The effects of client management concessions and ingratiation attempts on auditors' trust and proposed adjustments

ADIAC-00264; No of Pages 11 Advances in Accounting, incorporating Advances in International Accounting xxx (2015) xxx–xxx

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The effects of client management concessions and ingratiation attempts on auditors' trust and proposed adjustments William F. Messier Jr.

, Jesse C. Robertson c,2, Chad A. Simon d,⁎

a,b,1

a

Department of Accounting, University of Nevada Las Vegas (UNLV), 4505 S. Maryland Parkway, Box 456003, Las Vegas, NV 89154, United States Norwegian School of Economics, Norway Department of Accounting, University of North Texas, 1155 Union Circle #305219, Denton, TX 76203, United States d School of Accountancy, Jon M. Huntsman School of Business, Utah State University, 3540 Old Main Hill, Logan, UT 84322-3540, United States b c

a r t i c l e

i n f o

Available online xxxx Keywords: Audit adjustments EPS Incentives Ingratiation Trust

a b s t r a c t Prior research suggests client management often has incentives to achieve higher earnings. One way management can try to achieve incentives is by reducing the level of proposed audit adjustments before end-of-audit negotiations. In this study, we examine whether client management can achieve smaller proposed adjustments by using influence tactics, such as ingratiating and making concessions to less experienced auditors (staff and seniors). We find that when a manager concedes on an initial potential adjustment, auditors place more trust in the manager and propose smaller aggregate adjustments. Furthermore, ingratiation has a marginally positive effect on auditor trust when the manager first concedes. However, our results indicate that the benefits to the client manager of conceding are limited in a key way: auditors are not more likely to propose aggregate adjustments that would allow the conceding manager to meet/beat the consensus analysts' EPS forecast. © 2015 Elsevier Ltd. All rights reserved.

1. Introduction Client managers often have incentives to report higher net income – particularly to meet or beat analyst expectations (e.g., Levitt, 1998; Matsunaga & Park, 2001; Bartov, Givoly, & Hayn, 2002) – and auditors are aware of these incentives (Nelson, Elliott, & Tarpley, 2002). To ultimately report higher earnings, managers can try to manipulate the financial statements and/or minimize the impact of audit adjustments. In this study, we examine whether a client manager with an incentive to report higher earnings can gain more of an auditor's trust3 and minimize the impact of proposed audit adjustments by conceding on the first of two accounting issues, and by ingratiating (i.e., complementing) the auditor.4

⁎ Corresponding author. Tel.: +1 435 797 9055; fax: +1 435 797 1475. E-mail addresses: [email protected] (M. William F.), [email protected] (J.C. Robertson), [email protected] (C.A. Simon). 1 Tel.: +1 702 895 1576; fax: +1 702 895 4306. 2 Tel.: +1 940 369 8156; fax: +1 940 565 4234. 3 Rousseau, Sitkin, Burt, and Camerer (1998, p. 395)) define trust as “a psychological state comprising the intention to accept vulnerability (i.e., willing to be persuaded) based upon positive expectations of the intentions or behavior of another.” We believe an auditor most trusts the client when the auditor has “positive expectations” of the client's desire to properly record account balances and views the client as credible (i.e., makes believable assertions; c.f. Merriam-Webster (2012)). 4 Ingratiation is a strategic action designed to result in positive affect (e.g., likability), which in turn increases the prospect the ingratiated individual complies with the ingratiator's appeal (Jones, 1964; Cialdini & Goldstein, 2004).

We extend prior research, which has considered the impact of manager concessions on experienced auditors (managers or partners) during auditor/client negotiations (e.g., Ng & Tan, 2003; Hatfield, Houston, Stefaniak, & Usrey, 2010), but not the potential impact of client concessions on less experienced auditors (staff and seniors) before negotiations over final adjustments even begin. The potential for client attempts to influence these less experienced auditors is important for several reasons First, if managers can decrease proposed audit adjustments, which form the audit team's starting point for negotiations and map into auditor expectations for adjustments to be made during final negotiations (Ng & Tan, 2003), they may be able to achieve net income goals before negotiations even begin. Second, prior research suggests less experienced auditors can be assigned tasks that can (ultimately) contribute to the determination of proposed audit adjustments [e.g., “understand[ing] management's method/model” and assessing the “reasonableness of [an] estimate” (see Griffith, Hammersley, & Kadous, Forthcoming, Table 3)].5 Thus, seniors and staff can be involved

5 The Griffith et al. (Forthcoming, 8) study had participants focus on “complex estimate[s] such as a fair value or impairment analysis.” Given that the tasks in our study are likely less difficult (accounts receivable and inventory obsolescence judgments), we believe staff and seniors could take on similar roles in the tasks from our study as well. Furthermore, less experienced auditors can be assigned the task of accumulating the set of issues “to be reconciled with management/disposed of by the auditor” and that represent “audit differences discovered by the staff auditor” (Hatfield et al., 2010, 1192 and Fig. 1 on page 1193, respectively).

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Please cite this article as: William F., M., et al., The effects of client management concessions and ingratiation attempts on auditors' trust and propos..., Advances in Accounting, incorporating Advances in International Accounting (2015), http://dx.doi.org/10.1016/j.adiac.2015.03.008

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in formulating proposed adjustments that ultimately serve as the starting point for negotiations between more experienced auditors and the client. Next, interactions between management and less experienced auditors, including staff, are common in the audit setting (Bennett & Hatfield, 2013). Furthermore, these interactions may not yield similar results to prior research on the effects of concessions on highly experienced auditors, given prior research suggests experience may lead to decreased skepticism over time in some circumstances. For instance, Nelson (2009) uses Kaplan, Moeckel, and Williams (1992) as an example of a possible indication of lower skepticism; Kaplan et al. (1992) find that managers select more non-misstatement explanations for an analytical procedure ratio task than staff (although the average rank given to these explanations did not differ between these groups). Additionally, Payne and Ramsay (2005, 325) find that “staff auditors in [their] study were significantly more skeptical than the seniors …”, consistent with their argument that auditors “likely revise their beliefs of the likelihood of fraud downward as they continue to experience audits without fraud, and become less skeptical over time, ceteris paribus” (Payne & Ramsay, 2005, 324). Shaub and Lawrence (1999) similarly find that staff demonstrate higher skepticism in various scenarios. Thus, it is unclear whether the benefits of concessions documented with more experienced auditors (e.g., Hatfield et al., 2010) will hold with less experienced auditors. In addition, trust can be thought of as the opposite of suspicion (Shaub, 1996), and can hinder skepticism (Nelson, 2009). SEC Enforcement Actions (Beasley, Carcello, & Hermanson, 2001; Louwers, Henry, Reed, & Gordon, 2008) and Public Company Accounting Oversight Board (PCAOB) (PCAOB) (2011)) inspections indicate insufficient skepticism (i.e., too much trust in clients) contributes to audit failures and deficiencies. On this note, PCAOB Chairman James Doty has stated, “Investors depend on independent audits to provide a meaningful check on the financial statements prepared by company management …. Without professional skepticism, the audit cannot serve that essential function” (Public Company Accounting Oversight Board (PCAOB) (PCAOB), 2012). While recent field evidence suggests auditors believe they can take actions such that trust does not have adverse results (Rennie, Kopp, & Lemon, 2010), auditors' perceptions may not match reality (e.g., Kennedy & Peecher, 1997). In this vein, and in light of mixed results on the impact of trust on auditor decisions (e.g., Kerler & Killough, 2009; Kerler & Brandon, 2010), we answer Rennie et al.'s (2010) call for more study of factors that impact auditors' trust of their clients. Finally, while ingratiation has been studied extensively in the psychology and organizational behavior literatures, this construct has received limited attention in auditing. The results of Robertson (2010) indicate high incentives can hurt a manager's ingratiation attempt in an audit setting. However, we hold incentives constant (at a high level) and propose that in this context, managers who make a concession, which is inconsistent with their incentives, will be more likely to benefit from ingratiation. Thus, we hypothesize that managers can leverage incentives to result in more successful (from the client's perspective) ingratiation attempts. One hundred-three auditors completed a sequential, multi-task experiment centering on an auditor conducting inquiries during fieldwork. The experiment places the auditor in the context of adjustment recommendations while wrapping up fieldwork, and discussing two separate, material issues with the client's controller. We manipulate manager concession by having the client manager either accept or reject a potential adjustment during the first inquiry. We also manipulate whether the manager ingratiates the auditor during this inquiry and measure the auditor's trust of the manager before the auditor proceeds to the second inquiry. We find that auditors place greater trust in an incentivized manager who concedes to the adjustment during the first inquiry, as well as an interaction where ingratiation marginally increases trust if the manager

concedes on this first issue. We also find that auditors in the conceding condition propose smaller aggregate adjustments across the two accounts than auditors in the disputing condition, consistent with prior work on concessions. However, the benefit to the client conceding on the first proposed adjustment is limited in a key way: conceding did not improve the client manager's likelihood of meeting the EPS forecast through a lower proposed aggregate adjustment. This result is consistent with guidance from the Securities and Exchange Commision(SEC) (1999), SAB 99, Public Company Accounting Oversight Board (PCAOB) (PCAOB) (2010b) and large firms (Eilifsen & Messier, Forthcoming) that such a key qualitative materiality consideration could and should influence auditor decisions. Next, we do not find that making a concession interacts with ingratiation to affect auditors' proposed adjustments or the likelihood of meeting the benchmark. Furthermore, although our results suggest that managers can affect auditors' trust in them, the trust auditors place in the manager does not influence auditors' aggregate proposed adjustments. This study makes several contributions to the accounting literature. First, we identify a strategy that client managers can use with less experienced auditors during fieldwork to reduce the level of proposed audit adjustments. Second, we extend prior concession work, which previously has not considered concessions involving both multiple audit issues and consideration of the EPS forecast [e.g., Hatfield et al. (2010) consider multiple issues but not the forecast; Ng and Tan (2003) consider the forecast in a single-issue setting]. We find that a concession's effect may be limited in a key way; even though a conceding client manager can potentially secure a lower proposed aggregate adjustment, it did not impact the client's ability to meet the forecast. Finally, we extend accounting research on ingratiation. Prior research in this area suggests high incentives work against a client manager's ability to influence the auditor using ingratiation (Robertson, 2010). In contrast, our results suggest a manager might be able to benefit from high incentives by conceding on a material issue, and thus at least appear to behave inconsistently with those incentives, before attempting to ingratiate the auditor. We organize the remainder of this paper as follows. The second section describes our hypotheses development, the third section describes our method, and the fourth section presents our findings. The fifth section closes with conclusions, research suggestions, and limitations.

2. Hypotheses development 2.1. Client manager incentives Source credibility theory (e.g., Birnbaum & Stegner, 1979; O'Keefe, 1990; Chaiken & Maheswaran, 1994) suggests client assertions should be less persuasive as client incentives increase. Consistent with this theory, when increased client incentives are present, auditors assess a heightened risk of material misstatement (Hirst, 1994), rely less on the manager (Anderson, Kadous, & Koonce, 2004), and are more prone to recommend adjustments (Robertson, 2010). These findings are consistent with professional responsibilities to consider the source of evidence (e.g., client or third party) as a component of evidence reliability (PCAOB, 2010a, AS 15). One incentive of great concern to regulators (e.g., Levitt, 1998) is meeting the analysts' forecast EPS benchmark. Prior literature provides evidence that managers have incentives to meet this benchmark (e.g., Matsunaga & Park, 2001; Bartov et al., 2002). Consistent with these findings, Nelson et al.'s (2002, 189) study of auditor perceptions of earnings management finds that “(t)he incentive identified most often was meeting analyst expectations ….” Thus, prior theory and research suggest auditors could discount evidence from incentivized managers and the analyst forecast is a particularly strong incentive.

Please cite this article as: William F., M., et al., The effects of client management concessions and ingratiation attempts on auditors' trust and propos..., Advances in Accounting, incorporating Advances in International Accounting (2015), http://dx.doi.org/10.1016/j.adiac.2015.03.008

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Nevertheless, prior research findings on auditor decisions related to the analyst benchmark are not necessarily consistent with this argument. For instance, Libby and Kinney (2000) find auditors are less likely to expect adjustments of quantitatively immaterial issues if the adjustments would cause the client to miss an analyst forecast. Furthermore, auditors arrive at a lower adjustment if they are less skeptical and the adjustment would cause the client to miss an analyst forecast (Brown-Liburd, Cohen, & Trompeter, 2013). Finally, Ng and Tan (2003) find auditors are more likely to make judgments that result in the client missing the analyst benchmark when ineffective oversight is present but accepted guidance exists, and when effective oversight is present but no accepted guidance exists. In summary, even though theory suggests auditors would be prone to keep client incentives in check with increased skepticism, the forecast benchmark appears to influence auditor decisions, including in the client's favor. 2.2. Auditor trust Tomkins (2001) asserts that all inter-organizational business relationships are contingent on trust. While the auditor–client relationship is unique, a recent field study (Rennie et al., 2010) indicates auditors do place some degree of trust in client managers. Trust is important in the audit environment because auditors potentially are more likely to agree with or rely on assertions provided by managers they trust (e.g., Kramer, 1999); therefore, trust can potentially hinder professional skepticism (see also Nelson, 2009). Indeed, Rennie et al. (2010) find manager behavior can affect auditors' trust in management, and call for more study of factors that impact auditors' trust of their clients. In auditing research, Kerler and Killough (2009) find that descriptions of past client interactions (provided by the researchers) can affect levels of auditor trust in a client, and that these measures of trust are (are not) associated with fraud risk judgments when a prior experience with the client is described as negative (positive). Kerler and Brandon (2010, 252) find a positive relationship between a measurement of auditor trust of a client and “auditors' commitment to the goal of supporting the client-preferred method.” Thus, prior research provides some mixed results on whether trust will affect auditor performance. Robertson (2010) relies on source credibility theory (e.g., Pornpitakpan, 2004) to discuss incentives and we similarly rely on it here to discuss trust. Trustworthiness is one component of source credibility (the other being competence/expertise) (O'Keefe, 1990; Pornpitakpan, 2004), and can be referred to as “reporting bias” (Eagly, Wood, & Chaiken, 1978). Trustworthiness is a function of incentives to make assertions that are not representative of actual proceedings (Birnbaum & Stegner, 1979). Source credibility theory also provides insight into how clients with high incentives can gain the auditor's trust. O'Keefe (1990 136) states that sources will be seen as “more trustworthy if the position advocated disconfirms the audience's expectations about the communicator's views.” Thus, this theory indicates that client managers with earnings incentives can potentially gain the auditor's trust by conceding to an income-decreasing adjustment (i.e., by behaving inconsistently with those incentives).6 Thus, we expect that behaving inconsistently with incentives (by making a concession) will generate more trust than behaving consistently with incentives. 6 Psychology research also supports this conclusion by suggesting that actions taken in light of incentives can influence interpersonal assessments; for instance, people judge an individual who behaves favorably toward those in higher positions and unfavorably toward those in lower positions as relatively “dislikeable” (e.g., Vonk, 1998); liking and disliking have long been recognized as forms of affect (e.g., Zajonc, 1980; Herr & Page, 2004). Therefore, actions taken in light of incentives can create interpersonal affect, which, according to organizational behavior theory, can in turn produce trust (Williams, 2001, 2007). Vonk (1999) similarly finds that people judge an individual's constructive actions more positively if those actions are aimed at those in lower (vs. higher) positions.

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2.3. Concessions in the audit setting Accounting research on concessions has typically focused on the setting of auditor–client negotiations. When multiple issues are considered without considering the analyst benchmark, concessions on both insignificant (Sanchez, Agoglia, & Hatfield, 2007; Hatfield, Agoglia, & Sanchez, 2008) and objective (Hatfield et al., 2010) accounting issues can improve overall outcomes for a client manager or auditor.7 Ng and Tan (2003) find that a subjective, qualitatively material concession can help a client manager with the analyst benchmark during negotiations but consider a single issue even though most audits will involve multiple proposed adjustments (see Eilifsen & Messier, 2000). We extend the audit concession literature in several important ways. First, we examine whether client concessions affect auditor trust in the client.8 Second, we enhance experimental realism by having auditors deal with multiple issues when the analyst benchmark information is available; auditors should consider this benchmark (Eilifsen & Messier, Forthcoming) and will likely deal with multiple potential adjustments during the engagement (Eilifsen & Messier, 2000). Third, we use a fieldwork setting rather than an end-of-period negotiation setting, which allows us to test whether a client can achieve higher net income by influencing the auditor's establishment of the proposed adjustment (rather than lowering a previously set proposed adjustment).9 The fieldwork setting also commonly involves less experienced auditors interacting with management (Bennett & Hatfield, 2013). Importantly, given auditor skepticism may decrease over time (see, e.g., Shaub & Lawrence, 1999; Payne & Ramsay, 2005), it is possible that client actions such as concessions that influence more experienced auditors might not affect less experienced auditors. Fourth, prior studies involving multiple accounts use objective or insignificant accounting concessions (e.g., Sanchez et al., 2007; Hatfield et al., 2010).10 In contrast, we manipulate whether the client makes a concession on a subjective, quantitatively material issue.11 We argue that such a concession can send a strong signal to the auditor in

7 Recent related research also indicates auditors can reach more positive outcomes by presenting a bigger issue before a lesser issue during negotiations (Perreault, Kida & Piercey 2013). Our study focuses on a manager conceding to a smaller issue, followed by the auditor's inquiry involving a larger issue. Also, prior work has allowed negotiations between a client and auditor that can include concessions. For instance, Hatfield et al. (2010) have auditors negotiate on a material, subjective account and the (computer) opponent gives concessions during this negotiation if the auditor does not waive the issue; these authors do not report analysis on the effect of the opponent's concessions during this exercise, even when concessions occur. 8 In order to induce increased or decreased views of a client, Kerler and Killough (2009) have a manipulation that, in part, involves the client either conceding or not conceding on an immaterial bad debt issue; however, this concession is accompanied by a further description of the client such that in a prior period, the conceding (not conceding) client is also described as positive (negative) to work with, kind (rude) in interactions, etc. It is important to note that it does not appear that Kerler and Killough (2009) were trying to say that only the concession was driving their manipulation. Furthermore, this approach makes it difficult to disentangle the effect of conceding from the other factors in their manipulation. We are interested in isolating the effect of the concession on trust. 9 As discussed in the method section below, participants are first given a proposed adjustment amount for an accounts receivable issue and are told whether the client agrees or disagrees with this. Participants are subsequently asked what they expect the ultimate adjustment amount will be for this account. Later, participants are asked to determine the amount of proposed adjustment for an inventory issue. Even though participants are given the original proposed amount for the accounts receivable issue, we combine their expected accounts receivable adjustment amount with the proposed inventory amount for the total proposed adjustment measure. However, we also report results for the proposed inventory amount alone. 10 A concession in Ng and Tan (2003) would be considered material for a subjective issue because of its impact on the analyst forecast, but this study only involves a single issue. 11 At the time that this study was conducted, AU 312 was in effect. This standard was revised as part of the clarity project and AU-C 450 (American Institute of Certified Public Accountants (AICPA) (AICPA), 2012a) “Evaluation of Misstatements Identified During the Audit” directs auditors to ask the client to adjust known, non-trivial misstatements without regard to the type of misstatement (i.e., subjective or otherwise) (Eilifsen & Messier, Forthcoming). See also Hatfield et al. (2010, footnote 7) on a similar point. Eilifsen and Messier (Forthcoming) provide a discussion of materiality standards and firm guidance in this area and note the similarity of ASB and international standards.

Please cite this article as: William F., M., et al., The effects of client management concessions and ingratiation attempts on auditors' trust and propos..., Advances in Accounting, incorporating Advances in International Accounting (2015), http://dx.doi.org/10.1016/j.adiac.2015.03.008

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circumstances where stakes are higher given the analyst benchmark.12 Accordingly, a manager who concedes on a subjective, material issue potentially sends a strong, positive signal to the auditor that the manager is willing to forego the wiggle room provided by subjective, gray areas of GAAP (i.e., shows a desire to “get the accounting right”), thereby sacrificing incentives. In such a case, based on the research cited previously, the auditor would potentially trust a conceding manager more and/or treat the manager more favorably when resolving subsequent issues. Therefore, we expect that if an auditor proposes an adjustment on an initial, quantitatively material issue and the manager accepts the adjustment, the manager will be able to obtain a more favorable adjustment amount on the second issue such that the aggregate audit adjustment amount is more favorable: H1. Auditors will trust a client manager more when the manager concedes, rather than disputes, on an initial, quantitatively material issue. H2. Auditors will be more likely to propose lower aggregate audit adjustments that favor a client manager when the manager concedes, rather than disputes, on an initial, quantitatively material issue. 2.4. Ingratiation Ingratiation is a strategic action wherein an individual speaks favorably of others to try to influence them (e.g., Jones, 1964; Cialdini & Goldstein, 2004; Robertson, 2010). Robertson (2010) discusses prior organizational behavior research in this area, which shows that individuals who ingratiate others can benefit, including that they are more likely to receive employment offers, positive evaluations, increased pay, and promotions than those who do not ingratiate (Wayne & Ferris, 1990; Wayne & Kacmar, 1991; Gordon, 1996; Orpen, 1996; Appelbaum & Hughes, 1998; Varma, Toh, & Pichler, 2006). However, the degree to which ingratiation succeeds depends on whether the ingratiator can generate positive interpersonal affect from the other person (Wayne & Ferris, 1990; Appelbaum & Hughes, 1998; Cialdini & Goldstein, 2004), which creates pressure to fulfill with the ingratiator's requests (Cialdini, 1993). Ingratiation's potential benefits thus appear highly dependent on its perceived sincerity. Thacker and Wayne (1995) find that subordinates who ingratiate supervisors are less prone to receive promotions than non-ingratiating subordinates and conclude that “supervisors may be interpreting subordinates' friendly overtures as self-serving attempts to get ahead” (Thacker & Wayne, 1995, p. 749). This point is consistent with Jones (1964), who argues that ingratiation will likely go awry if the incentives potentially motivating the ingratiator come to be apparent. In an audit context, Robertson (2010) finds that ingratiation results in stronger positive affect from auditors toward the client, and auditors are less likely to propose an adjustment for an ingratiating client with low profitability incentives than an ingratiating client with high profitability incentives. One implication of Robertson (2010) is that incentives can hinder the impact of ingratiation in an audit setting. However, we expect managers with high profitability incentives will be given preferential treatment if they concede on an initial issue (H1 and H2). Thus, we also expect that conceding will be viewed as more sincere and thus more likely to benefit ingratiation attempts, despite profitability incentives. In other words, contrary to Robertson's (2010) findings, we expect that incentives can actually improve the impact of ingratiation if the manager makes a concession. Specifically, we expect the following interaction: H3. When an incentivized manager initially concedes (disputes), auditors will trust an ingratiating manager more (less) than a noningratiating manager.

12 This position is supported by arguments that auditors and managers may have different interpretations of GAAP, making subjective issues more contentious than objective issues (e.g., Wright & Wright, 1997; Braun, 2001; Sanchez et al., 2007; Hatfield et al., 2010).

