Auditing, Auditor Judgment, Dilution effect, Non diagnostic information

This study examines analyst forecast errors within the context of stock recommendations. We predict positive forecast error (i.e., optimism) for buy recommendations and negative forecast error (i.e., pessimism) for sell recommendations. We offer two explanations for this prediction: (1) the unconscious tendency to process information in a manner that supports one’s goal, which we refer to as the “objectivity illusion” hypothesis, and (2) the economic incentive to boost trade, which we refer to as the “trade boosting” hypothesis. The pattern of analyst forecast bias we predict (i.e., optimism for buys and pessimism for sells) is opposite in direction to that predicted by the management relations hypothesis—a commonly cited hypothesis for analyst forecast bias. We find broker‐analyst earnings forecast errors are significantly optimistic for buy recommendations and significantly pessimistic for sell recommendations, consistent with the objectivity illusion and trade boosting hypotheses. Our study indicates that the pattern of results reported in prior research (i.e., increasingly optimistic earnings forecasts as the stock recommendation becomes less favorable) is likely driven by a correlated omitted variable, actual earnings. Results of an analysis to distinguish between trade boosting and objectivity illusion appear more consistent with the objectivity illusion.

Das et al. (1998) suggest that as earnings become less predictable, analysts issue increasingly optimistic forecasts to please managers and consequently gain, or at least limit the loss of, access to managers' private information. We reexamine the association between earnings forecast error and earnings predictability because there is evidence suggesting that deliberate earnings forecast optimism is not an effective mechanism for gaining access to managers' information (e.g., Eames et al. 2002; Matsumoto 2002). We document associations between earnings level and both forecast error and earnings predictability. These associations suggest that earnings level may be an important control variable when examining the association between forecast error and earnings predictability. When we control for the level of earnings we find no significant association between forecast error and earnings predictability. Thus, we find no evidence that analysts intentionally issue optimistically biased earnings forecasts.

ABSTRACT Reported deficiencies continue to persist in audits of fair value measurements and other complex accounting estimates (hereafter, “FVMs”), despite improvements in auditor performance observed by regulators. The persistence of reported deficiencies in audits of FVMs suggests that factors underlying this trend may be more complicated and multidimensional than previously suggested by regulators and academic research, which has focused largely on auditors' unsatisfactory performance as the principal source of reported deficiencies. Drawing from the judgment and decision‐making expertise literature, we gather field‐based data from audit experts to identify additional factors that are likely to be contributing to differences of opinion between audit and inspection experts and the persistence of reported deficiencies in audits of FVMs. We find evidence that audit experts interpret standards and evaluate audit evidence differently than inspectors, and thus perceive there to be a gap between what auditors and inspectors regard as sufficient appropriate audit evidence to support audits of FVMs (hereafter, “FVM gap”). Moreover, results highlight several areas in audits of FVMs where differences of opinion exist between auditor and inspector experts regarding what constitutes a reported deficiency. Within the contexts we examine, our results identify additional factors, beyond deficient auditor performance, that may contribute to the FVM gap. We also report audit partners' recommendations for ways to reduce the FVM gap and suggest avenues for future research. Gaining a more complete understanding of sources contributing to reported deficiencies will help regulators, standard setters, audit firms, and academics to identify ways to reduce the FVM gap and reported deficiencies in audits of FVMs.

Recent reviews of the academic literature indicate that little is known regarding how users evaluate the materiality levels auditors use or respond to quantitative materiality disclosure. Regulators around the world have taken different stances on whether materiality should, or should not, be disclosed in the auditor’s report. In response to the dearth of research on these policy decisions, we examine the effect of audit materiality disclosures, or lack thereof, on professional investors’ decision making across different investment contexts (debt vs. equity, public vs. private). Our study is designed to test global audit public policy and as such our hypotheses are motivated by assertions made by regulators, auditing standards, and audit theory. Among a sample of 246 professional investors in our main experiment and 91 professional investors in two supplemental experiments, we find no consistent evidence that investors incorporate materiality disclosures into their investment decisions. Most importantly, we find evidence that investors’ understanding of materiality is not in line with regulator assertions. For example, investors fail to make consistent connections between the amount of disclosed audit materiality and the level of auditor effort. Our results hold across debt and equity investment settings for both public and private companies. In sum, our findings suggest that disclosures of audit materiality are not well understood by professional investors and are not viewed as decision relevant. This research informs practitioners, regulators, and academics regarding the effect of materiality disclosure on investor decision making as well as stakeholders’ views and expectations of overall materiality.

In this study, we leverage judgment decomposition and information acquisition theories to develop and test an intervention to improve group auditors' identification of and response to component‐level qualitative risk. Improving group auditors' response to qualitative risk is important because (1) group audits are prevalent today and require multiple qualitative risk assessments, (2) auditors have historically overlooked qualitative risks, and (3) prior interventions have failed to improve auditors' response to qualitative risk. In an experiment with 88 audit partners and managers, we find that a hybrid risk assessment approach that combines elements of judgment decomposition and notetaking improves auditors' group audit planning decisions. Specifically, auditors utilizing our hybrid approach are better able to identify and respond to component‐level qualitative risks than auditors who use a holistic approach. Importantly, the improvement in qualitative risk response does not come at the expense of auditors' response to quantitative risk.

Projects seeking to define, measure, and evaluate audit quality are on the agendas of auditing standards setters as well as audit firms. The Public Company Accounting Oversight Board ( PCAOB ) currently provides information regarding audit quality through the release of inspection reports, and the Board intends to establish and report audit quality indicators. To provide additional perspective on audit quality, we obtain auditors' and investors' views, definitions, and indicators of audit quality. We find that investors' definitions of audit quality focus more on inputs to the audit process than do auditors', and that investors view the number of PCAOB deficiencies as an indicator of overall firm quality. We find a consensus that auditor characteristics may be the most important determinants of audit quality, and that restatements may be the most readily available signal of low audit quality. We relate responses to a general audit quality framework, provide support for archival audit research, and identify additional disclosures that participants suggest could signal audit quality. Taken together, we provide evidence regarding the construct of audit quality in the post‐ SOX environment, evaluate many of the audit quality indicators proposed by the PCAOB , and suggest avenues for future research.