Do Auditors and Audit Committees Lower Fraud Risk by Constraining Inconsistencies between Financial and Nonfinancial Measures?

Abstract

Prior research finds that companies committing fraud exhibit large inconsistencies between reported revenue growth and growth in revenue-related nonfinancial measures (e.g., number of stores, employees, patents). However, prior research also suggests that auditors, on average, are not adept at identifying and constraining these differences. This study investigates whether certain auditors and audit committees are able to lower fraud risk by constraining inconsistencies between financial and related nonfinancial measures (NFMs). For a sample of companies across a variety of industries, we find that auditors with greater industry expertise and tenure and audit committee chairs with greater tenure are less likely to be associated with companies that exhibit large inconsistencies between their reported revenue growth and related NFMs. Surprisingly, we observe that audit committees with industry expert chairs are more likely to be associated with large inconsistencies (higher fraud risk) than audit committees without industry expert chairs. Our results suggest that the audit process can constrain fraud risk, but that not all forms of audit committee expertise are beneficial.

Keywords: Audit, Audit Committee, Fraud Risk, Non-Financial Measures

JEL Classification: M40