H4. When an incentivized manager initially concedes (disputes), auditors will propose lower aggregate adjustments that favor an ingratiating manager more (less) than a non-ingratiating manager. Auditors are required to be objective (International Federation of Accountants (IFAC) (IFAC), 2009; American Institute of Certified Public Accountants (AICPA) (AICPA), 2012b), and evidence from Rennie et al. (2010) indicates that auditors believe they can trust client personnel and still exercise appropriate skepticism; however, this research did not investigate the impact of trust on auditor judgments. 13 In contrast, research in the organizational behavior literature suggests that trust can influence subsequent judgments. For instance, Kramer (1999 p. 583) explains that individuals give trusted others “the ‘benefit of the doubt’” and Uzzi (1997) finds that employees employ trust as a heuristic that assumes the best regarding the decisions taken by trusted others. Limited accounting research provides some support of these findings. For instance, Kerler and Brandon (2010) find a positive association between auditors' trust and the degree to which the auditors “commit” to the client's accounting decision. These findings indicate that audit judgment is more likely to favor clients if auditors trust them more. Stated formally: H5. Auditors' trust of a client manager will positively affect the auditors' proposed aggregate audit adjustments.

3. Method 3.1. Participants The participants were experienced, practicing auditors from Norway enrolled in a Master's class at the time of the study. Norwegian auditors have been shown to make comparable judgments to U.S. auditors (Kochetova-Kozloski, Kozloski, & Messier, 2013). Upon completing the program, which includes a difficult examination, students become state authorized auditors (a CPA-like certificate) (see Kochetova-Kozloski et al., 2011, who use a similar participant set). We excluded any individuals who did not have audit experience. We collected data in two independent sessions in consecutive fall semesters. One of the researchers administered the case during a regular class session.14 In aggregate, we received 103 useable cases (62 from the first collection, 41 from the second), consisting of one audit manager, 66 seniors, and 36 staff.15 The majority of participants (86%) worked for Big 4 audit firms. All participants had performed audit procedures related to accounts receivable, and all but four had performed audit procedures related to inventory. Participants had an average of 2.19 years of audit experience and an average age of 27 years. We had 60 male participants and 43 female participants. Table 1 presents participants' demographic data. We infer from recent accounting literature (e.g., Griffith et al., Forthcoming) that staff and/or seniors can take on assignments related to estimates that perhaps at one time were left to more experienced 13 On this note, Rennie et al. (2010 p. 290) state “… we wish to emphasize that we were not, in this study, able to determine whether the levels of trust that auditors had for the client representative were such that the auditor's judgment would be compromised. This refinement can be a subject of future research.” Our study addresses this very issue. As noted previously, prior research (Kerler & Killough, 2009; Kerler & Brandon, 2010) provides evidence that auditors' trust of clients can affect auditor decisions and so we extend this work by isolating the effect of a concession (and ingratiation) on auditor trust and studying the impact of trust on additional auditor judgment. 14 MANOVA results indicate no differences across the two data collections for the scaled primary dependent variables. Logistic regression indicates that a higher percentage of participants in the first data collection (25 of 62, or 40.3%) left the client at/above the EPS forecast than in the second data collection (8 of 41, or 19.5%) (Wald χ2 = 4.73, p = 0.030). Hypotheses tests (H2, H4, and H5) involving whether the auditor left the client at/above the forecast are robust to controlling for the timing of data collection. 15 Our hypotheses tests are not sensitive to controlling for auditor experience or rank as a main effect.

Please cite this article as: William F., M., et al., The effects of client management concessions and ingratiation attempts on auditors' trust and propos..., Advances in Accounting, incorporating Advances in International Accounting (2015), http://dx.doi.org/10.1016/j.adiac.2015.03.008

M. William F. Jr. et al. / Advances in Accounting, incorporating Advances in International Accounting xxx (2015) xxx–xxx Table 1 Participant demographics (n = 103). Panel A: continuous demographics (in years) Mean 2.19 27.06

Audit experience Age

Standard deviation 1.14 2.85

Panel B: categorical demographics

Audit rank

Firm size

Audit experience: Accounts receivable Audit experience: Inventory Registered auditor Highest education completed

Gender

Staff auditor Senior Manager Single office Regional National International, non-big 4 Big 4 Yes No Yes No Yes No Bachelor Master Other Female Male

Frequency

Percent

36 66 1 1 2 5 6 89 103 0 99 4 13 90 55 45 3 43 60

34.95% 64.08% 0.97% 0.97% 1.94% 4.85% 5.83% 86.41% 100.00% 0.00% 96.12% 3.88% 12.62% 87.38% 53.40% 43.69% 2.91% 41.75% 58.25%

auditors, supporting our design. As noted previously, staff and/or seniors can be involved with activities that could relate to proposed audit adjustments (see Griffith et al., Forthcoming). A second issue is whether staff and seniors interact with controllers in practice, which is the setting of our study. Bennett and Hatfield (2013, 34) surveyed staff-level auditors “with up to two years of audit experience” from firms ranging from international to local and found that staff auditors frequently interact during the audit, often threeplus times in a week, with company managers, and that these managers can include controllers. Importantly, our experiment explicitly stated: (1) the setting was fieldwork – “there is still some work to be done on two issues before fieldwork is complete”; (2) negotiations had not begun – if the client did not accept the first adjustment at this time it would “be settled later during auditor–client negotiations”, and (3) a higher-level asked them to begin the work on whether to propose the inventory adjustment — “your supervisor has also asked you to make a preliminary recommendation for whether to propose an adjusting journal entry to Beta's inventory”. We also note the tasks used in the current study (accounts receivable collectability and inventory obsolescence) are either comparable to or arguably less complex than those used in prior research with similar participants. For example, prior research has used participants with a similar level of experience (i.e., seniors, who make up the majority of our participants) to make initial going concern judgments (Ricchiute, 1999; Agoglia, Hatfield, & Brazel, 2009) and evaluations of whether internal controls will impede fraud (Agoglia, Kida, & Hanno, 2003). Finally, participants assessed the realism and understandability of the case on nine-point Likert-type scales ranging from 1 = “Not at all Realistic [Understandable]” to 9 = “Very Realistic [Understandable].” Participants found the case both realistic (M = 6.72) and understandable (M = 7.18), with both average assessments significantly greater than the scale midpoints of 5.00 (both p-values b 0.001; unless noted, all p-values are two-tailed). In summary, we believe our sample is appropriate for interactions with the client controller during fieldwork. 3.2. Experimental materials and procedures To design our experiment, we created the concession manipulation, trust measures, and the account receivable task; we also

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adapted materials from prior research.16 We conducted a pilot test with auditing students at a large public university in the United States to further refine the experiment. The case involved a hypothetical publicly-traded retailer of electronics accessories, Beta Technologies (hereafter, Beta). Participants were given background information, including selected unaudited financial statement information, along with the consensus analysts' EPS forecast. They also received information about Beta's performance-based compensation, which was linked to meeting the forecast benchmark. The case explained that the controller participates in the bonus plan, which implied that the controller had an incentive to increase reported earnings both to allow the company to meet the key benchmark and to obtain a bonus for himself.17 The auditors were also told that they would work on two audit issues toward the end of the engagement. All participants were then presented with the first issue, which involved a potential write-off of a material account receivable. Participants were told that they “are asked to make a preliminary recommendation about whether to propose an adjusting journal entry to Beta's accounts receivable.” The case stated that one of Beta's major customers had experienced financial issues due to unforeseen costs of a new information system, and there was a good possibility that the customer would declare bankruptcy. The participants were told that “[a]fter gathering pertinent information about potential recovery,” they (the auditor) recommended a proposed adjustment of $496,667, which was above the materiality allocated to accounts receivable (tolerable misstatement = $466,667). This proposed write-off made up approximately 29% of the $1,686,667 difference that would cause the client to miss the analyst EPS forecast.18 The participants were told that if the controller agreed (disagreed) with the proposal, the client would revise its records (subsequent negotiation would address the issue). Participants then read Tore's statement regarding the write-off and were assigned to one of the four experimental conditions (discussed below). The participants next (1) assessed the likelihood that the recommended adjustment would be made, (2) made a judgment of the adjustment amount to accounts receivable that would ultimately be booked (representing the proposed adjustment for accounts receivable), and (3) rated two trust measures (discussed below) for the controller. The second audit issue involved inventory obsolescence, which arose because a competitor introduced an advanced alternative to one of Beta's products. Participants were “asked … to make a preliminary recommendation for whether to propose an adjusting journal entry to Beta's inventory.” The case explicitly stated that if Beta were to write down the entire inventory for the product in question ($6,600,000), Beta would miss its benchmark, and the controller would miss the bonus. While participants were not told the exact amount of adjustment that would affect the benchmark, we note here that any adjustment greater than $1,686,667 (across the two issues) would cause Beta to miss the EPS benchmark. During an inquiry, the controller explained that he did not want to write down the inventory until the company had a chance to sell the product in developing countries. However, based on the evidence, there was no clear historical pattern to predict whether the client 16 We adapted information, including company and employee information, the ingratiation manipulation, inventory task, and some of the case questions from Robertson (2010). Robertson's (2010) case/inventory task was based on Bhattacharjee and Moreno's (2002) case and input from practitioners; Robertson's (2010) affect questions were based on prior research (e.g., Wayne & Ferris, 1990). 17 Matsunaga and Park (2001) provide evidence that CEO cash bonus compensation can be affected by missing analyst forecasts. Feng and McVay (2010) also recognize management bonuses could be tied to these forecasts. 18 Thus, the accounts receivable issue is quantitatively material (i.e., the proposed adjustment was greater than the materiality assigned to the account) even though, by itself, it is not qualitatively material in terms of causing the client to miss the analyst benchmark. However, if the accounts receivable account is written down, a smaller adjustment on the inventory issue would be needed to cause the client to miss this benchmark.

