Abstract
We design an experiment to examine the influence of audit experience on subsequent reporting decisions when auditors become managers of audited firms. In contrast to the independence issues that can arise when auditors and their clients are related by prior affiliation, we focus this study on the more common case in which auditors assume subsequent employment with other firms’ clients. In a bi-matrix experimental game that captures key features of the strategic tension between auditors and reporters, we find that reporters who have prior experience as an auditor, particularly the experience of having been a diligent auditor, are more sensitive to large penalties for aggressive reporting than are reporters whose experience is exclusively as a reporter. Our results suggest implications for regulators in predicting the effects of reporting penalties and for firms in considering the effects of CPA experience when hiring for reporting positions.
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Notes
We use the term “reporters” loosely to include any executive, manager, or accountant with discretionary reporting responsibilities for an audited entity.
Smith (1994) argues that in a strict game-theoretic sense, public announcements such as the matrix of payoffs we provide to all participants creates common information but not necessarily common knowledge, insofar as experimental participants cannot be entirely sure of how others will perceive and use the common information.
We are grateful to Urs Fischbacher for providing us with this software.
For directional hypotheses, including directionally predicted interactions, we report one-tailed p-values. McNeil et al. (1996, pp. 137–139) discuss the rationale for one-tailed tests of directionally predicted interactions.
We also considered the possibility that professional auditors themselves might change over time, but this appears not to be the case. Our analyses show that professional auditors’ behavior is relatively stable over Stages 2 and 3, bearing in mind that they sat out in Stage 1 while professional reporters and auditor–reporters gained their initial experience. Within the weak-deterrent regime, professional auditors chose diligent an average of 66.1% of the time in Stage 2 and 70.7% of the time in Stage 3. Within the strong-deterrent regime (the regime of primary theoretical interest to us), professional auditors chose diligent an average of 55.9% of the time in Stage 2 and a nearly identical 56.3% of the time in Stage 3.
The differences in observed reporting behavior occurred primarily in the first eight periods of the stage. The effects of regime and auditor type are strongly associated with reporting behavior in those periods (R 2 = 0.586) but are only weakly associated with observed reporting behavior in the last eight periods of the stage (R 2 = 0.067).
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Acknowledgments
We are grateful for helpful comments from Russell Lundholm, editor, an anonymous referee, John Dickhaut, Bill Kinney, Lisa Koonce, Susan Krische, Mark Peecher, Joel Pike, Karen Pincus, Rachel Schwartz, workshop participants at the University of Arkansas, the University of Illinois at Urbana-Champaign, the University of Texas at Austin, and participants at the 2007 Hong Kong University of Science and Technology Summer Symposium on Accounting Research and the 2006 Annual Meetings of the American Accounting Association and the Economic Science Association. We thank the McCombs School of Business for financial support. The third author also gratefully acknowledges the support of the Charles T. Zlatkovich Centennial Professorship in Accounting.
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Bowlin, K.O., Hales, J. & Kachelmeier, S.J. Experimental evidence of how prior experience as an auditor influences managers’ strategic reporting decisions. Rev Account Stud 14, 63–87 (2009). https://doi.org/10.1007/s11142-008-9077-0
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DOI: https://doi.org/10.1007/s11142-008-9077-0