Jennifer R. Joe

Why Press Coverage of a Client Influences the Audit Opinion

In this study I use an experiment to examine why auditors are more likely to issue going–concern opinions when the client has been the subject of negative press coverage prior to the date of the audit opinion. I find no evidence that negative press coverage increases auditors’ perceptions of legal liability, as was suggested in the prior literature. I do find, however, that negative press coverage increases auditors’ perception of a clients bankruptcy probability and this, in turn, leads auditors to modify the audit opinion. Because the press coverage presented in this study provides no new information, the results suggest that auditors react too strongly to redundant information. This over–reaction can result in inefficient allocation of audit resources and can have deleterious affects on clients. Accordingly, policy makers, auditors and their clients might be interested in how auditors’ reliance on redundant information can be reduced.

The effect of constrained processing on auditors’ judgments

Abstract This study examines whether constraining experienced auditors’ processing by having them process evidence in a pre-established sequence (an experimental control technique used in previous studies) prevents them from using their usual processing strategies and thereby affects their judgments. We compare the relative attention to evidence and judgments of experienced and inexperienced auditors in a constrained versus an unconstrained processing condition. Consistent with expectations, experienced auditors’ going-concern judgments differed from inexperienced auditors’ judgments only when processing was unconstrained. This difference in judgments was the result of differential attention to evidence. These results demonstrate that the failure to consider how experienced auditors process evidence can result in inadvertently adopting control techniques that limit the generalizability of experimental findings. Although our study used a going-concern task, our conclusions are likely to apply to a variety of ill-structured audit tasks that require a goal-oriented, directed evaluation of evidence.

The Impact of Changes in the Reporting Environment on the Disposition of Proposed Audit Adjustments

We present evidence on the resolution of proposed audit adjustments during a unique period of time immediately following several US financial scandals and surrounding the passage of the Sarbanes-Oxley Act (SOX). During this period auditors and clients both faced increased scrutiny from investors and regulators. In addition, auditors had to contend with changed incentives, annual inspections and a new external regulator (i.e., the PCAOB). In comparison with prior studies we also consider a broader range of factors potentially impacting the resolution of proposed adjustments including the affect of client tenure, strength of internal controls, and repeat adjustments. Data on 458 proposed adjustments are obtained from the working papers of a sample of 163 audit engagements conducted during 2002 by a Big 4 firm. We find a dramatic reduction in the proportion of waived audit adjustments when compared to prior studies, suggesting calls for greater auditor and client responsibilities increased conservatism. Results indicate audit adjustments are more likely to be waived for clients with whom the audit firm has had a longer relationship, although there is no pattern of favoring such clients. We also find that adjustments are more likely to be waived for clients with stronger internal controls, especially larger clients, and for repeat adjustments. Overall, the results suggest that there is increased conservatism in the resolution of proposed adjustments.

How Management's Expressions of Confidence Influence Auditors’ Testing

We examine how management’s expressions of confidence in a critical accounting estimate influence auditors’ reliance on inquiry evidence, measured by extent and nature of audit testing. Understanding whether, and how management confidence can influence auditor’s reliance on management’s explanations is important because client provided evidence, particularly inquiry evidence, is highly susceptible to management bias and manipulation. Further, recent research finds that managers tend to be overconfident in their ability and estimates, and that managerial overconfidence is associated with biased financial reporting. Consequently, auditors should exercise caution when considering management explanations accompanied with high levels of confidence. However, psychology research suggests that high levels of confidence could cause auditors to over-rely on management’s explanations. We conduct an experiment to examine how auditors respond to management’s statement of confidence in a critical accounting estimate under varying levels of client control risk. We find that although auditors intend to discount management’s expressions of confidence, in actuality, they decrease testing when management’s explanations are accompanied with expressions of high confidence compared to low confidence in high client risk scenarios. This result is troublesome because auditors’ reliance on management’s high confidence explanations makes them more likely to apply an ineffective audit procedure in a high control risk setting. Thus, our study is the first to document that management confidence is a potential cause of auditor over-reliance on management explanations as observed by regulators and documented in research findings.