The Role of Economic Trade-Offs in the Audit Opinion Decision: An Empirical Analysis

J. OF ACCOUNTING, AUDITING AND FINANCE, Vol 11, No 4, Fall 1996

Posted: 13 Jun 1998

See all articles by Jagan Krishnan

Jagan Krishnan

Temple University - Department of Accounting

Jayanthi Krishnan

Temple University - Department of Accounting

Abstract

We extend existing audit opinion models by incorporating economic trade-offs that arise in the auditor's qualification (modification) decision. Prior qualification studies (e.g., Dopuch, Holthausen, and Leftwich [1987]; Bell and Tabor [1991]) do not investigate whether the opinion issued is influenced by particular trade-offs facing an auditor. On the one hand, the audit firm faces the risk of losing the client if it issues a qualification, and on the other, failing to qualify exposes the auditor to lawsuits and reputation loss. We model the auditor's qualification decision as a two-stage model. We estimate a bivariate model that breaks down the probability of qualifying into two components: (1) the probability that the client deserves a qualified opinion based on the audit and (2) the probability that the auditor reports a qualified opinion, given it considers that the client deserves such an opinion. We hypothesize that the second stage decision to qualify or not is influenced by factors such as the auditor's risk of litigation, the type (Big Six or not) of auditor, the extent of outsider ownership, the share of public debt in total debt, the relative importance of the client in the auditor's portfolio, and the future growth rate of the client. Our results indicate that the auditor's litigation risk, the extent of outsider ownership, the relative importance of the client in the auditor's portfolio, and future growth are important factors in the audit opinion decision. Estimated mean and median probabilities indicate significantly higher values of reporting probabilities for qualified as compared to unqualified firms, suggesting that the second stage is an important component of the qualification decision.

JEL Classification: C35, L84, M41, M49

Suggested Citation

Krishnan, Jagan and Krishnan, Jayanthi, The Role of Economic Trade-Offs in the Audit Opinion Decision: An Empirical Analysis. J. OF ACCOUNTING, AUDITING AND FINANCE, Vol 11, No 4, Fall 1996, Available at SSRN: https://ssrn.com/abstract=2657

Jagan Krishnan (Contact Author)

Temple University - Department of Accounting ( email )

Fox School of Business & Management
1801 Liacorous Walk
Philadelphia, PA 19122
United States
215-204-8126 (Phone)
215-204-5587 (Fax)

Jayanthi Krishnan

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States
215-204-3085 (Phone)

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