The Joint Role of Auditors' and Auditees' Incentives and Disincentives in the Resolution of Detected Misstatements

Abstract

SUMMARY We investigate the joint role of auditors' and auditees' incentives and disincentives in the decision to waive detected economically important misstatements (EIM) using a proprietary dataset with longitudinal information from 850 audit engagements completed over the period 2005 to 2015 in The Netherlands. The empirical results show that auditors are more likely to waive EIM as their economic incentives (e.g., abnormally high audit fees, provision of non-audit services) increase. Auditors are also more likely to waive EIM as the auditee's incentives increase but less likely to waive as the auditee emplaces disincentives in the form of independent governance structures. Further, we find that the presence of an independent supervisory board dampened the effect of non-audit services on waiving EIM. Taken together, the results show that auditors' and auditees' incentives affect waiving decisions, which can potentially compromise both financial reporting reliability and audit quality. JEL Classifications: M40; M41; M42; M48.

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