Fraud Detection and Financial Reporting and Audit Delay
AbstractI formulate a model to emphasize the fraud detection role of auditors in the financial market, providing a theoretical framework to examine the likelihood of and market reaction to a financial reporting and audit delay. The model has an auditor considering whether to perform extended audit procedures after observing a red flag generated from regular audit procedures. An audit delay is represented by the event of extending audit procedures and manifested as a financial reporting delay observed by the market. I find that the equilibrium likelihood of a delay decreases when the reliability of regular and extended audit procedures improves and/or when the ex ante probability of fraud reduces. My result on the market reaction to a delay suggests that while a negative average reaction is intuitive and has been documented, the reaction can be positive for an individual firm. I derive a closed-form condition indicating when a positive reaction is possible. Specifically, a delay can be good news to the market when the ex ante probability of fraud, the imprecision of a red flag, and the effectiveness of extended audit procedures for detecting fraud are all high. The result is new in the literature. I also discuss the model's empirical implications with suggestions for regression equation specifications.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 27857.
Date of creation: 20 Sep 2010
Date of revision:
Audit delay; financial reporting lag; extended audit procedures; red flag; fraud detection; SAS 82; SAS 99; business ethics;
Find related papers by JEL classification:
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- M42 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - Auditing
- K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
- M21 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - Business Economics
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