Firm Observability, Diversified Investors' Auditing Preferences, and the Nature, Timing and Extent of Auditors' Tests (An Empirical Analysis)
Craig, Thomas Robert
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https://hdl.handle.net/2142/71389
Description
Title
Firm Observability, Diversified Investors' Auditing Preferences, and the Nature, Timing and Extent of Auditors' Tests (An Empirical Analysis)
Author(s)
Craig, Thomas Robert
Issue Date
1984
Department of Study
Accountancy
Discipline
Accountancy
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Business Administration, Accounting
Abstract
This study develops an analytical and methodological framework to test whether external auditors' elections concerning the nature, timing and extent of their tests are consistent with the auditing preferences of fully diversified investors, where such preferences are conditioned on (and only on) the observability of the auditee's production and investing activities.
The study argues that firm observability is an important factor affecting financial statement distortion risk. This is because the increased likelihood of detection occasioned by increased firm observability acts as an important deterrent to managers who otherwise may bias financial statements. Also, it is argued that bias is the most important component of financial statement distortion risk from the standpoint of diversified investors, if only because the risk of unintentional distortions in financial statements can be eliminated through portfolio diversification.
The study's model development chapter deduces diversified investors' auditing preferences conditioned on firm observability, concluding that investors prefer that the year-end phase of auditors' examinations be more extensive as the observability of firms decreases. The research design chapter than develops a surrogate for relative firm observability (earnings estimation errors of skilled financial analysts), a surrogate for the relative extensiveness of the year-end phase of an auditor's examination (in general, the date of the auditor's report), and a research methodology to test whether auditors' overall nature, timing and extent elections are consistent with the auditing preferences of diversified investors. The empirical results of the study, which are based upon a random sample of 154 NYSE firms over a four-year period, lead to the conclusion that auditors' overall nature, timing and extent elections are consistent with the auditing preferences of diversified investors, where such preferences are conditioned on the observability of the firms examined.
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