Business Strategy, Financial Reporting Irregularities, and Audit Effort
Kathleen A. Bentley-Goode
The University of New South Wales (UNSW) - School of Accounting
Thomas C. Omer
University of Nebraska at Lincoln - School of Accountancy
Nathan Y. Sharp
Texas A&M University - Department of Accounting
March 26, 2012
Contemporary Accounting Research, Forthcoming
This study examines whether clients’ business strategies are a factor in determining the occurrence of financial reporting irregularities and the level of audit effort. We use the organizational strategy theory of Miles and Snow (1978, 2003) to develop a comprehensive measure of business strategy using publicly available data. We find that Miles and Snow’s Prospector strategy is more likely to be involved in financial reporting irregularities and generally requires greater audit effort. The business strategy measure also appears to capture client business risk and provides incremental explanatory power beyond the individual measures of client complexity or risk used in traditional audit fee models. We contribute to the literature by constructing a replicable business strategy measure and identifying organizational business strategy as an important ex ante determinant of financial reporting irregularities and levels of audit effort. Our results suggest that investigating how audits can be improved to reduce financial reporting irregularities among Prospector clients is an important area for audit practice and future research.
Keywords: audit effort, audit fees, business strategy, financial reporting irregularities
JEL Classification: D21, L21, L22, M40, M42
Date posted: March 29, 2012
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