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    The Interplay of Management Incentives and Audit Committee...
    research summary posted November 15, 2016 by Jennifer M Mueller-Phillips, last edited February 28, 2017, 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 Interplay of Management Incentives and Audit Committee Communication on Auditor Judgment
    Practical Implications:

    This study indicates that increasing the frequency of informal communication between the audit committee and the audit team can positively impact reporting quality, but auditors need to be sensitized to how management may exhibit undue influence and its potential to undermine audit committee effectiveness. From a practical standpoint, this study indicates that failing to consider specific expectations communicated by the audit committee can have severe consequences.

    Citation:

    Brown, J. O. and V. K. Popova. 2016. The Interplay of Management Incentives and Audit Committee Communication on Auditor Judgment.  Behavioral Research in Accounting 28 (1): 27-40.

    Keywords:
    audit committee communication, management incentives, competing preferences, source credibility and auditor judgment
    Purpose of the Study:

    Over the past two decades, the audit committee has evolved from a passive observer to a critical player in ensuring quality financial reporting. Just recently, the PCAOB approved Auditing Standard No. 16 to enhance communication between the external auditor and the audit committee in order to better facilitate the audit committee’s oversight role and improve financial reporting quality. However, despite this reform, auditors continue to harp on the importance of management’s role in corporate governance and its ability to exhibit significant influence during the audit. Consequently, the purpose of this study is to examine the interplay of management and the audit committee on auditor judgment, and whether auditor’s sensitivity to a characteristic of management, its incentive to influence the auditor, moderates the effectiveness of additional oversight by the audit committee. It is also important to examine whether auditors are effectively integrating expressed expectations voiced by the audit committee, in light of the recent passage of AS No. 16.

    Design/Method/ Approach:

    The authors administered a 2 x 2 between-subjects experiment that required audit seniors to evaluate management’s estimate for obsolete inventory. The auditors either were or were not given additional communication from the audit committee of its expectations. Management’s incentives to influence the auditor were also manipulated by varying the perceived propensity to manage earnings.  

    Findings:
    • The authors find that management’s incentives to influence the auditor not only affect the persuasiveness of management-provided information but also spill over to impact the potential benefit of additional audit committee communication on auditor judgments.
    • The authors find that when management’s incentives were lower, additional audit committee communication had no effect on auditor judgments, and auditors documented more items consistent with management’s aggressive reporting preference.
    • The authors find that when management’s incentives were higher, the additional communication of the audit committee had a significant and positive impact on auditors’ evidence evaluation and judgments, as auditors were less supportive of management’s aggressive estimate and also documented a greater proportion of evidence items consistent with the audit committee’s expressed expectations. 
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight