Managers sometimes implement accounting standards (such as the lease standard) opportunistically to move debt off balance sheet. Regulators and standard-setters are considering the adoption of principles-based accounting standards to reduce such opportunism. We report the results of an experiment in which experienced financial managers, with incentives to structure a transaction off balance sheet, take a reporting position on how a lease is to be reported. We manipulate the type of accounting standards (principles-based, rules-based) and the type of auditor (principles-oriented, rules-oriented, or client-oriented). Results show that for a rules-based standard, auditor-type does not influence participants’ propensity to report the transaction off balance sheet. However, for a principles-based standard, auditor-type matters in that this propensity is lowest when the auditor is principles-oriented as opposed to rules- or client-oriented. Our results suggest that a move toward more principles-based standards is likely to result in improved financial reporting quality only when there is a corresponding shift in auditors’ mindsets toward being more principles-oriented.

In this study, we investigate whether audit managers' assessment of the quality of work their subordinates perform is influenced by the managers' prior impressions of these subordinates, and whether managers whom the firm considers outstanding are less susceptible to such an effect. We conduct an experiment using actual audit senior-manager teams. Each senior and manager participating in the experiment has been classified by his or her firm as either outstanding or average. Each manager is paired with two audit seniors (one outstanding senior and one average senior), and each evaluates the memos written by his or her paired seniors. Managers evaluate the quality of the memos twice: (1) first, with the identities of the seniors indicated on the memos, and (2) later, when the seniors' identities are not explicitly revealed. Results show that average managers evaluate memos written by outstanding seniors more favorably than those written by average seniors when they know the identities of the memos' authors, but not when the identities of the seniors are not revealed. Outstanding managers do not appear susceptible to this effect.

We examine determinants of audit engagement profitability using proprietary data from the national office of a Big 4 public accounting firm in Canada. We verify through interviews with senior audit partners that the audit realization rate is the primary measure used to assess engagement-level profitability, and use the former to proxy for engagement profitability in our archival analysis. We find that engagement profitability is positively associated with the firm's assignment of lead senior audit managers, as identified by the national office, and its delivery of intangible client service dimensions, such as communication, customization, and responsiveness (obtained from satisfaction surveys of client management and audit committee chairs). We find no evidence that audit quality, measured by discretionary accruals and audit adjustments, is sacrificed to attain higher engagement profitability. We discuss implications for regulation and competition in audit markets.