Client Corruption Culture and External Auditor Monitoring

72 Pages Posted: 24 Aug 2017 Last revised: 19 Dec 2018

See all articles by Tracy Gu

Tracy Gu

The University of Hong Kong (HKU), Accounting Division, Faculty of Business and Economics

Xiaoding Liu

Texas A&M University - Department of Finance

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business

Date Written: December 1, 2017

Abstract

The existing empirical literature has shown that audit fees are higher for firms with greater perceived audit risk. However, there is no empirical evidence as to whether auditors are successful in reducing the incidence of fraud in situations when ex-ante fraud risk is high. Conceptually, any evaluation of auditors’ ability to prevent or detect fraud must recognize the importance of clients’ ex-ante fraud risk as a benchmark. The corporate governance literature shows that a firm’s fraud risk is deeply rooted in its corporate culture. Using client corruption culture as a measure of ex-ante fraud risk, we examine whether auditors are effective in reducing the incidence of accounting fraud associated with a corrupt client culture. We find that audit effort reduces the incidence of fraud attached to a corrupt client culture and audit effort (proxied by audit report lag) is greater for clients with a higher corruption culture. By contrast, the relationship between corruption culture and the incidence of accounting errors is insignificant (or much weaker). Rather, internal control weaknesses increase the risk of accounting errors, and additional audit effort in the presence of internal control weaknesses reduces the incidence of errors. Our findings provide insights into the monitoring role of auditors in fraud detection and prevention, and add to the auditing literature on the important role client corruption culture plays in audit production.

Keywords: Corporate Corruption Culture, Ex-Ante Fraud Risk, Audit Effort, Accounting Fraud, Restatement, Accounting Errors

JEL Classification: G30, M43, Z10

Suggested Citation

Gu, Tracy (Ti) and Liu, Xiaoding and Simunic, Dan A., Client Corruption Culture and External Auditor Monitoring (December 1, 2017). Available at SSRN: https://ssrn.com/abstract=3024391 or http://dx.doi.org/10.2139/ssrn.3024391

Tracy (Ti) Gu (Contact Author)

The University of Hong Kong (HKU), Accounting Division, Faculty of Business and Economics ( email )

#1312, KK Leung Building
Pokfulam Road
Hong Kong
+852 3917-8345 (Phone)

Xiaoding Liu

Texas A&M University - Department of Finance ( email )

Texas A&M University
College Station, TX 77843
United States

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
416-486-5361 (Phone)
416-486-6158 (Fax)

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