Auditor choice as a commitment device
Journal of Financial Reporting and Accounting
ISSN: 1985-2517
Article publication date: 3 September 2018
Abstract
Purpose
This study aims to examine how firms choose an auditor in the presence of bilateral information asymmetry between insiders and outsiders regarding firms’ economic performance.
Design/methodology/approach
This study presents a one-period reporting bias game with a firm’s risk-neutral manager and investors in the capital market, in which a manager with private information chooses an auditor and reports earnings to investors who acquire their own information. The analysis focuses on the possibility that the manager engages an auditor to constrain earnings management as a commitment device to minimize reporting error cost.
Findings
The results show that the manager’s optimal auditor choice is determined based on investor sensitivity to the earnings report, and managerial incentives for earnings management, discounted by the uncertainty of reporting errors. The results for optimal auditor choice are counterintuitive: engaging a higher-quality auditor could seemingly be associated with aggressive earnings management.
Originality/value
This study advances the understanding of the theoretical basis of firms’ auditor choice in the context of market investors’ information acquisition when auditors exercise their discretion in reporting. This issue has received limited attention in the extant literature.
Keywords
Acknowledgements
This work was supported by JSPS under Grant Numbers 26380622 and 26380635.
Citation
Noda, A. (2018), "Auditor choice as a commitment device", Journal of Financial Reporting and Accounting, Vol. 16 No. 3, pp. 374-394. https://doi.org/10.1108/JFRA-05-2017-0036
Publisher
:Emerald Publishing Limited
Copyright © 2018, Emerald Publishing Limited