The Effects of Subjectivity on Manager and Auditor Reporting

Kyungha (Kari) Lee, Rahul Menon; The Effects of Subjectivity on Manager and Auditor Reporting. The Accounting Review 1 September 2019; 94 (5): 273–295. doi: https://doi.org/10.2308/accr-52316

Posted: 28 Mar 2022

See all articles by Kyungha Lee

Kyungha Lee

Rutgers Business School at Newark & New Brunswick

Rahul Menon

Purdue University

Date Written: September 2019

Abstract

This paper develops an economic model of how subjectivity in accounting estimates affects a
manager’s reporting behavior and auditors’ subsequent information aggregation decision. In our model, the auditor receives a potentially manipulated report from the manager and uses an additional, albeit less precise, estimate to verify the report. We show, perhaps surprisingly, that as subjectivity increases, the auditor puts more weight on the manager’s report, but the manager manipulates her report less. The overall effect of subjectivity on audit precision and the expected bias in the audited report is nonmonotonic. We further analyze how subjectivity affects the manager’s investment behavior and optimal compensation structure. By introducing the notion of subjectivity, our model provides novel insight and empirical implications on managerial reporting behavior, audit quality, and investment efficiency when involving accounting estimates.

Keywords: subjectivity, accounting estimates, specialists, auditing estimates, earnings manipulation

JEL Classification: M40, M41, M42

Suggested Citation

Lee, Kyungha (Kari) and Menon, Rahul, The Effects of Subjectivity on Manager and Auditor Reporting (September 2019). Kyungha (Kari) Lee, Rahul Menon; The Effects of Subjectivity on Manager and Auditor Reporting. The Accounting Review 1 September 2019; 94 (5): 273–295. doi: https://doi.org/10.2308/accr-52316, Available at SSRN: https://ssrn.com/abstract=4068875

Kyungha (Kari) Lee (Contact Author)

Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Rahul Menon

Purdue University ( email )

610 Purdue Mall
West Lafayette, IN 47906
United States

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