The Influence of Auditors' Perceptions of Organizational Decline on Audit Risk

Abstract

This paper builds upon the work of researchers who have examined the effects of decline on an organization's exchange partners. Its purpose is to examine the relationship between auditors' perceptions of oganizational decline and audit firms' specification of clients' audit risk. Based on relevant organizational decline and accounting literatures, we propose that perceptions of greater decline are associated with higher firm assigned audit risk. We also propose that larger, public and longer-term audit clients would make this connection stronger. The results reveal that the relationship of perceived decline to audit risk is quadratic (curved) rather than linear as anticipated. Assigned audit risk is high for smaller, privately held firms perceived to be rapidly declining or rapidly growing. Audit risk is even higher for larger, public client firms perceived to be in rapid decline. However, audit risk is relatively low for larger, public firms perceived to be rapidly growing. The time a firm is an audit client is not important. An implication of these findings is that research on the reactions of an organization's exchange partners to decline should be extended to include their reactions to rapid growth for certain types of organizations.