When do Audit Managers Prefer Staff to Underreport Time?

Abstract:     
Public accounting watchdog groups have expressed concern that the practice of underreporting can negatively affect audit quality and lead to other unethical behaviors that can increase audit risk. While the practice is prohibited by audit firm policies, if underreporting by engagement staff is tacitly rewarded by the audit managers evaluating staff work, an environment is created in which underreporting time may be necessary for staff to succeed and advance within the firm. Our study considers the role of audit managers in perpetuating the practice of underreporting by examining the extent to which, and under what circumstances, managers accept (i.e., implicitly reward) such behavior from their audit staff. Utilizing an experiment in which engagement staff appear to have worked more hours than were budgeted, we manipulate staff reporting accuracy (underreporting hours worked in order to meet budget versus accurately reporting exceeding the budget) and managers’ personal preference for the client (high versus low). We find that staff reporting accuracy and managers’ personal preference for the client interact to affect managers’ performance evaluations of staff, with the highest evaluations going to staff who underreport when the manager’s preference for the client is high, and the lowest going to staff who accurately report that they have exceeded budget when the manager’s preference for the client is high. Further, we find that managers are more likely to request an underreporter on a different engagement, regardless of their preference for the current client. When we run the same experiment using partner participants, we find that, unlike managers, partners do not reward or prefer staff who underreport. Interestingly, and consistent with agency theory, partners penalize both underreporters and staff who report exceeding budget (compared to a baseline condition in which staff actually meet budget). These results suggest that managers’ own incentive structures influence how they evaluate their audit staff, contributing to an environment that implicitly rewards underreporting of time even though firm policy explicitly prohibits the behavior.

Number of Pages in PDF File: 34

Keywords: underreporting, eating time, agency theory

working papers series