Managerss Audit Negotiation Judgments Before an Initial Public Offering

Abstract

Auditor-client negotiations are a common and critical part of the financial reporting process, yet we know little about contextual factors that influence negotiation judgments from the manager’s perspective. Managers have incentives to act aggressively since outcomes often materially impact financial reports and managerial compensation. However, managers also have incentives to behave less aggressively since unresolved issues may result in audit delay, qualification or auditor resignation, all of which may damage firm and/or managerial reputation. These two opposing incentives are particularly prominent during the initial public offering (IPO) planning period when information asymmetry between managers and outsiders is arguably at its highest, and scrutiny from a variety of IPO monitors begins to heighten. We examine the impact of two pervasive IPO monitoring parties – auditors and audit committees – on the pre-negotiation judgments of 137 experienced CFO/controllers. Prior audit negotiations research suggests that a contentious past relationship with the auditor compels managers to be less aggressive, while a stronger audit committee curbs managerial opportunism. We thus expect that relative to other conditions, managers faced with a contentious past auditor relationship and a stronger audit committee will be least aggressive in an audit negotiation during the IPO planning period. To test our hypothesis, we use a 2 x 2 experimental factorial design with past auditor relationship (contentious or cooperative) and audit committee strength (stronger or weaker) manipulated between-subjects. The results support our expectations. Further, additional analysis indicates that these strong monitoring mechanisms have a sustained impact on managers’ judgments in the IPO offer year.