Two Models of the Auditor-Client Interaction: Tests with United Kingdom Data

Posted: 30 Oct 1996

See all articles by Stephen C. Hansen

Stephen C. Hansen

University of Southern Maine - School of Business

John S. Watts

Ernst & Young LLP

Abstract

Accounting research contains two distinct approaches to the interaction between accounting management and the independent auditor. Game theory suggests that the auditor's testing strategy will affect the manager's reporting strategy, and that the strategies form an equilibrium. The game-theoretic approach views the auditor as active, in that he acknowledges the effect that his testing strategy has on the manager's reporting. In contrast, in the decision-theoretic approach, the auditor tests reports, but ignores the effect that his testing might have on the manager's reporting behavior. Essentially, the decision theoretic approach views the auditor as passive, taking the reporting strategy as given when designing tests. We use United Kingdom data to estimate both models and test their validity using nested hypothesis tests. Our results demonstrate that the active, game-theoretic model better describes the auditor-manager interaction. This is the first empirical validation of the game-theoretic model using archival accounting data.

JEL Classification: M49, M41

Suggested Citation

Hansen, Stephen C. and Watts, John S., Two Models of the Auditor-Client Interaction: Tests with United Kingdom Data. Available at SSRN: https://ssrn.com/abstract=2787

Stephen C. Hansen (Contact Author)

University of Southern Maine - School of Business ( email )

P.O. Box 9300
Portland, ME 04104
United States

John S. Watts

Ernst & Young LLP ( email )

1225 Connecticut Ave NW # 700
Washington, DC 20036
United States

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