Investor Sentiment, Misstatements, and Auditor Behavior^*

Abstract

High investor sentiment has been linked with opportunistic managerial behavior in the face of more optimistic investors and analysts. We extend this line of work by documenting that the likelihood of misstatements is higher when sentiment is high. Although this would suggest elevated audit risk, we posit that a contemporaneous reduction in auditors' litigation cost could drive down audit fees and going concern opinion (GCO) reporting conservatism in order to please clientele. Consistent with this notion, we document that auditors charge lower fees and report GCOs less conservatively when sentiment is high. However, this reduction in reporting conservatism is unwarranted; results reveal that auditors are less likely to issue GCOs to clients which subsequently file for bankruptcy during high sentiment periods. We conduct additional tests to examine whether auditors' litigation costs indeed vary with sentiment and document that auditors are less likely to be sued and the market reacts less negatively to misstatement announcements when sentiment is high. Collectively, our findings suggest that, although misstatement risk is increasing with sentiment, auditors' litigation risk actually declines.

Seasonal affective disorder and audit quality

“…The average |DA| in our sample is 0.083, which is comparable with the average |DA| reported in Demirkan et al (2012). The mean value of RESTATE is 0.054, which is very close to 0.058 reported in Amin et al (2021). The mean values of SADC indicate that the average SAD hours at an audit office during the audit period is around 1.354.…”

A Tale of Two Professions: The Impact of SOX and the Global Economic Crisis on Public Accounting and Law Firms’ Performance

“… 3. Consistently, prior work finds that managers’ misreporting incentives are influenced by capital market forces (Amin et al, 2020). …”

Underwriter Discourse, IPO Profit Distribution, and Audit Quality: An Entropy Study from the Perspective of an Underwriter–Auditor Network

“…(2) going-concern opinions; (3) financial reporting characteristics, such as the use of gross accruals or the tendency of firms to meet or exceed quarterly analysts' consensus estimates of earnings; and (4) perception-based metrics, such as earnings response coefficients, stock price reactions to auditor-related events, and cost of capital metrics (Amin et al, 2021) [35].…”