To read this content please select one of the options below:

Auditor choice as a commitment device

Akihiro Noda (Faculty of Economics, Shiga University, Hikone, Japan)

Journal of Financial Reporting and Accounting

ISSN: 1985-2517

Article publication date: 3 September 2018

246

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

Related articles