Professional Documents
Culture Documents
of Pages 6
ScienceDirect
www.elsevier.com/locate/bushor
ACCOUNTING MATTERS
KEYWORDS Abstract While financial statements are the responsibility of management, they are
Negotiation; ultimately a product of collaboration between management and their auditors–—likely
Auditor; involving negotiations over proposed audit adjustments. This installment of Account-
Reciprocity; ing Matters discusses the implications of prior research in psychology and social
Audit adjustment psychology regarding negotiations as applied to the context of auditor-client man-
agement negotiations. Specifically, we consider recently published research by
Hatfield and colleagues regarding how these auditor-client discussions may be
influenced in unexpected ways if not viewed through the lens of negotiation. This
research finds that explicit consideration of negotiation characteristics (e.g., wheth-
er the unaudited financial statement data is the ‘first offer’ of client management,
whether negotiations have created reciprocity pressures for the current negotiation)
can influence these auditor-client discussions in predictable ways. Understanding the
unconscious biases resulting from these ‘negotiation rules’ is key for auditors to
effectively translate audit quality into improved financial statement quality.
# 2014 Kelley School of Business, Indiana University. Published by Elsevier Inc. All
rights reserved.
0007-6813/$ — see front matter # 2014 Kelley School of Business, Indiana University. Published by Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.bushor.2014.11.008
BUSHOR-1195; No. of Pages 6
2 ACCOUNTING MATTERS
ACCOUNTING MATTERS 3
will comment on important themes of ACM nego- auditors did stick to their initial offer in subsequent
tiations that may be of particular interest to audit negotiations, this initial offer–—and, thus, the nego-
practitioners. tiated outcome–—was influenced by the magnitude of
the client’s initial offer (i.e., amount in unaudited
financial statements).
2. Initial offers
4 ACCOUNTING MATTERS
misstatements while simultaneously fostering func- auditor when the auditor utilizes the concession
tional relationships with their clients. Because ACM approach. Sanchez et al. also found that auditors
negotiations directly affect financial reporting quali- echoed this sentiment, as they indicated they were
ty and impact the auditor-client relationship, an able to improve client satisfaction and retention
effective negotiation strategy may enable the audi- through the use of a concession approach during
tor to successfully fulfill both tasks. Sanchez, Agoglia, negotiations. In a related study, Hatfield et al.
and Hatfield (2007) set out to test the effectiveness of (2008) examined whether auditors will employ such
a specific negation strategy based on the societal a concession strategy based on reciprocity and what
norm of reciprocity, while Hatfield, Agoglia, and client characteristics increase the extent to which it
Sanchez (2008) considered whether auditors would is used. Experimental results suggest that auditors
use this strategy to help them overcome a tough are willing to use this concession strategy. Further-
negotiation environment while maintaining a posi- more, auditors increase their use of a concession
tive relationship with their client. approach when a client’s management is known to
Sanchez et al. (2007) investigated a strategy be a difficult (competitive) negotiator and when
whereby auditors brought to the attention of man- retention risk is high.
agement some of the waived, inconsequential audit Taken together, these studies suggest that the use
differences identified during an audit. By waiving of a reciprocal strategy is an effective way to con-
the inconsequential differences in full view of the vince clients to post audit adjustments as well as a
client–—referred to as a concession approach–—the way to positively influence the relationship between
auditor can promote a collaborative environment auditors and their clients. This approach demon-
that encourages the client to be more cooperative strates how an understanding of the negotiation
when negotiating material audit differences. literature and the expectations it produces can help
Discussions with auditors suggest that such small auditors manage difficult situations. When the cli-
issues are generally waived at the ‘workpaper’ level ent is known to be a tough negotiator or is perhaps
such that the client is likely unaware that the willing to enhance their negotiation power through
auditor had an issue and subsequently waived it. the use of threats (i.e., threat of switching audi-
Clearly, waiving such minor issues is not at odds with tors), auditors can reduce their perceived pressure
professionalism or the regulatory environment, by simply being more transparent with regard to the
which may prevent the use of the more general waiving of small issues, and by doing so activate the
strategy of bidding high and then conceding (Ng & client’s need to reciprocate.
