Christopher Koch

Disclosing conflicts of interest – Do experience and reputation matter?

In a controlled laboratory experiment, we investigate the effects of disclosing conflicts of interest on the reporting behaviour of information providers. First, we replicate the findings of Cain, Loewenstein, and Moore (Cain, D.M., Loewenstein, G., & Moore, D.A. (2005). The dirt on coming clean: Perverse effects of disclosing conflicts of interest. Journal of Legal Studies 34, 1-25) that such disclosure can trigger more biased reporting, since it removes moral concerns. Second, we show that this effect diminishes or even reverts with experience and reputation. Third, we observe that non-disclosure can have the positive effect of facilitating the formation of reputation.

What Dimensions of Lead Auditor Expertise Matter for Audit Quality and Audit Fees

This study investigates the effects of lead auditors’ technical and managerial knowledge on audit quality and audit fees. The German institutional environment enables us to track auditors over their careers and measure their various personal attributes. We find that lead auditors’ technical knowledge is more important for audit quality than their managerial knowledge; however, their managerial knowledge is a more influential driver of audit fees than their technical knowledge. The results of various identification strategies including firm-fixed effects models, propensity-score matching, and instrumental variables approaches suggest that the observed relations are treatment rather than selection effects. The findings enhance our understanding of the role and nature of expertise in auditing and demonstrate the value of lead auditor identification as currently discussed by the PCAOB and the IAASB.

Limiting Auditor Liability? - Experimental Evidence on Risk and Ambiguity Attitudes under Real Losses

This paper is motivated by the current debate on limiting auditor liability. In a laboratory experiment, the effect of limited versus unlimited liability on behavior under risk and ambiguity is investigated for risks involving small probabilities. The amount of liability is manipulated in such a way that subjects can pay with their show-up fee under limited liability, but they can suffer out-of-pocket losses under unlimited liability. Findings are that both risk aversion and ambiguity aversion are higher under unlimited liability than under limited liability, and these two constructs are correlated under unlimited liability. These findings provide new empirical evidence for the intuition that aversion toward risk and ambiguity plays an especially important role in auditor behavior under unlimited liability. Our experimental results emphasize the importance of considering risk and ambiguity attitudes in economic models on liability, especially when liability regimes are compared that differ in liability limits or ambiguity.

Effects of Client Pressure and Audit Firm Management Control Systems on Auditor Judgments

We examine the effects of pressures from client management and the audit firm’s own management control systems (MCS) on auditors’ willingness to accept an aggressive accounting that is preferred by client management. We find that auditors perceiving more pressure from client management to accept the client’s aggressive accounting react by increasing the size of the proposed adjustment needed to bring the client’s accounting into conformity with GAAP. However, we find that when client management promotes the jointness of interests they share with the auditor or the audit firm’s MCS focuses the auditor more on client service quality the auditor experiences increased affinity for the client and proposes lower adjustments in response to the same accounting facts. Furthermore, we find that the auditor’s proposed adjustment to client accounting leads to intended use of negotiation tactics that are consistent with the relative size of the proposed adjustment: larger proposed adjustments result in relatively greater auditor intentions to use contending tactics whereas smaller adjustments lead to increased intentions to use compromising tactics. Two implications emerge from our research. First, that client management, if subtle with its use of pressure, can nudge auditors towards accepting the aggressive accounting management wants. Second, the audit firm’s own MCS can facilitate auditor identification with client needs leading to a lesser willingness by auditors to challenge aggressive client management accounting.

Limiting Liability? – Risk and Ambiguity Attitudes Under Real Losses

Using a laboratory experiment in which the unlimited liability treatment involves real out-of-pocket losses, we investigate and compare the behavioral effects of auditors’ limited and unlimited liability on behavior under risk and ambiguity. We find that aversion to both risk and ambiguity are higher under unlimited liability than under limited liability, and that these two constructs are correlated under unlimited liability. Our findings explain why some auditors might be hindered in performing their duties properly under unlimited liability. Further, our findings emphasize the importance of appropriately modeling risk and ambiguity attitudes in economic models on liability.

Joint Audit, Audit Market Structure, and Consumer Surplus

We use a structural application of the discrete choice model to investigate how the introduction of a joint audit policy would affect audit market structure and consumer surplus. We perform this policy evaluation by identifying demand fundamentals in a joint audit regime and applying them to a single audit regime. We find that a joint audit requirement has the potential to change the audit market structure substantially but that the effects are sensitive to the specific policy design. For example, small audit firms gain market share in a joint audit regime but only if an equal sharing of the workload between the two joint auditors is not required. Our counterfactual analysis reveals that the introduction of a joint audit regime would be associated with a substantial loss of consumer surplus. The loss results from restricting clients from giving all of the audit work to their most preferred audit firm, but it is partly offset by gains in consumer surplus deriving from the opportunity to choose the best combination of auditor pairs. Our policy evaluation should be of interest to regulators, audit firms, and audit clients.

A Review of Bias Research in Auditing: Opportunities for Integrating Experimental Psychology and Experimental Economics

The objective of this paper is to show opportunities for integrating psychological and economics research in auditing. For this purpose, auditing research that employs both the methodologies of experimental psychology and experimental economics is collectively reviewed. The review is structured along three fundamental research questions: (1) Are auditors prone to biases; (2) what are the consequences of biased judgment in auditing; and (3) do features of the audit environment interact with the biased judgment? While both the research approach of experimental psychology and experimental economics are employed for addressing these resesarch questions, both approaches differ in their focus and their implementation. This review highlights these differences, outlines the main findings and identifies future research opportunities.