Does Auditor Assurance of Client Prosocial Activities Affect Subsequent Reporter-Auditor Negotiations?

Abstract

In two incentivized experiments, we investigate the potential for auditor assurance of prosocial activities akin to Environmental, Social, and Governance (ESG) initiatives to bias the initial positions and final outcomes of subsequent reporter-auditor negotiations. This possibility arises from the psychological theory of licensing, with a prosocial activity providing the motivation for licensing, while auditor assurance provides a perceived opportunity for licensing. We find that the combination of a preliminary prosocial activity by the reporter with auditor assurance of that activity leads reporters to specify more aggressive initial negotiation positions, although it does not result in more lenient initial positions by the auditor. The final outcomes of reporter-auditor negotiations are biased in the reporter’s favor in our first experiment, in which auditor assurance of a prosocial reporter activity is of a social and collaborative nature. This result does not extend to our second experiment in which auditor assurance is not collaborative, although we still observe more aggressive reporters. Overall, our research identifies aggressive reporting as a potential unintended consequence of ESG assurance, especially when that assurance is of a more collaborative variety.

Keywords: financial reporting; auditor independence; moral licensing; Environmental, Social, and Governance (ESG) initiatives; accounting estimates; experimental economics