Firm Managers’ Fair Value Estimates in Anticipation of an Audit

Abstract

Accounting estimates, including those related to fair value, are pervasive in financial reports and susceptible to managerial manipulation. Financial statement audits are conventionally viewed as a deterrent to such manipulation. In an experiment with 127 accounting professionals averaging over 18 years of experience, we test whether the opposite is true in settings, like fair value, where auditing implies that reported amounts are likely arrived at through negotiation between managers and auditors. Results reveal that participants in the role of a CFO “start high” with their fair value estimates when anticipating having to interact with auditors. This tendency to “start high” is more pronounced when past auditor-manager negotiation outcomes have favored the auditor’s, versus the manager’s, preferred reporting position. Finally, although CFO’s do not proactively respond to auditor expertise in their initial estimates, they expect expert auditors to prompt lower final reported fair value estimates.