Does the CFO’s Power Relative to the Audit Partner Affect Financial Reporting Outcomes? Evidence from Goodwill Impairment Decisions

Abstract

Qualitative evidence suggests that chief financial officers (CFOs) can exert influence over the external auditor in certain negotiation settings. We investigate this possibility using archival methods by focusing on the power dynamic between CFOs and their primary counterpart—the lead engagement partner—during the audit of a complex estimate. Specifically, we identify engagements with large disparities in age between the CFO and partner to capture CFOs in a relatively more powerful position. As a key financial reporting outcome, we focus on the annual goodwill impairment analysis because it relies on significant assumptions and management has an incentive to avoid recording the loss due to negative capital market consequences. Our results provide a pattern of evidence indicating that relatively powerful CFOs exert influence to obtain their preferred outcome of reporting fewer impairments. In cross-sectional analysis, we find that these results are concentrated in settings where market signals are less clear, which we attribute to the partner having less observable evidence to rely on during the negotiation. Finally, using an alternative negotiation setting, we find that relatively powerful CFOs are more likely to avoid disclosure of a material weakness even though it was likely warranted. Our collective evidence highlights that the CFO and partner should not be viewed as isolated actors; instead, characteristics of their relationship provide insight into circumstances when auditors have greater difficulty withstanding client pressure.

Keywords: auditor-client relationship, relative power, negotiations, complex estimates, goodwill impairments

JEL Classification: M41, M42, M12