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Accounting Audits: On Financing Risk in the Presence of Agency Conflicts

26 Pages Posted: 10 May 2012 Last revised: 5 Mar 2016

Beatriz Mariano

Cass Business School

Date Written: December 1, 2015

Abstract

This paper examines how accounting audits impact investment decisions in the presence of agency conflicts. Investors choose between a short-term risk-free asset and a long-term risky project. The manager in charge of the latter has incentives to inflate interim payoffs to be able to continue a project that destroys value. An accounting audit mitigates this problem by allowing for intermediate project valuation, and therefore, for investors to cut off financing to such project before it becomes too unprofitable. This reduces initial concerns with agency conflicts, even if the incentives of the manager to inflate payoffs remain unchanged, and boosts investors financing of the risky project. These results are particularly relevant for new and innovative firms.

Keywords: Accounting audits; Agency conflicts; Investment; Optimal contract

JEL Classification: M41, M42, G30, G31

Suggested Citation

Mariano, Beatriz, Accounting Audits: On Financing Risk in the Presence of Agency Conflicts (December 1, 2015). Available at SSRN: https://ssrn.com/abstract=2055459 or http://dx.doi.org/10.2139/ssrn.2055459

Beatriz Mariano (Contact Author)

Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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