A Tale of Two Incentives: Investigating Auditors’ Willingness to Reveal Prior Misstatements
48 Pages Posted: 9 Aug 2014 Last revised: 31 Oct 2017
Date Written: June 1, 2015
Abstract
Existing research suggests the threat of litigation and reputational concerns can motivate auditors to improve audit quality in the current period. However, it is unclear how these two incentives unfold when auditors face the restatement of their previously audited, but materially misstated, work. We investigate the individual and joint effects of two potential incentives, litigation risk and reputation concerns, on the likelihood that auditors will encourage the restatement of materially misstated financial statements upon which they previously opined. When considered independently, we find higher reputational concerns decrease the likelihood of restating misstated financial statements, with no average effect from increased litigation risk. When examined jointly, we find that restatement of the misstated period is less likely when both reputation and litigation risk are high, but more likely when the risk of litigation and reputational concerns are low. These findings provide important insights regarding auditors’ response to incentives.
Keywords: Litigation, reputation, restatements, audit quality, incentives
JEL Classification: M40
Suggested Citation: Suggested Citation