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could move the inventory in this case. Participants were then asked to answer the following questions: (1) “The likelihood that you will recommend an adjusting journal entry to write off the electronic accessories inventory” and (2) “What amount of an adjustment do you propose concerning the electronic accessories inventory” (representing the proposed adjustment for inventory). Finally, participants responded to additional inventory-related questions and provided demographic data.

3.3. Independent variables We use a 2 × 2 between-participants design with Concession (concede or dispute) and Ingratiation (yes or no) as independent variables. In the concede condition, the manager agreed that a write-off of the customer account for the amount in question was appropriate (the Appendix presents the text of this manipulation).19 In the dispute condition, the manager did not accept the auditor's proposed write-off of the customer account by stating that it was unnecessary. The second independent variable was whether the manager ingratiated the auditor during the discussion of the write-off by stating the following (adapted from Robertson, 2010): “I'm glad to have had a chance to talk with you about our account receivable issue because you seem to really understand our company and its accounts. I'm sure that I will enjoy working with you on the rest of the audit.”

scales from psychology address trust as a personality trait, our focus is on a client's ability to place the auditor in a trusting state.22 The second dependent variable is the combined amount of the (expected) accounts receivable and (proposed) inventory adjustments.23 In the case, auditors are specifically asked how much of an adjustment they expect will be booked for the accounts receivable issue and are also asked how much of an adjustment they would propose on the inventory account. We combine these judgments and label this aggregate number Total_Adjustment.24 The third dependent measure is whether this total audit adjustment causes the client's adjusted EPS to either meet/exceed or fall below the consensus analysts' EPS forecast—we label this variable EPS_vs._Forecast. This measure is important because a prominent component of our case is the manager's incentive to equal or exceed the forecast benchmark. 4. Results 4.1. Manipulation checks Our case included two binary manipulation checks, one for each independent variable.25 Reported hypotheses tests below generally lead to the same conclusions if we limit our analysis to the 73 participants who passed both checks.26 Both manipulation checks had a pass rate of 81.6% (84 out of 103 participants passed each manipulation check). Robertson (2010) reported a similar manipulation check pass rate (83%) for his ingratiation manipulation check. 4.2. Main effects of concession

3.4. Dependent variables We use three dependent variables to test our hypotheses.20 The first is the average of the two assessments of trust placed in the manager following the first audit issue, which we label Trust_Scale.21 We measured each question on a nine-point Likert-type scale (1 = Strongly Disagree to 9 = Strongly Agree) following the manipulations and the questions about the account receivable adjustment, but before the inventory issue. The first trust measure is “Tore [the client controller] wants to properly record financial statement account balances.” This audit-specific measure potentially captures the extent the auditor trusts the manager to follow financial accounting principles. Given that trust can be defined as “the intention to accept vulnerability based upon positive expectations of the intentions or behavior of another” (Rousseau et al., 1998, 395), we believe this is a good measure of trust in the auditing environment because it involves the auditor's assessment of the client's desire for proper financial reporting (i.e., the auditor's “positive expectations” for accounting treatment). The second trust measure, “Tore is a credible person”, is a more general measure of trust; we argue the word “credible” is acceptable for several reasons. First, under source credibility theory, variations in source incentive impact trustworthiness and sources that take actions inconsistent with incentives, such as accepting auditor adjustments, will be more trusted (O'Keefe, 1990). Second, we minimized the risk of trust demand effects by not using the word “trust.” Third, while 19 If the client wrote off the entire auditor-recommended accounts receivable adjustment ($496,667), the amount the client would need to write-off in order to miss the analyst forecast benchmark would be reduced to $1,190,000. 20 For the likelihood of proposing an inventory adjustment, all cell means, means for manipulation levels, and the grand mean were higher than the scale midpoint (all two-tailed p ≤ 0.001). This finding indicates that auditors in all conditions, on average, intended to propose inventory adjustments, but the question remains: how will the aggregate adjustments (across accounts receivable and inventory) impact the manager's ability to achieve the benchmark? 21 We use factor analysis with varimax rotation to confirm the validity of Trust_Scale. The two measures of trust load onto a single, reliable construct (Cronbach's alpha = 0.865).

H1 predicts that an auditor will trust a client manager more when the manager concedes on an initial, quantitatively material issue than when the manager disputes. Table 2, Panel A presents the 2 × 2 ANOVA with Trust_Scale as the dependent variable and Panel B presents descriptive statistics. The Concession variable is significant (F = 32.03, p b 0.001, one-tailed), as auditors in the concession condition assessed higher 22 While some prior auditing research tends to focus on trust as a trait and finds this measure of trust can affect auditor actions (e.g., Rose, 2007), our focus is on trust as a state that is subject to a client manager's influence, consistent with other auditing research (e.g., Kerler & Killough, 2009). One measure of trait trust is the Rotter (1967, 653–654) “Interpersonal Trust Scale”, which includes items such as “Most elected public officials are really sincere in their campaign promises” and “Parents usually can be relied upon to keep their promises”. In addition to measuring a trait rather than a state, we believe such questions are less appropriate for measuring the trust auditors place in clients because the auditor–client relationship is very different from more general settings such as politician– citizen and parent–child. While Kerler and Killough (2009) also measure state trust, they use a different trust scale measure. 23 If participants believed the accounts receivable adjustment was booked to the allowance account without replenishment, this would bias against us finding results because going against incentives (the concession) is less meaningful as there is no immediate effect on net income. Alternatively, if participants believed the accounts receivable issue would impact current earnings, a write-off of the entire accounts receivable account would account for approximately 29% of the adjustment needed to cause the client to miss the analyst benchmark. This would move the client closer to the benchmark if the client were either a) using the direct write-off method, or b) needing to replenish the allowance for doubtful accounts following write-offs. Our analysis assumes the accounts receivable write-off would impact net income. 24 The case presented monetary amounts in Norwegian Krone (NOK). Given the exchange rate at the time of data collection, we divided the NOK amount by 6 to convert to U.S. dollars for presentation in this paper. We determined the amount of adjustment needed to miss the analyst forecast, with rounding, before making this conversion for our EPS_vs._Forecast measure. 25 These questions were as follows: “On the first account you considered, you recommended an adjustment to write down the account receivable balance. Did Tore agree or disagree with your recommended adjustment (select one)?” and “Did Tore explicitly state that he would enjoy working with you on the rest of the audit (select one)?” 26 The only difference in the inferences of hypothesis tests between our full reported sample and the sample limited to those who passed both manipulation checks is that the H3 preplanned contrast comparing the ingratiation and no ingratiation conditions within the concession condition becomes significant (p = 0.027, one-tailed) rather than marginally significant. Given the number of check failures, we report results for the full sample.

