Business School

The Influence of a Self-Interest Threat to Auditor Independence and Emotion on Auditors’ Inventory

Judgments

Janne Chung – York UniversityJeffrey Cohen – Boston College

Gary Monroe - UNSW

• Using an experiment, we investigate the effects of ethical conflict and emotion on auditors’ inventory judgments

• We manipulate emotion and self interest threat in an experimental case and ask auditors what inventory value they will recommend for the client in the case materials

• We expect that the presence of a self interest threat will lead individuals to value the client’s ending inventory less conservatively

• We expect that a more positive emotion will lead to less conservative inventory judgments compared to a more negative emotion.

• We expect an interaction effect between self interest threat and emotion

• The results confirm our expectations

Overview of the paper

Introduction

• We examine whether the presence/absence of a job offer from an audit client affects auditors’ judgments – Job offer during the audit of the client creates a

potential conflict of interest (self-interest threat) • We examine the effect of emotion on audit judgment

– Affective states including emotion have a long history in the psychology literature, but have been largely overlooked by auditing researchers

– We extend the findings in the psychology literature to the audit profession and contribute to our understanding of how emotion could affect audit judgment

Introduction

• Psychology literature reports that affective state (mood) impacts ethical decision-making– Apart from Connelly et al. (2004) who examine management

issues using college students, no study has examined the effect of emotion on ethical decision-making

– With the exception of Cianci and Bierstaker (2009) who examine the effects of moods on ethical decision-making in a hypotheses-generation task, we are not aware of any other auditing study that has examined this issue

– Therefore, we examine the interaction effects between emotion and the presence (absence) of an self interest threat on audit judgment

Ethical conflict• People tend to respond to conflicts of interest through

decision-making biases (Bastedo 2009). – When individuals are presented with situations where

personal self-interest is contrary to ethical behavior, their response is potentially one of self-interest. This bias is unconscious, which makes it difficult for people to recognize that their decision is affected by self-interest (Moore and Loewenstein 2004)

– Self-interest may play a role in strengthening people’s decision heuristics such as unconsciously biasing even routine decision-making (Chugh, Bazerman, and Banaji 2005; Simon, 1957; Tversky and Kahneman 1974).

– Conflicts of interest create ethical dilemmas that

influence an individual’s independence (Premeaux 2004)

Ethical conflict• When a client makes a job offer to an audit team member, it

could create a conflict of interest for the audit staff member– auditor may act as an advocate for the client by making

decisions that are in the client’s favor, for example, by signing off on less conservative asset or liability values.

H1: Participants who read case materials containing a conflict of interest expect an auditor to act out of self-interest by recommending less conservative inventory values to the audit manager compared to participants who did not read case materials containing a conflict of interest.

Emotions

• Positive affect – results in positive views of the judgment

context – leads to more positive judgments of self and

others (Clore et al. 1994) – more likely to overestimate the likelihood of

favorable events occurring and underestimate the likelihood of unfavorable events occurring (Nygren et al. 1996)

– Chung, Cohen and Monroe (2008) find that positive affective state (mood) leads to less conservative inventory valuation by auditors

Emotions• Negative affect

– results in negative views– leads to more negative evaluations and actions

(Forgas 1992)– Kadous (2001) demonstrates that negative

emotions in an auditor negligence case affected jurors’ judgment of auditors - higher levels of negative emotion resulted in a more negative evaluation of auditors and higher penalties were handed out to them

– Chung, Cohen and Monroe (2008) find that negative affective state (mood) leads to more conservative inventory valuation by auditors

Emotions

We manipulate emotion as positive, neutral and negative

H2: Participants in the negative emotion condition expect an auditor to recommend inventory values to the audit manager that are more conservative compared to auditors in the positive emotion condition. 

Joint effects of self-interest and emotionH3a: Positive-emotion participants who read case materials

that contained a job offer expect an auditor to make significantly less conservative judgments relative to all other conditions.

H3b: Negative-emotion participants who read case materials that did not contain a job offer expect an auditor to make significantly more conservative judgments relative to all other conditions.

H3c: Positive-emotion participants who read case materials that contained a job offer expect an auditor make significantly less conservative judgments relative to negative-emotion participants who read case materials that did not contain a job offer.

