Does Economic Policy Uncertainty Matter for Financial Reporting Quality? Evidence from the United States

Economic policy uncertainty and audit effort: evidence from audit hours

“…First, this empirical paper is the first to directly examine the EPU and audit effort using comprehensive firm/year audit hour data. Auditors perceive significant EPU as the possibility of firms' earnings manipulation risk increases (Yung and Root, 2019;Bermpei et al, 2020), which contrasts with the findings in Zhang et al (2018). Hence, auditors work more audit hours, which might increase firms' audit fees, implying that audit hours might be the pertinent explanatory variable to explain why firms' audit fees increase in a significant EPU environment even when fees per hour decrease slightly.…”

“…Bedard and Johnstone (2004) showed that auditors assess situations involving aggressive earnings management and that a relationship exists between those assessments and auditors' planning for audit effort and price decisions. Hence, Bermpei et al (2020) used US data to suggest that EPU is positively associated with earnings management and that this empirical result supported the "lean against the wind" theory. This theory suggests that, during periods of high uncertainty, earnings management could be stronger because managers are motivated to provide a good financial picture of the firm to calm and satisfy MAJ 36,4 outsiders.…”

“…Further, Yung and Root (2019) showed that using 18 countries' data, significant EPU increases firms' earnings management and supports the "lean against the wind" theory. Then, this study posits that if auditors perceive significant EPU as possible earnings manipulation risk, which would motivate managers to conduct aggressive earnings management, then they might work more audit hours in response to the significant EPU circumstance, following prior papers (Nagar et al, 2019;Yung and Root, 2019;Bermpei et al, 2020). However, the possibility exists that auditors do not perceive or do not reflect external environmental changes regarding EPU on their audit processes; if so, then a significant association might not exist between EPU and audit effort or reduce their audit fees following bargaining power story.…”

“…From an ex ante perspective, this paper posits that auditors might perceive significant EPU as a change in the audit environment and possibly increasing earnings manipulation risk because of the high information asymmetry between manager and auditors (Nagar et al, 2019). Therefore, in this significant EPU condition, the possibility is strong that aggressive earnings management behavior will be pursued (Yung and Root, 2019;Bermpei et al, 2020). Ultimately, auditors work more audit hours to reduce their concerns over audit risk derived from the significant EPU.…”

“…In this line of research, auditors perceive a significant EPU situation as a negative audit circumstance because Bermpei et al (2020) showed that, in a significant EPU circumstance, managers aggressively engage in earnings management to calm outsiders. Further, Yung and Root (2019) used international data to suggest that significant EPU increases firms' earnings management.…”