Real Activities Manipulation and Auditors' Client-Retention Decisions

In this study, we examine the effect of clients' real activities manipulation (RAM) on auditors' client-retention decisions. We find that, with the exception of RAM through overproduction, clients' opportunistic operating decisions are positively associated with the likelihood of audi...

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Bibliographic Details
Published in:The Accounting review 2014-01, Vol.89 (1), p.367-401
Main Authors: Kim, Yongtae, Park, Myung Seok
Format: Article
Language:English
Subjects:
Accounting theory
Audit engagements
Auditing
Auditors
Benchmarking
Business audits
Client relationships
Creative accounting
Decision analysis
Decision making
Earnings
Financial management
Internal audits
Litigation
Management audits
Manipulation
Money management
Opportunistic behavior
Proxy reporting
Proxy statements
Resignations
Retention
Risk theory
Studies
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Summary:In this study, we examine the effect of clients' real activities manipulation (RAM) on auditors' client-retention decisions. We find that, with the exception of RAM through overproduction, clients' opportunistic operating decisions are positively associated with the likelihood of auditor resignations. We also provide evidence that auditors are especially sensitive to clients' RAM to just meet or beat earnings benchmarks in their client-retention decisions. In addition, we find that clients whose auditors resign from engagements tend to hire smaller auditors and these clients engage in RAM more aggressively. Our additional analysis shows that, with the exception of RAM through overproduction, clients' abnormal operating decisions are significantly associated with litigation risk against auditors. Overall, our evidence suggests that auditors drop clients with aggressive RAM to avoid excessive risk.
ISSN:0001-4826
1558-7967
DOI:10.2308/accr-50586