Figure 1 showing expected effects between self-interest threat and emotion on inventory

valuation for Experiment One

Positive emotion Neutral emotion Negative emotion Self-interest threat absent

□______________ Self-interest threat present

Inve

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Participants

• 96 (49 males and 47 females) auditors with 4+ years of experience – 51 in-charge seniors and 45 supervisors or managers– average age - 30 years– average working experience - 101 months– average accounting working experience - 91

months– average auditing working experience - 84 months– average of 13 inventory audits– 76% worked for Big 4 firms

• Paid $50 for participating

Experiment• Participants read experimental materials about an

audit client. First, read information concerning Pat, an in-charge audit senior whose career progression is on track – To create self-interest threat, half read case

materials informing them that Pat is considering accepting a very attractive job offer from the client and he had not disclosed this

– Other half read case materials that did not contain a job offer

• Next, all participants were told that Pat is assigned the inventory section of the audit of an electronics manufacturing company

Experiment• All participants given same background information about the

client, e.g., history of client, financial statements, information on corporate governance

• Detailed information specific to the current year’s audit of inventory was provided – Participants informed that procedures for this section of the

audit had been satisfactorily completed– However, difference of opinion between Pat and the client

regarding the valuation of inventory– Initial audit testing indicated caused Pat to estimate

inventory should be valued at $136,000,000 compared to the client’s carrying amount of $148,000,000

Experiment• Participants informed that Pat meets with client’s financial

controller (FC) to discuss possibility that inventory may be overstated, next course of action to take, and possibility of hiring independent valuers At this point, the emotion manipulation was introduced.

• Participants read the conversation between Pat and the VP– Positive emotion - materials describe a kind, helpful, and

courteous FC– Neutral emotion – materials describe a FC who is neither

mean nor kind, helpful nor unhelpful, and discourteous nor courteous

– Negative emotion – materials describe a mean, unhelpful, and discourteous FC

Experiment• Based on the conversation between Pat and the FC, the

services of two independent appraisers (A and B) are secured and both return a range of valuations that are lower than the client’s with A’s being lower than B’s.– A: 129,600,000 – 134,000,000– B: 137,400,000 – 140,600,000

• Participants then answered two questions– What inventory balance would Pat recommend to the

audit manager?– What inventory balance would you recommend to the

audit manager?• they wrote down the value

• Participants then responded to manipulation checks and provided demographic data.

Manipulation checks• Pleasure, Arousal, and Dominance (PAD) scale used to

measure emotions and responses to environmental stimuli– PAD scale does not purport to measure emotions per se,

instead it assesses the perceived pleasure, arousal and dominance elicited by a set of environmental stimuli

– Pretesting indicated our case materials only triggered the Pleasure dimension so we only included scales relating to that dimension

– 7 items anchored by: pleased (annoyed); hopeful (despairing); happy (unhappy); satisfied (unsatisfied); relaxed (bored); contented (melancholic); and stimulated (relaxed)

– Responses on a 7-point scale – we sum the scores for the 7 items – higher score is more negative

Manipulation checks• Results for PAD

– positive 17.4 (6.6)– neutral 24.1 (6.2)– negative 35.5 (4.5)

• ANOVA and Games-Howell tests used to test differences– positive-emotion participants experienced higher pleasure

than neutral-emotion participants (p < .001) – neutral-emotion participants experienced higher pleasure

than negative-emotion participants (p < .0001) • Self rated their expertise – relatively high - 5 out of 7• Rated realism of case materials – good - 4.8 out of 7

ResultsMore conservative is lower value

Dependent Variable: Pat’s Inventory Balancea

Emotion

Self-interest threat

Total Absent

Mean (sd) Present

Mean (sd) Positive 136,707,000

(1,322,000) 138,271,000

(2,101,000) 137,538,000

(1,923,000)

Neutral 136,075,000 (2,505,000)

137,281,000 (1,766,000)

136,678,000 (2,219,000)

Negative

135,438,000 (1,748,000)

136,281,000 (2,259,000)

135,860,000 (2,033,000)

Total 136,060,000 (1,961,000)

137,298,000 (2,173,000)

136,692,000 (2,153,000)

ResultsPanel B: Tests of Between-Subjects Effects

Source Type III Sum of

Squares

df Mean Square F Sig.

Corrected Model 8.189E+13 5 1.638E+13 4.112 .002

Intercept 1.791E+18 1 1.791E+18 449686.065 .000

Self-Interest 3.478E+13 1 3.478E+13 8.733 .004

Emotion 4.239E+13 2 2.119E+13 5.322 .007

Self-Interest * Emotion 2.071E+12 2 1.035E+12 .260 .772

Error 3.584E+14 90 3.983E+12

Total 1.794E+18 96

Corrected Total 4.403E+14 95

a. R Squared = .186 (Adjusted R Squared = .141)

ResultsContrast coding used

Panel C: Contrast results (two-tailed)*

Contrast Value of Contrast Std. Error t Sig.

Contrast 1, presence of self-interest threat in the positive emotion will be significantly less conservative than all the other cells (H3a).

9571274 2667968 3.587 .001

Contrast 2, absence of self-interest threat in the negative emotion will be significantly more conservative than all the other cells (H3b).

-7427254 2733033 -2.718 .008

Contrast 3, presence of self-interest threat in the positive emotion will be significantly less conservative than absence of self-interest threat in the negative emotion. (H3c)

2833088 695120 4.076 .000

* The overall contrast is significant at p = .002 (F = 4.112).

Results