An Analysis of Auditors’ Risk Assessment and Client Acceptance Decisions in Family Firms

• In Event: Interaction between Auditor and Client

Abstract

Very little is known about how auditors assess risks in family firms relative to non-family firms. Our study experimentally examines auditors’ assessments of control risk and fraud risk, as well as auditors’ client acceptance recommendations for family firms vs. non-family firms with varying levels of audit committee (AC) strength. In the experiment, 60 audit partners and managers from all of the Big 4 audit firms and another large international audit firm examine a case describing a hypothetical company, and evaluate that company as a potential new audit client. We find that auditors assess both control risk and fraud risk to be higher for family firms than for non-family firms, and they are less likely to make client acceptance recommendations for family firms. Moreover, auditors assess risks to be greatest, and audit client desirability to be the lowest, for family firms with weak ACs. Our findings suggest that auditors assess more severe agency conflicts to be present in family firms than in non-family firms, consistent with the Type II agency conflict, according to which family members may become entrenched and behave opportunistically to extract rents and potentially expropriate the firm’s resources at the expense of minority shareholders.

Authors

• Gopal V. Krishnan, American University

• Marietta Peytcheva, Lehigh University