An Examination of Auditors’ Responsiveness to Risk Cues: Evidence from Fair Value Estimates

56 Pages Posted: 10 Apr 2020 Last revised: 19 Jan 2021

See all articles by Chris E. Hogan

Chris E. Hogan

Michigan State University - Department of Accounting & Information Systems

Sarah E. Stein

Virginia Tech

Sarah B. Stuber

Texas A&M University - Mays Business School

Date Written: January 18, 2021

Abstract

PCAOB inspections and field studies consistently highlight difficulties faced by auditors when testing fair value estimates, but the root causes of these deficiencies are less understood. One strategy to reduce bias and improve audit quality is to enhance auditors’ effectiveness in incorporating cues into their risk assessment process. In this study, we seek to understand whether and when auditors incorporate cues indicating increased risk into their evaluation of fair value estimates. Consistent with concerns about auditors’ performance in this area, we find that more than one-third of fair value estimates in our security-level dataset differ from the true fair value by a non-trivial amount that should warrant further auditor consideration. If auditors effectively incorporate cues, we predict a negative association between observable risk cues and fair value errors. Our findings indicate auditors’ ability to integrate cues depends on the nature of the cue and expertise of the auditor. We fail to find evidence that either experts or non-experts incorporate indirect cues identified in the planning stage of the audit, which require drawing connections across accounts or time. In contrast, experts appear to outperform non-experts only in incorporating direct cues identified during substantive testing. These analyses enhance our understanding of variation in auditors’ performance and highlights potential areas for improvement.

Keywords: fair value, investment security, expert auditors, Big 4, cues, property-casualty insurance companies

JEL Classification: M41, M42, G22, G23

Suggested Citation

Hogan, Chris E. and Stein, Sarah E. and Stuber, Sarah, An Examination of Auditors’ Responsiveness to Risk Cues: Evidence from Fair Value Estimates (January 18, 2021). Available at SSRN: https://ssrn.com/abstract=3559448 or http://dx.doi.org/10.2139/ssrn.3559448

Chris E. Hogan

Michigan State University - Department of Accounting & Information Systems ( email )

270 North Business Complex
East Lansing, MI 48824-1034
United States

Sarah E. Stein (Contact Author)

Virginia Tech ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

Sarah Stuber

Texas A&M University - Mays Business School ( email )

Wehner 401Q, MS 4353
College Station, TX 77843-4218
United States

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