The Effect of Confirmation Bias on Auditorss Risk Assessments: Archival Evidence

Abstract

Experimental research in accounting provides extensive evidence that auditors’ judgments are negatively affected by the use of heuristics. However, there is little research investigating whether the negative effects of using heuristics manifest in practice and survive the quality control processes that regulators and audit firms have in place to mitigate them. In this study, we focus on one such heuristic – confirmation bias – and identify a setting where the effects of auditors’ use of this heuristic are likely to manifest. Our findings indicate that auditors with previous experience auditing a client with a history of low risk followed by an increase in risk do not adequately respond to the higher level of risk. Consistent with expectations, we find that this effect is mitigated when the risk increase is likely to violate auditors’ reasonableness constraint, when the client is highly visible or has high institutional holdings, and when the auditor is a Big Four or industry specialist auditor. Our study complements prior experimental research by providing evidence that auditors’ use of heuristics has an economically significant effect on auditor judgments in practice and that the negative effects of using heuristics can survive the quality control processes that audit firms have in place.