The Effect of Accounting Uncertainty and Auditor Reputation on Auditor Objectivity

This paper reports the results of experimental economic markets that examine whether accounting uncertainty impacts an auditor's objectivity in a setting where the auditor also has an incentive to build and maintain a reputation for objectivity. In particular, we explore if an auditor's reputation impacts her decision of whether to exploit uncertainty regarding the appropriate accounting treatment for a client by agreeing with her client's preferred accounting treatment even when her evidence suggests an alternative treatment is more likely to be correct. While a wide range of research has examined the impact of uncertainty on auditor objectivity, our research is the first to explicitly incorporate auditor reputation into the research design. Our research design captures a professional auditor's incentives to build and maintain a reputation that may mitigate her incentives to violate her objectivity in the presence of accounting uncertainty. The results provide strong evidence that accounting uncertainty impacts auditor objectivity even though the lack of objectivity diminishes the auditor's reputation which in turn damages market participants. Specifically, our markets suggest that when accounting uncertainty does not exist, an auditor maintains her objectivity by truthfully reporting. It appears that she remains objective due to concerns about her reputation with managers and investors. However, when accounting uncertainty does exist, an auditor impairs her objectivity by misreporting in favor of managers. Our results specify boundary conditions for the impact of auditor reputation on auditor objectivity, and suggest that regulators should focus on enhancing auditor incentives to maintain objectivity when faced with accounting uncertainty. It appears that due to reputation effects, regulators do not need to be as concerned about objectivity violations when accounting pronouncements provide unambiguous guidance. Our results suggest that future research should assess the ability of other forces to reduce the propensity of auditors to violate objectivity when faced with accounting uncertainty.