CEO Behavioral Integrity, Auditor Responses, and Firm Outcomes

Abstract

We investigate the audit fee response to CEO behavioral integrity (BI). BI refers to the perceived congruence between an individual’s words and deeds (Simons 2002). Because low word-deed congruence should result in more explanations when communicating, we use variation in explanations beyond firm fundamentals and CEO-specific characteristics in more than 30,000 shareholder letters to serve as a linguistic-based proxy for CEO BI. We find audit fees increase as BI decreases, but BI is not associated with financial misstatement or litigation. These findings are potentially consistent with auditors undertaking additional work in response to low BI, which in turn mitigates the risk of restatements and lawsuits. The likelihood of option backdating increases as BI decreases, consistent with the contention that auditors lacked incentives to prevent backdating. Finally, BI is increasing in future performance, which suggests CEOs partially underpin the returns to high-integrity corporate cultures.

Keywords: CEO behavioral integrity; audit fees; financial misreporting; corporate culture

JEL Classification: J24, L25, M14, M41, M42