Perceptions of Tone at the Top from the Inside: Insights into Audit Pricing

Abstract

SUMMARYTone at the top plays an important role in entities' internal control over financial reporting (ICFR) and in auditors' planning and risk assessment decisions. Using a novel measure based on employee perceptions, we find that strong tone at the top is associated with reduced audit pricing and that this relation holds even for firms that report effective ICFR. This relation is stronger when employees' tone perceptions are more consistent throughout the organization, when accounting is more complex, and when earnings manipulation risk is higher. We also find that strong tone is negatively associated with the incidence of reported material weaknesses and positively associated with positive abnormal accruals, and that the management integrity component of tone is more strongly associated with audit pricing than is the quality of management communication. Finally, we find evidence that auditors become familiar with employees' tone perceptions in the normal course of an audit.