be waived.

    Design/Method/ Approach:

    Evidence was collected prior to September of 2010. This study is an experiment that was distributed via email. Participants consisted of 65 auditors with ranks ranging from manager to partner. The case materials provided a brief case related to inventory obsolescence and asked participants to determine the audit adjustment they believed should be recorded as well as the audit adjustment they believed would actually be recorded by the hypothetical client

    Findings:

    This study examined jointly the effects of management incentives for earnings management and CEO relationship with the audit committee on waived audit differences, which was measured as the difference between what participants thought the adjustment should be ideally versus what it would be after negotiations with the client.

    • Auditors estimated smaller amounts of the proposed adjustment would be waived if posting the full adjustment would cause the company to miss EPS targets. In other words, auditors are more conservative and waive smaller amounts of proposed adjustments when management has a high incentive to manage earnings.
    • When incentives to manage earnings are low (adjustment would not cause the company to miss EPS targets) then the relationship of the CEO with the audit committee does not influence the amount of the adjustment that is waived.
    • When incentives to manager earnings are high (adjustment would cause the company to miss EPS targets) and the CEO has a relationship with audit committee member(s) auditors anticipate less of the adjustment being waived than when the CEO has no relationship with audit committee member(s). The study attributes this effect to the auditors perceiving greater bargaining power when the CEO has no relationship because the audit committee is more independent and therefore more likely to support the auditor.
    Category:
    Auditor Judgment, Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Board/Audit Committee Composition, Earnings Management, Earnings Management
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