Do Audit Actions Consistent with Increased Auditor Scepticism Deter Potential Management Malfeasance?

Abstract

Effective audits are claimed to not only enhance the detection of fraud but also the deterrence of potential fraud. We conduct an experiment with 167 senior corporate managers in which we examine whether changes in auditor actions and behaviours consistent with auditors exhibiting a heightened level of professional scepticism deter managers from committing corporate malfeasance. We examine three audit action changes: an increase in management inquiry rigour, an increase in the extent of the audit sample and a change in the nature of the audit tests. All of these changes are situated in an experimental design where the objective probability of detecting managerial malfeasance does not change and managerial malfeasance can occur in the same period as the audit action changes. We find that changing the nature of the evidence collected decreases participating managers’ intention to commit corporate malfeasance. Furthermore, we find that the most common auditor response in practice, increasing the extent of the sample without changing tests, does not reduce managers’ intention to commit malfeasance. Finally, we find that combining the use of more critical client questioning with increasing extent of testing does result in less managerial intent to commit malfeasance. Implications of these findings are discussed.

Keywords: professional scepticism, management malfeasance, fraud, deterrence, effective audits, types of audit evidence, cost allocation

JEL Classification: M4, M40, M41