How do auditors’ use of industry norms differentially impact management evaluations of audit quality under principles-based and rules-based accounting standards?

Abstract

Interactions between auditors and client management affect audit quality on an engagement because those interactions influence and incentivize auditor behavior and decision-making. I perform an experiment using 191 management participants to investigate (1) whether an auditor’s use of professional judgment or industry norms to justify proposed adjustments increases management’s evaluation of audit quality, and (2) whether these evaluations differ under principles-based or rules-based standards. I find that, although management views industry norms to be more credible, they disregard an auditor’s justification method and evaluate audit quality based on underlying accounting attributes when reporting under a more rules-based standard, such as US GAAP. However, when an accounting standard is more principles-based, such as IFRS, using industry norms positively influences perceptions of audit quality. Thus, when standards are less precise, auditors are incentivized to engage in herding behavior by defaulting to industry norms when determining appropriate accounting treatments. This study increases our understanding of the incentives and motivations faced by auditors in their interactions with client management under both rules-based and principle-based accounting standards.