Negotiated Reporting and Auditor Size

Abstract

The extant literature views audited financial reports resulting from client-management proposing a report and an auditor issuing an opinion on the report. But the literature finds that this process is a negotiation that is an iterative process between the auditor and client-management. This auditor-client-management (ACM) literature relies on the early research of Antle and Nalebuff (1991) and Zhang (1999) for theoretical guidance, but both studies assume negotiation is a take-it-or-leave-it offer, and not an iterative process. Given the misalignment between the ACM literature and theoretical guidance, we address the ACM relationship by constructing a model that reflects the iterative negotiation process and addresses the role of auditor size in the cost of the audit and the accuracy of the audited report. Our results on auditor size differ, however, when negotiation is modeled as a take-it-or-leave-it offer, thus highlighting the need for theoretical guidance that aligns with the ACM literature’s findings.

Keywords: Audit Reports, Negotiation

JEL Classification: M42, C78