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M. William F. Jr. et al. / Advances in Accounting, incorporating Advances in International Accounting xxx (2015) xxx–xxx Table 2 ANOVA results and descriptive statistics for the auditor's trust of the client manager (n = 103). Panel A: ANOVA results for auditors' trust of the client manager (Trust_Scalea)

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Table 3 ANOVA results and descriptive statistics for the audit judgments (n = 103). Panel A: ANOVA results using the total amount of audit adjustmentsa (Total_Adjustment) as the audit judgment. SS and MS in billions.

Variable

SS

df

MS

F

p-Valueb

Hypothesis

Variable

SS

df

MS

F

p-Valueb

Hypothesis

Concession (C) Ingratiation (I) C×I

77.57 0.17 6.76

1 1 1

77.57 0.17 6.76

32.03 0.07 2.79

b0.001 0.790 0.049

H1 – H3

Concession (C) Ingratiation (I) C×I

19074.13 38.88 31.00

1 1 1

19074.13 38.88 31.00

4.68 0.01 0.01

0.017 0.922 0.931

H2 – H4

Panel B: cell means (SD) (n) for auditor's trust of the client manager (Trust_Scale)

Panel B: cell means (SD) (n) for Total_Adjustment (means and SD in millions of dollars)

Ingratiationd c

Ingratiationd

Concession

No

Yes

Overall

Concession

Dispute

4.80 (1.68) (27) 6.02 (1.50) (24)

4.37 (1.58) (26) 6.62 (1.44) (26)

4.59 (1.63) (53) 6.33 (1.48) (50)

Dispute

Concede

a Trust_Scale is the extent the auditor trusts the manager, and is measured during the first audit issue (accounts receivable). It is a scale comprised of two items: (1) "Tore [the client controller] wants to properly record financial statement account balances"; and (2) "Tore is a credible person." We measure both items on nine-point Likert-type scales ranging from 1 = “Strongly Disagree” to 9 = “Strongly Agree”. b p-Values are one-tailed only for hypothesized relationships in the predicted direction. c Concession is a binary independent variable and refers to whether the manager conceded to, or disputed with, the auditor during the first audit issue. In the concede condition (Concession = 1), the manager agreed with the auditor that a write-off of the specific account in question was necessary. In the dispute condition (Concession = 0), the manager disagreed with the auditor and explicitly stated that the auditor's recommended write-off was likely unnecessary. d Ingratiation is a binary independent variable (Present = 1, Absent = 0) and refers to whether the manager attempted to ingratiate the auditor.

trust (M = 6.33) than those in the dispute condition (M = 4.59). These results are consistent with H1. H2 predicts that an auditor will be more likely to propose adjustments that favor a client manager when the manager concedes, rather than disputes on the initial, quantitatively material issue. We test H2 using both the adjustment amounts (Total_Adjustment) and the relationship between adjusted EPS and the forecast benchmark (EPS_vs._Forecast). Table 3 (panel A) presents the ANOVA with Total_Adjustment as the dependent variable. Concession is significant (F = 4.68, p = 0.017, one-tailed). As shown in Panel B, auditors who encounter a manager who initially concedes provide a lower total adjustment (M = $2.29 million) than auditors who encounter a manager who initially disputes (M = $3.15 million). These results support H2. Table 3 (Panel C) presents the logistic regression model for analyzing H2 using whether the auditor's combined adjustment allowed the client to meet the forecast benchmark (EPS_vs._Forecast) as the dependent variable. Concession is not significant (Wald χ2 = 0.102, p = 0.375, onetailed). As shown in Table 3 (Panel D), auditors who encounter a manager who initially concedes are not more likely to leave the client at or above the forecast benchmark (38.00%) than auditors who encounter a manager who initially disputes (26.42%). This result does not support H2 and suggests that while auditors are willing to reward a manager who initially concedes (with a smaller total adjustment), they do not appear more willing to allow such a manager to achieve a key qualitative benchmark. 4.3. Interactive effects of concession and ingratiation H3 predicts that Concession and Ingratiation will interact to affect trust (Trust_Scale) such that when the manager concedes, auditors will trust an ingratiating manager more than a non-ingratiating manager. H3 also predicts that when a manager disputes, auditors will trust the ingratiating manager less than a non-ingratiating manager. Table 2 shows the ANOVA results (Panel A) and descriptive statistics (Panel B) for H3, which reveal that the Concession × Ingratiation interaction is significant on Trust_Scale1 (F = 2.79, p = 0.049, one-tailed).

c

Concede

Overall

No

Yes

Overall

3.12 (2.42) (27) 2.29 (1.96) (24) 2.73 (2.23) (51)

3.19 (2.11) (26) 2.29 (1.43) (26) 2.74 (1.84) (52)

3.15 (2.25) (53) 2.29 (1.69) (50) 2.73 (2.04) (103)

Panel C: logistic regression results using the relationship between adjusted EPS and the EPS forecast as the audit judgment (EPS_vs._Forecaste) Variable

B coefficient

Wald chi-square

Exp(B)

p-Value

Hypothesis

Concession (C) Ingratiation (I) C×I

.205 −.999 .660

0.102 2.753 0.575

1.228 .368 1.934

0.375 0.097 0.448

H2 – H4

Panel D: percentage of auditors who left the client at/above the EPS forecast Ingratiation Concession

No

Yes

Overall

Disagree Concede Overall

8/27 (29.63%) 12/24 (50.00%) 20/51 (39.22%)

6/26 (23.08%) 7/26 (26.92%) 13/52 (25.00%)

14/53 (26.42%) 19/50 (38.00%) 33/103 (32.04%)

a Total_Adjustment is the dollar amount of the combined adjustments to write-down the accounts receivable and inventory accounts. Given that we initially captured this measure in Norwegian Krone (NOK) and the exchange rate at the time of data collection, we divided the NOK amount by 6 to convert to dollars. b p-Values are one-tailed only for hypothesized relationships in the predicted direction. c Concession is a binary independent variable and refers to whether the manager conceded to, or disputed with, the auditor during the first audit issue. In the concede condition (Concession = 1), the manager agreed with the auditor that a write-off of the specific account in question was necessary. In the dispute condition (Concession = 0), the manager disagreed with the auditor and explicitly stated that the auditor's recommended write-off was likely unnecessary. d Ingratiation is a binary independent variable (Present = 1, Absent = 0) and refers to whether the manager attempted to ingratiate the auditor. However, note that in Panel C, when the logistic regression was run, SPSS reversed the coding such that Ingratiation = 1 when the manager did not attempt to ingratiate and Ingratiation = 0 when the manager did attempt to ingratiate. e PS_vs._Forecast refers to whether the combined audit adjustment brings the client's EPS below the consensus analysts' EPS forecast. The variable coding is 0 = at/above the forecast benchmark and 1 = below the forecast benchmark. Note that an adjustment greater than $1,686,667 would cause the client to miss this benchmark.

