“Tone at the top”: management’s discussion and analysis and audit quality

Abstract

Purpose This paper aims to investigate whether the managers’ emphasis on audit in the management’s discussion and analysis (MD&A) section of the 10-K filing, as part of the firm’s “tone at the top,” is linked to audit quality. Design/methodology/approach Adopting a computational linguistics approach, the authors measure the manager’s audit emphasis as the frequency of audit-related words in the MD&A. The authors then assess the relationship between audit emphasis and audit quality with ordinary least squares and probit regression models. Findings This study finds that the manager’s audit emphasis, proxied by the count of audit-related words, is positively associated with audit fees, audit delay, the appointment and retention of Big 4 and industry-specialist auditors, and the probability of switching to Big 4 auditors, while negatively linked to abnormal accruals and the possibility of financial misstatements. Research limitations/implications The audit emphasis measure suffers from limitations. The computer program determining audit emphasis may misinterpret words in the MD&A. Researchers need to consider procedures to minimize misinterpretations. Practical implications Frequency of audit words in the MD&A reflects the firm’s aspiration for audit quality. Auditors, regulators and investors could ascertain such aspiration from past and current MD&As. Originality/value This study associates the manager’s emphasis on audit, measured with computational linguistics from the MD&A, with realized audit quality.

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