The Impact of Risk and the Potential for Loss on Managers’ Demand for Audit Quality

51 Pages Posted: 30 Jul 2019 Last revised: 16 Apr 2021

See all articles by Patrick J. Hurley

Patrick J. Hurley

Northeastern University - Accounting Group

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems

Kara Obermire

Oregon State University

Amy C. Tegeler

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 7, 2021

Abstract

This study uses experimental economic markets to investigate the impact of risk and the potential for loss on managers’ demand for audit quality. We posit that these two important contextual factors influence managers’ audit quality preferences. We study these factors because they are ubiquitous to companies, and we focus on their influence on managers because managers continue to play a significant role in the auditor hiring process and we know relatively little about their auditor preferences. We predict risk, the potential for loss, and their interaction will each decrease manager demand for high audit quality due to a desire to achieve greater reporting flexibility. Experimental results are consistent with our predictions; specifically, increased risk, the potential for loss, and to a lesser extent their interaction, significantly reduce managers’ likelihood of hiring the best available auditor in the market. Path analysis indicates that this reduction in audit quality demand leads to increases in misreporting. Finally, we observe investors overpaying for assets to a greater extent when managers hire lower-quality auditors. Our results show that the contextual factors of risk and the potential for loss, that are ubiquitous to companies, can reduce demand for audit quality, which can increase misreporting behavior and ultimately harm investors.

Keywords: audit quality, demand, risk, risk aversion, loss aversion, experimental economics

Suggested Citation

Hurley, Patrick J. and Mayhew, Brian W. and Obermire, Kara and Tegeler, Amy, The Impact of Risk and the Potential for Loss on Managers’ Demand for Audit Quality (April 7, 2021). Contemporary Accounting Research, Forthcoming, Northeastern U. D’Amore-McKim School of Business Research Paper No. 3425666, Available at SSRN: https://ssrn.com/abstract=3425666 or http://dx.doi.org/10.2139/ssrn.3425666

Patrick J. Hurley (Contact Author)

Northeastern University - Accounting Group ( email )

360 Huntington Ave.
Boston, MA 02115
United States

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-2714 (Phone)
608-263-0477 (Fax)

Kara Obermire

Oregon State University ( email )

410 Austin Hall
Corvallis, OR 97331
United States

Amy Tegeler

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business ( email )

P.O. Box 742
3202 N. Maryland Ave.
Milwaukee, WI 53201-0742
United States

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