Contrast (untabulated) interaction results are partially in the manner predicted. Within the concede condition, auditors placed marginally more trust in an ingratiating manager (M = 6.62) than a non-ingratiating manager (M = 6.02; p = 0.090, one-tailed). Within the dispute condition, auditors placed equal trust in an ingratiating manager (M = 4.37) and a non-ingratiating manager (M = 4.80; p = 0.158, one-tailed). A potential explanation for this result is that in the dispute condition auditors already placed relatively lower trust in the manager and ingratiation does not cause them to trust the client any less (i.e., a “floor” effect). These results partially support H3 and suggest that ingratiating clients can potentially affect auditor trust by first conceding. Given the significant overall interaction, we also use the preplanned contrasts to determine whether the H1 main effect holds for both levels of our Ingratiation manipulation. In the no ingratiation condition,

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4.5. Sensitivity analysis: probability-weighted adjustments

Table 4 Hypothesis tests for H5 (n = 103). Panel A: hypothesis test using the total amount of audit adjustments (Total_Adjustment) as the audit judgment IV

DV

Unstandardized t Beta

Trust_Scalea Total_Adjustmentb −31305.04

p-Valuec Hypothesis

−0.28 0.392

H5

Panel B: logistic regression results using the relationship between adjusted EPS and the EPS forecast as the audit judgment (EPS_vs._Forecast) IV

DV

B Coefficient

Wald Chi-square

p-Value

Hypothesis

Trust_Scale

EPS_vs._Forecastd

0.102

.739

0.390

H5

a

Trust_Scale is the extent the auditor trusts the manager, and is measured during the first audit issue (accounts receivable). It is a scale comprised of two items: (1) "Tore [the client controller] wants to properly record financial statement account balances"; and (2) "Tore is a credible person." We measure both items on nine-point Likert-type scales ranging from 1 = “Strongly Disagree” to 9 = “Strongly Agree”. b p-Values are one-tailed only for hypothesized relationships in the predicted direction. c Concession is a binary independent variable and refers to whether the manager conceded to, or disputed with, the auditor during the first audit issue. In the concede condition (Concession = 1), the manager agreed with the auditor that a write-off of the specific account in question was necessary. In the dispute condition (Concession = 0), the manager disagreed with the auditor and explicitly stated that the auditor's recommended write-off was likely unnecessary. d Ingratiation is a binary independent variable (Present = 1, Absent = 0) and refers to whether the manager attempted to ingratiate the author.

participants assessed a higher level of trust when the manager concedes (M = 6.02) compared to when the manager disputes (M = 4.80), (p = 0.003, one-tailed). In the ingratiation condition, participants assessed a significantly higher level of trust when the manager concedes (M = 6.62) compared to when the manager disagreed (M = 4.37) (p b 0.001, one-tailed). These results are consistent with H1. H4 predicts that Concession and Ingratiation will interact to affect auditor judgment such that when the manager concedes, auditors will propose lower aggregate adjustments that favor an ingratiating manager more than a non-ingratiating manager. H4 also predicts that when a manager disputes, auditors will propose higher aggregate adjustments that favor an ingratiating manager less than a non-ingratiating manager. As shown in the ANOVA model in Table 3 panel A the Concession × Ingratiation interaction is not significant on Total_Adjustment (F = 0.01, p = 0.931). As shown in the logistic regression in Table 3 Panel C, the interaction is not significant on EPS_vs._Forecast (Wald χ2 = 0.575, p = 0.448). Therefore, H4 is not supported. 4.4. The effect of trust on adjustments H5 predicts an auditor's trust of the client manager will positively affect the auditor's proposed aggregate audit adjustments. As shown in Table 4, Trust_Scale does not have a significant relationship with either the aggregate adjustment (Panel A) or whether this adjustment left the client at/above the EPS forecast (Panel B). Thus, our results do not support H5.27 27 The ANOVA used to analyze H2 and H4 examined the combined adjustment for both audit issues. We now use a MANOVA (see Table 5) to investigate the effects of our manipulations on the individual adjustments. For the overall MANOVA model, only Concession was significant (untabulated Pillai's trace = 0.15, F = 8.49, p b 0.001). Participants in the dispute condition expected smaller adjustments to be booked to accounts receivable (F = 12.76, p = 0.001), the first issue. This appears to reflect the client's willingness to contend this issue. In contrast, participants in the dispute condition proposed larger adjustments to inventory (F = 5.86, p = 0.017). This is consistent with our overall conclusion that auditors tend to offer smaller aggregate adjustments following a client concession on the initial issue. If we run an ANOVA for participants' inventory adjustments while controlling for their accounts receivable adjustments, those in the dispute condition proposed larger inventory adjustments (F = 3.85, p = 0.027, one-tailed). If we run this same test and only include the participants who passed the manipulation check (n = 73), the effect of a concession on the proposed inventory adjustment becomes marginally significant (F = 2.52, p = 0.059, one-tailed). If only the inventory adjustment is used to calculate the meet/beat variable, results are consistent with our previous findings for H2, H4, and H5 (i.e., no effect of concession) for the full sample.

To address whether the results of hypotheses tests are sensitive to using probability-weighted audit adjustments, we transformed the scales used to assess the likelihood of adjustments to probabilities, and then multiplied these probabilities by the actual adjustment numbers for each issue.28 These steps yielded a probability-weighted amount for both the accounts receivable and inventory adjustments, which we summed to create an aggregate probability-weighted adjustment. In general, our inferences from statistical analyses do not change if we use the total probability-weighted adjustment rather than the actual adjustments reported above. We do note that for our second transformation method (i.e., one of the three methods), Concession has a marginal effect on the EPS issue (Logistic regression Beta = .894, exp(Beta) = 2.444, Wald χ2 = 2.135, p = 0.072, one-tailed), with more participants in the concede condition (23 of 50, or 46.00%) leaving participants at/above the forecast than in the dispute condition (20 of 53, or 37.74%). While this result suggests that whether the client concedes can potentially have some effect on the likelihood of meeting or beating, this is limited to one probability calculation method. Given that our main analyses and the other transformations suggest that the Concession manipulation does not affect the likelihood of meeting or beating the analyst benchmark, we conclude it does not appear that conceding has a significant effect on the likelihood of meeting the analyst forecast. 5. Conclusion This study reports the results of a multi-task audit experiment that investigates whether a client manager can make a concession and/or ingratiate the auditor before auditor–client negotiations to influence auditor judgment in the manager's favor, despite the manager's incentives to meet analyst expectations. Consistent with our hypotheses, auditors proposed lower aggregate adjustments when the manager conceded on the initial, smaller but quantitatively material, subjective accounting issue. However, in our main tests there was not a significant difference between the likelihood of auditors allowing a manager to meet or exceed the consensus analysts' EPS forecast, and thus obtain a bonus, in the conceding vs. not conceding conditions. We also find no interaction between conceding and ingratiating the auditor on the aggregate audit adjustment amount or on the likelihood of meeting the forecast benchmark. Next, we find auditors place more trust in a manager who concedes on the initial accounting issue. In addition, our manipulations interact such that auditors place marginally more trust in a manager who concedes and ingratiates the auditor during the inquiry involving the first issue. We also find no association between trust and the aggregate adjustment, although a conceding manager receives a lower aggregate adjustment than a disputing manager. One logical explanation, given the auditing literature we have cited previously (e.g., Hatfield et al., 2010), is that auditors are reciprocating. Furthermore, auditing standards (e.g., AS 14, Public Company Accounting Oversight Board (PCAOB) (PCAOB), 2010b) and firm guidance (Eilifsen & Messier, Forthcoming) require consideration of qualitative factors. Thus, assuming auditors are reciprocating, our results suggest some benefit (from the client's perspective) to conceding managers, but also a key limitation involving the client's ability to meet its EPS forecast. This constraint on the benefits of conceding may arise because “[h]istorically, auditors have been held accountable when adverse financial statement 28 We converted our 1–9 scales to probabilities in three ways, all of which led to similar inferences compared to the results reported above. First, we converted the scale such that 1 = 10%, 2 = 20%, … 9 = 90%. This method is based on our scale ranging from very low to very high rather than 0 to 100%. Second, since participants might have equated the scale ceiling with 100%, we converted the scale such that 1 = 11.11%, 2 = 22.22%, … 9 = 100%. Third, to allow for the possibility that participants equated the scale floor with 0%, we converted the scale such that 1 = 0%, 2 = 11.11%, … 9 = 88.88%.

