Aggressive Reporting and Probabilistic Auditing in a Principles-Based Environment

42 Pages Posted: 7 Sep 2013

See all articles by Suzanne Bijkerk

Suzanne Bijkerk

Erasmus University Rotterdam (EUR)

Vladimir Karamychev

Erasmus University Rotterdam (EUR) - Department of Economics; Tinbergen Institute; Tinbergen Institute Rotterdam

Otto H. Swank

Erasmus University Rotterdam - Department of Economics; Tinbergen Institute Rotterdam (TIR)

Date Written: September 5, 2013

Abstract

We analyze the reporting strategies of firms and the investigation strategies of auditors in an archetype principles-based financial reporting system. To this end, we add a verification stage to a standard cheap-talk game, and apply the resulting game to financial reporting. We show that for a principles-based system to work properly, firms should bear a sufficient share of the cost of a thorough investigation. Furthermore, we find that a principles-based system is a mixed blessing. On the one hand, it leads to a plausible investigation strategy of the auditor, in which "suspected" reports receive most attention. On the other hand, a principles-based system only indirectly weakens firms' incentives to report aggressively.

Keywords: Cheap Talk, Financial Reporting, Principles-based Regulation, Stochastic Auditing

JEL Classification: D82, M42

Suggested Citation

Bijkerk, Suzanne and Karamychev, Vladimir and Swank, Otto H., Aggressive Reporting and Probabilistic Auditing in a Principles-Based Environment (September 5, 2013). Available at SSRN: https://ssrn.com/abstract=2321078 or http://dx.doi.org/10.2139/ssrn.2321078

Suzanne Bijkerk

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Vladimir Karamychev (Contact Author)

Erasmus University Rotterdam (EUR) - Department of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Tinbergen Institute Rotterdam ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Otto H. Swank

Erasmus University Rotterdam - Department of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute Rotterdam (TIR)

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 4081448 (Phone)
+31 10 2120551 (Fax)

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