Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigation

Audits are claimed to not only enhance the detection of fraud but also the deterrence of fraud. This study examines whether different audit procedures and attitudes conveyed to management deter aggressive earnings management that may be fraudulent, and whether such different procedures and attitudes conveyed influence managers’ perceptions about the ethicality of any anticipated earnings management. In an experiment with 171 senior corporate managers, we find that compared to the condition where the audit proceeds the same as last year, managers anticipate that there would be less earnings management when the nature of evidence collected has increased probative value; and when the auditor conveys a more sceptical attitude via more critical inquiry combined with either an increase in the evidence extent (increased sample size) or the nature of the evidence. However, this reduction in anticipated earnings management is not found with either the increased extent of evidence collected alone or more critical inquiry alone, suggesting that a combination of action and attitude changes compared to a change in either action alone or attitude alone better signals to managers the heightened scepticism that enhances the effectiveness of auditor deterrence. We also find, after controlling for the underlying ethical disposition of managers, that the different audit procedures and attitudes conveyed to management affect managers’ perceptions of the ethicality of anticipated earnings management. Interestingly, the conditions that engender greater earnings management also paradoxically increase managers’ perceived unethicality of the anticipated earnings management. Together these findings have implications for how different changes in audit approaches may result in differential managerial responses about their intention to commit fraud and its appropriateness. This study is one of the first papers to provide experimental empirical evidence that specific audit actions conveying heightened scepticism have significant influence on managerial judgments and behaviours with respect to committing aggressive earnings management.