How do Auditors View Managers' Voluntary Disclosure Strategy? The Effect of Earnings Guidance on Audit Fees

Posted: 1 Apr 2009 Last revised: 19 Sep 2011

See all articles by Gopal V. Krishnan

Gopal V. Krishnan

Bentley University

Mikhail Pevzner

University of Baltimore - Merrick School of Business

Partha Sengupta

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Date Written: September 18, 2011

Abstract

The objective of this study is to examine the relation between attributes of earnings forecasts issued by managers and audit fees. Although there is an extensive literature on managers’ disclosure of earnings forecasts, there is a paucity of research on how auditors incorporate information from these voluntary disclosures. We find that the issuance of an annual or quarterly management earnings forecast in the prior period is positively associated with the current period audit fees. Our results indicate that on average, audit fees are higher by about 7% for firm-years associated with an annual forecast. Among the firms that issue earnings forecasts, we find no association between audit fees and likelihood of updating a previously issued earnings forecast, indicating that auditors do not view such behavior negatively. Further, we find audit fees to be positively associated with the error and the bias (or optimism) in the forecasts for annual forecasts but not for quarterly forecasts. Overall, these results suggest that management’s forecast behavior captures higher business risk for the auditor via greater risk of earnings management or litigation risk.

Keywords: Audit fees, Management Earnings forecasts, Litigation Risk, Fraud Risk

JEL Classification: M40, M41, M49

Suggested Citation

Krishnan, Gopal and Pevzner, Mikhail and Sengupta, Partha, How do Auditors View Managers' Voluntary Disclosure Strategy? The Effect of Earnings Guidance on Audit Fees (September 18, 2011). Journal of Accounting and Public Policy, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1371255

Gopal Krishnan

Bentley University ( email )

175 Forest Street
Waltham, MA 02452
United States
781-891-2477 (Phone)

Mikhail Pevzner (Contact Author)

University of Baltimore - Merrick School of Business ( email )

1420 N. Charles St.
Baltimore, MD 21201-5779
United States

Partha Sengupta

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street, SW
Mail Stop 6E-3
Washington, DC 20219-0001
United States
202-679-5525 (Phone)

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