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    Business Strategy, Financial Reporting Irregularities, and...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
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    Title:
    Business Strategy, Financial Reporting Irregularities, and Audit Effort
    Practical Implications:

    This study provides several important contributions to the existing accounting literatures on financial reporting irregularities. The authors provide evidence that the differences in the client business risk of companies’ choice of business strategies is an underlying determinant of financial statement quality. Also, the findings provide evidence that auditors appear to recognize and adjust audit effort based on clients’ business strategies. This study is important because it identifies organizational business strategies as an important determinant of both financial reporting irregularities and audit effort based off publicly available data.

    For more information on this study, please contact Kathleen, A. Bentley.
     

    Citation:

    Bentley, K. A., T. C. Omer, and N. Y. Sharp. 2013. Business Strategy, Financial Reporting Irregularities, and Audit Effort. Contemporary Accounting Research 30 (2).

    Keywords:
    business strategies; audit effort; financial statement quality.
    Purpose of the Study:

    This study examines the effect clients’ business strategies have on the occurrence of financial reporting irregularities and the level of audit effect. Using Miles and Snow’s (1978, 2003) strategy typology, the authors attempt to provide evidence that increases the understanding of underlying determinates of financial reporting quality. They provide a measure of business strategy that requires only publicly available information and is generalizable across industries. Using these measures, this study is able to provide evidence of whether companies’ business strategies exhibit differences in the occurrences of financial reporting irregularities.

    Design/Method/ Approach:

    The authors of this study use the organizational strategy theory of Miles and Snow to develop a comprehensive measure of business strategy using publicly available data. Relying on this theory, the authors developed a discrete STRATEGY composite measure, which proxies for the organization’s business strategy. Higher STRATEGY scores represent companies with prospector strategies and lower score represent companies with defender strategies. Using logistic regression, the authors determine whether the company strategies are associated with financial reporting irregularities. Level of audit effort was determined using audit fee data. All of this data is combined and analyzed to produce overall conclusions.

    Findings:
    • Companies following a prospector strategy are more likely than companies following a defender strategy to experience financial reporting irregularities across three samples of irregularities: SEC AAERs, shareholder lawsuits related to alleged accounting improprieties, and accounting restatements.
    • The business strategy measure represents client business risk and is not a substitute for financial reporting risk.
    • Clients following prospector strategies have higher audit fee, suggesting that auditors expend greater audit effort for these clients.
    • Despite higher audit fees for prospectors, fees are not high enough to account for the riskiness of these clients.
       
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Business Risk Assessment (e.g. industry - IPO - complexity)