An Investigation of Auditors' Judgments When Companies Release Earnings Before Audit Completion

Abstract

Over two-thirds of United States public companies now announce annual earnings prior to (versus with, or after) audit completion. We expect this practice has potential to increase pressure in auditor/client negotiations over post-announcement audit adjustments. In a controlled experiment with audit partners and senior managers, we find, in the presence of today’s typical level of audit committee engagement, auditors are significantly more likely to accept aggressive financial reporting when earnings have been released (versus drafted). Further, we test and find this effect is mitigated with strong audit committee effectiveness (i.e., including ideal, but achievable, characteristics typically currently lacking in today’s average committees). Our process-model tests find the joint effects are mediated by auditors’ directional goals such that in the absence of strong audit committees, released earnings increases auditors’ directional goals, leading to lower judgment quality. Our study provides evidence on the importance of investing in high-quality audit committees in promoting high-quality financial reporting.

Keywords: Auditor Judgment; Audit Committees; Professional Identification; Earnings Announcements; Audit Completeness; Financial Reporting Quality