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    The Effects of Trust and Management Incentives on Audit...
    research summary posted May 7, 2012 by The Auditing Section, last edited May 25, 2012, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
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    Title:
    The Effects of Trust and Management Incentives on Audit Committee Judgments
    Practical Implications:

    The results of this study suggest that the judgments of more trusting audit committee members are largely insensitive to indicators of management’s incentives to manage earnings. It appears that high levels of dispositional trust among members of the board of directors can have serious consequences, and high trust is common among audit committee members.  To overcome this possible concern, boards of directors and audit committees may consider training audit committee members to recognize the relationships between incentives and the likelihood of management deception in order to improve audit committee judgment. 

    Citation:

    Rose, A.M., J.M. Rose, and M. Dibben. 2010. The effects of trust and management incentives on audit committee judgments. Behavioral Research in Accounting 22(2): 87-103.

    Keywords:
    Audit committee; management incentives; trust
    Purpose of the Study:

    Audit committee members are entrusted with substantial authority to enhance corporate governance, including overseeing the audit process, hiring and firing auditors, and resolving auditor and management disputes.  However, prior research suggests that audit committee members do not consistently view management’s incentives to be threats to management credibility.  The authors propose that audit committee members’ disposition to trust plays a critical role in their interpretation of management incentives and associated judgments.  Below are two objectives that the authors address in their study: 

    • Examine how dispositional trust influences audit committee members’ decisions to support the auditor when management has incentives to manage earnings.
    • Examine how dispositional trust influences audit committee members’ assessment of management credibility and likelihood of deception when management has incentives to manage earnings. 
    Design/Method/ Approach:

    The authors collected their evidence using a simulated task completed by experienced, independent, and currently-serving audit committee members.  Participants were asked to act as audit committee members and make a subjective judgment about auditor- proposed adjustments.  Participants were assigned to an environment of either higher or lower levels of management incentive to manipulate earnings based on proximity to EPS.  The research evidence is collected in the mid-2000s time period (post SOX).

    Findings:
    • The authors find that less trusting audit committee members are more likely to support the external auditor than are more trusting audit committee members when management has incentives to manage earnings.
    • The authors find that less trusting audit committee members are more likely to perceive that management is not credible and more likely to perceive that management is being deceptive than are more trusting audit committee members when management has incentives to manage earnings.
    • The authors find that less trusting audit committee members are more likely to perceive that management’s incentives to manage earnings result in potential deception by management, and less trusting audit committee members increase their support for the auditor because of concerns about management deception. 
    Category:
    Governance, Corporate Matters
    Sub-category:
    Board/Audit Committee Oversight, Audit Committee Effectiveness
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