The Auditor's Slippery Slope: An Analysis of Reputational Incentives

Abstract

Reputational concerns have commonly been perceived to have a positive effect on auditing firms' execution of their monitoring and attesting functions. This paper demonstrates that this need not always be the case by studying a two-period game of repeated interaction between a manager and an auditor under the assessment of the market for audit services. Regarding reputation as the sole motivator for the auditor, we illustrate how reputational concerns induce an auditing firm to misreport. We investigate the reasons and circumstances under which such misreporting takes place. In particular, a strategic manager can induce the audit firm down a slippery slope, wherein the managerial fraud increases as the tenure of the audit firm progresses, whereas the auditor's fraud reporting probability decreases.reputation, auditing, game theory, sequential equilibrium

Gradual escalation: The role of continuous commitments in perceptions of guilt

“…That is, the gradual way in which many unethical acts develop, ranging from corporate misconduct to arguments that explode into violence, may also account for the failures of auditors to report misconduct on the part of corporate executives (Corona & Randhawa, 2010) or the failures of bystanders to intervene when violence erupts. Therefore, while prior research has examined how gradual changes affect actors, in the present work, we focus on how gradual escalations affect outside observers.…”

The Effects of Auditor Tenure on Fraud and Its Detection

“…Because we have two distinct periods, we can compare the two settings: a continuing auditor that audits both periods and a setting in which the audit in each period is performed by a different auditor. Corona and Randhawa (2010) also examine a two-period strategic audit setting, in which the manager in each period chooses fraud or no fraud and the auditor chooses an audit report. They demonstrate a circumstance in which an auditor that does not identify fraud in one period might not report fraud that is detected in a later period because it would highlight their failure in the previous period.…”

How Effective Is Internal Control Reporting under SOX 404? Determinants of the (Non‐)Disclosure of Existing Material Weaknesses

“…Recent theoretical research also suggests that a "slippery slope" effect can exist that increases in auditor tenure and dampens the auditor's incentives to expose managerial misreporting because doing so would also reveal the auditor's failures to stem the misreporting in previous periods(Corona and Randhawa [2010]). 18 We do not posit an association between recent auditor changes and detection.…”