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Table 5 MANOVA between-subjects results and descriptive statistics for the individual adjustments (n = 103). Panel A: MANOVA results using the individual adjustments as the audit judgments. SS and MS in billions Variable

SS

df

MS

F

p-valuea

Dependent measure

Concession (C)b C Ingratiationc Ingratiation C × ingratiation C × ingratiation

291.57 24082.27 8.06 82.35 4.06 57.48

1 1 1 1 1 1

291.57 24082.27 8.06 82.35 4.06 57.48

12.76 5.86 0.35 0.02 0.18 0.01

0.001 0.017 0.554 0.888 0.674 0.906

Accounts receivable adjustmentd INV adjustmente Accounts receivable adjustment INV adjustment Accounts receivable adjustment INV adjustment

Panel B: cell means (SD) (n) for the expected accounts receivable adjustment (means and SD in millions of dollars) Ingratiation Concession

No

Yes

Overall

Disagree

0.39 (0.20) (27) 0.48 (0.07) (24) 0.43 (0.16) (51)

0.36 (0.19) (26) 0.48 (0.10) (26) 0.42 (0.16) (52)

0.37 (0.19) (53) 0.48 (0.08) (50) 0.43 (0.16) (103)

Concede

Overall

Panel C: cell means (SD) (n) for the proposed inventory adjustment (means and SD in millions of dollars) Ingratiation Concession

No

Yes

Overall

Disagree

2.73 (2.45) (27) 1.81 (1.94) (24) 2.29 (2.25) (51)

2.83 (2.14) (26) 1.81 (1.41) (26) 2.32 (1.87) (52)

2.78 (2.28) (53) 1.81 (1.67) (50) 2.31 (2.06) (103)

Concede

Overall

a

p-Values in this table are two-tailed. Concession is a binary independent variable and refers to whether the manager conceded to, or disputed with, the auditor during the first audit issue. In the concede condition (Concession = 1), the manager agreed with the auditor that a write-off of the specific account in question was necessary. In the dispute condition (Concession = 0), the manager disagreed with the auditor and explicitly stated that the auditor's recommended write-off was likely unnecessary. c Ingratiation is a binary independent variable (Present = 1, Absent = 0) and refers to whether the manager attempted to ingratiate the auditor. d The accounts receivable adjustment is the participant's expected dollar adjustment for the first audit issue, accounts receivable. Given that we initially captured this measure in Norwegian Krone (NOK) and the exchange rate at the time of data collection, we divided the NOK amount by 6 to convert to dollars. e The inventory adjustment is the participant's proposed dollar adjustment for the second audit issue, inventory. Given that we initially captured this measure in Norwegian Krone (NOK) and the exchange rate at the time of data collection, we divided the NOK amount by 6 to convert to dollars. b

outcomes (e.g., client bankruptcies, material misstatements due to fraud, or large decreases in market capitalization) follow after particular audit conclusions (e.g., an unqualified opinion or the absence of a going-concern modification)” (Peecher, Solomon & Trotman, 2013). This study makes several contributions to the literature. First, we bridge some gaps in audit research on concessions. This literature tends to focus on concessions in a multi-issue setting without considering analyst benchmarks (e.g., Hatfield et al., 2010), even though auditors recognize the importance of the analyst forecast benchmark (Nelson et al., 2002), or a single issue that can affect the client's ability to meet the EPS forecast (Ng & Tan, 2003), even though audits often result in multiple proposed adjustments (see Eilifsen & Messier, 2000, for a review). We incorporate both of these relevant factors. We also look at the potential impact of a client concession on less experienced auditors during fieldwork while other studies (see, e.g., Hatfield et al., 2010) look at the impact of concessions on more experienced auditors during negotiations. Relatedly, we look at whether concessions can affect the establishment of a proposed audit adjustment rather than a concession's impact on a previously determined proposed adjustment. Second, Kadous, Kennedy, and Peecher (2003, 766) consider pressure to allow an aggressive reporting approach that “avoids a negative earnings surprise” and allows the client to continue to report higher income. In their study, the client's desired approach was about three

percent (of annual revenue) higher than alternative approaches, although they do not explicitly state whether this is material or not; they find that auditors are more likely to accept the client's position if they rate higher on the adoption of a goal consistent with the client's approach (Kadous et al., 2003). We extend this work by finding auditors are not more likely to allow the client to meet the forecast benchmark when an incentivized manager initially concedes. Third, concerning ingratiation, Robertson (2010) finds that incentives can hinder ingratiation. In contrast to the tone of Robertson's (2010) work, we find that incentivized managers who initially concede can gain marginally greater trust from the auditor using ingratiating. Fourth, regarding trust, although incentives can reduce trust (Shaub, 1996), we find client managers with high incentives can gain more of the auditor's trust by initially conceding. However, we find that the trust auditors place in clients does not influence audit judgments, providing experimental evidence to support auditors' claims that they act so that their trust of the client does not impair skepticism (Rennie et al., 2010). Our finding that trust does not affect auditors' adjustment decisions is consistent (inconsistent) with Kerler and Killough's (2009) finding that auditors who encounter a scenario with a positive (negative) prior interaction with the client do not have (do have) trust measures that are associated with their fraud risk judgments. Similarly, as Kerler and Brandon's (2010) findings were not entirely consistent with Kerler and

Please cite this article as: William F., M., et al., The effects of client management concessions and ingratiation attempts on auditors' trust and propos..., Advances in Accounting, incorporating Advances in International Accounting (2015), http://dx.doi.org/10.1016/j.adiac.2015.03.008

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Killough's (2009) findings or ours, we invite more research on the effect of auditors' trust in a client on auditor judgments. Our study is subject to limitations. For example, as with many audit experiments, our participants would typically have access to more information. Next, the inventory (i.e., second issue) judgments featured the client disputing any adjustment in all conditions. Thus, the controller's disagreement on this issue may have impacted auditors' inventory judgments by countering some of the gains from the accounts receivable concession. Future research might profitably examine whether our findings hold if auditors make their judgments without first receiving a client's explanation as to why an adjustment is not appropriate. Finally, as mentioned previously, we did not provide the adjustment amount that would cause the client to miss the benchmark and future research could investigate whether providing this information would affect auditors in a similar setting as our study. Acknowledgements We thank those who have provided feedback on this paper, including Chris Agoglia, Sanaz Aghazadeh, Mary Curtis, Scott Emmett, Jon Grenier, Rick Hatfield, Jessen Hobson, Natalia Kochetova, Mark Nelson, Ed O'Donnell, Robert Pavur, Dave Piercey, Tammie J. Rech-Schaefer, Chad Stefaniak, Nate Stephens, Bill Tayler, Lisa Victoravich, Chris Wolfe, David Wood, Aaron Zimbelman, Mark Zimbelman, other attendees at the 7th Annual BYU Accounting Research Symposium, the Sixth European Auditing Research Network (EARNet) Symposium, the 2011 AAA Annual Meeting, and the 2011 AAA ABO Conference and reviewers. We also appreciate the feedback received from workshop participants at the HEC — Paris, University of North Texas, Utah State University, and Washington State University who have provided valuable feedback. We thank the participants for taking the time to complete this study. Professor Messier received financial support for this research from the Kenneth and Tracy Knauss Endowed Chair in Accounting at UNLV and the Adjunct Professor position at NHH. Professor Robertson thanks UNT for financial support received for this research. Professor Simon thanks UNLV and Utah State University for financial support received for this research. Appendix A Independent variable levels for the concession manipulation. Concede: “Well, as you know, we have a customer who is facing some tough times. I would love to see the customer turn this issue around, especially since we've been working with them for years now, but I think there is a good chance they'll enter bankruptcy.” “So I believe it makes sense to write off a good portion of this account, and I think your estimated write off is necessary.” Dispute: “Well, as you know, we have a customer who is facing some tough times. I would love to see the customer turn this issue around, especially since we've been working with them for years now, and I think there is some chance they'll avoid bankruptcy.” “So I believe it makes sense to hold off and see what happens with the bankruptcy before we write off any of this account, so I think your estimated write off is probably unnecessary.” References Agoglia, C., Hatfield, R., & Brazel, J.F. (2009). The effects of audit review format on review team judgments. Auditing: A Journal of Practice and Theory, 28(1), 95–111. Agoglia, C., Kida, T., & Hanno, D.M. (2003). The effects of alternative justification memos on the judgments of audit reviewees and reviewers. Journal of Accounting Research, 41(1), 33–46. American Institute of Certified Public Accountants (AICPA) (2012a). AU-C 450: Evaluation of misstatements identified during the audit. (Available as of July 9, 2013 at: http:// www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C00450.pdf.).

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