Managing Risk in a Poor Economy: The Association between Economic Conditions and Risk Tolerance and Its Implications for Practice

Abstract

SUMMARY An academic study by Bagley, Dorminey, McSwain, and Reed (2016) regarding the association between economic activity and an auditor's response to risk was recently published, highlighting auditors' willingness to accept higher levels of risk to retain clients in challenging economic times without an appropriate adjustment to audit fees. Given that business cycles are a fact, auditors need to understand how they respond to increases in risk during a poor economy in ways other than increasing fees or resigning from audit engagements, neither of which is necessarily optimal to do during economic downturns. This paper summarizes Bagley et al. (2016) and provides alternative strategies firms can utilize to mitigate risk, regardless of economic conditions.