The Role of Incentives to Manage Earnings and Quantification in Auditors' Evaluations of Management-Provided Information

Abstract

We conducted an experiment with 113 experienced auditors to examine the influence of two factors on the persuasiveness of a management-provided nonerror explanation for an unexpected fluctuation in revenue. We expected that auditors' evaluations of a management explanation would depend jointly on whether it is quantified (i.e., put into numbers) and the managers' incentives to manage earnings. Instead, we find that the persuasiveness of managers' explanations is determined solely by their incentives. Focus on managers' incentives is consistent with auditors attending to regulators ‘ recent concerns about earnings management. However, such a focus implies that when the likelihood of earnings management appears low, auditors fail to take into account information about sufficiency that is contained in the quantified explanation when they revise their planning judgments.