Do Auditors Recognize the Dark Side of Management Ability?

• In Event: Audit Risk

Abstract

Audit standards require assessment of management accounting competence because higher competence is expected to decrease the likelihood of material misstatements. However, we suggest that when combined with compensation-based incentives to misreport, management’s accounting competence may increase, rather than decrease, the likelihood of material misstatements. We introduce a measure of management accounting competence, prior experience as a manager or partner at an audit firm, to demonstrate this potential dark side of accounting competence. In addition, we exploit audit standards’ guidance to examine how opportunity and rationalization moderate the combined effect of accounting competence and compensation-based incentives. We find that higher management accounting competence exacerbates the positive association between compensation-based incentives and the likelihood of restatements and that the interaction is primarily found when opportunity or rationalization is high. These results are consistent with a dark side of accounting competence emerging when compensation-based incentives are present. We also find management’s accounting competence attenuates the positive association between compensation-based incentives and audit fees, consistent with auditors viewing management’s accounting competence favorably despite the heightened risk of misstatement. The interaction results are primarily found when opportunity, but not rationalization, is high.

Authors

• Anne Albrecht, University of Missouri-Columbia

• Elaine G. Mauldin, University of Missouri-Columbia

• Nathan Newton, University of Missouri-Columbia