Articlegreen2009

Auditor Conservatism and Investment Efficiency

138 citations0/0 files storedThe Accounting Review

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

ABSTRACT: We develop a theoretical framework to investigate (1) both the determinants and the consequences of auditor conservatism in a capital market setting and (2) the implications of Section 201 of the Sarbanes-Oxley Act for auditor conservatism and investment efficiency. We derive three primary results. First, by adjusting the mix of audit and nonaudit fees, companies with high business risk induce auditor conservatism, while companies with low business risk induce auditor aggressiveness. Second, if auditor conservatism is in force, a greater client pressure on auditors improves audit quality; but if auditor aggressiveness is in force, a greater client pressure on auditors impairs audit quality. Third, the nature of a firm's investment inefficiency (overinvestment or underinvestment) depends on its auditor's attestation (conservative or aggressive). Our analysis also implies that a mandatory restriction of nonaudit services imposed by Section 201 may decrease audit quality and damage investment efficiency.

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References

2002The Relation between Auditors' Fees for Nonaudit Services and Earnings Management 2003Do Nonaudit Services Compromise Auditor Independence? Further Evidence 2002Do Non–Audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions 2004Auditor Independence, Non‐Audit Services, and Restatements: Was the U.S. Government Right?*2003Client Importance, Nonaudit Services, and Abnormal Accruals 1993Auditing Standards, Legal Liability, and Auditor Wealth 2006Did Conservatism in Financial Reporting Increase after the Sarbanes-Oxley Act? Initial Evidence 1991Conservatism and Auditor-Client Negotiations

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