Tan, 2003). This approach of waiving inconsequen-
tial items in view of the client is consistent with the
societal rule of reciprocity. That is, if the client 4. Deadline pressure
perceives the waiving of an inconsequential differ-
ence as a favor, then the client is likely to recipro- The general negotiation literature has determined
cate this favor in the future (e.g., conceding during that time pressure is a highly influential character-
the course of a future negotiation). Furthermore, istic in negotiations. As time pressure increases, the
prior negotiation research conducted in more gen- desire for each party to reach an agreement is
eral contexts (e.g., Benton, Kelley, & Liebling, 1972) enhanced (Pruitt, 1981). Experimental work con-
found that small concessions can be used to elicit ducted by Pruitt and Johnson (1970) suggests that
larger concessions by the other party. Thus, the concessions between negotiators are greater when
auditor may be able to promote financial statements time pressures are high compared to when time
that are free from material misstatement while also pressures are low. Smith, Pruitt, and Carnevale
fostering a functional working relationship with the (1982) provided similar results regarding time pres-
client by employing such a strategy. sure: they found that concession rates are greater
Consistent with prior literature regarding the under high deadline pressures. The general ratio-
efficacy of such an approach, Sanchez et al. nale for these findings is that deadline pressure
(2007) found that client management partici- increases the importance–—and salience–—of reach-
pants–—controllers and CFOs–—were more willing ing an agreement and also limits negotiators’ ability
to post significant income-decreasing adjustments to employ strategies that take an extended period of
when exposed to a concession strategy. Separate time to use (e.g., bid high then concede over time).
experiments have demonstrated that this strategy Bennett, Hatfield, and Stefaniak (in press) com-
improves the client’s willingness to post adjust- pared the effect of deadline pressure on both audi-
ments that are either objective or subjective. Ad- tor and client (controllers) participants. They
ditionally, controllers and CFOs are more satisfied considered the concessionary behavior of both sides
with the audit process and are likelier to retain the of the negotiation (i.e., the extent to which the
BUSHOR-1195; No. of Pages 6
ACCOUNTING MATTERS 5
parties concede from their initial positions). While Bennett et al. (in press) demonstrated the benefit
deadline pressure is a ubiquitous concern in most of considering both sides of the table in ACM nego-
audit tasks, and a highly important contextual char- tiations, especially when certain factors/pressures
acteristic in the general negotiation literature, au- are present for both parties. For example, if this
dit researchers had not examined its impact. Prior study had followed the research design of most prior
auditing research found that most ACM negotiations accounting negotiation research and only evaluated
occur near the end of the audit, when deadline how CFOs’ concessions varied under different dead-
pressures are likely high: 64% of survey responses line pressure (high vs. low), then a possible conclu-
indicated as much (Gibbins, McCracken, & Salterio, sion would be that the end of the audit deadline
2005). Deadline pressures in an audit context are does not impact auditor-client negotiations.
typically imposed by regulatory agencies. For exam-
ple, SEC filing deadlines constrain the amount of
time available to conduct ACM negotiations. Accord- 5. What have we learned?
ingly, consideration of how deadline pressure af-
fects auditors’ and their clients’ negotiation The financial statements are a result of collaboration
behavior is increasingly important as these dead- between client management and their auditors,
lines are compressed (e.g., accelerated filers). which often includes a negotiation process to resolve
Predictions regarding the differential effect of any differences in opinion about the content of the
deadline pressure on auditors and their clients are financial statements (Antle & Nalebuff, 1991). There
based on the relative power each have during nego- has been a great deal of research regarding negotia-
tiations. While the inability to reach an agreed-upon tions in the psychology and social psychology litera-
outcome is undesirable for both the client and the ture. Auditing research is catching up, and Hatfield
auditor, the authors suggest it is potentially worse for and colleagues have conducted several studies look-
the client, tipping the power in favor of the auditor. ing at how we can expect these findings from the
They conclude that the potential negative outcomes general negotiation literature to influence ACM
of a modified opinion for the auditor (i.e., potential negotiations. Even though auditors are somewhat
loss of client offset by reduced audit risk) are less peculiar negotiators, given their general lack of con-
damaging than the potential negative outcomes cession, they are nonetheless influenced by many of
for the client. For example, archival research has the characteristics identified in the general negotia-
demonstrated that a modified opinion can lead to tion literature. For example, Hatfield et al. (2010)
client outcomes such as negative market return, demonstrated that auditors rarely move off their
decreased market share, and negative earning signals initial recommendation to the client regarding an
(Frost, 1994; Loudder et al., 1992; Taffler, Lu, & adjustment. However, their study also demonstrated
Kausar, 2004). Thus, failing to reach an agreement that this initial recommendation is highly influenced
potentially carries a heavier penalty to the client, by the magnitude of client position and the occur-
resulting in enhanced negotiation power for the rence, or not, of a prior adjustment required by the
auditor. Consistent with this notion, Bennett et al. auditor. It is important that auditors access research,
(in press) found that in general, clients are more like that discussed here, to better prepare for ACM
willing to concede during ACM negotiations, while negotiations such that financial statement quality
auditors tend to use their enhanced power to hold can be maximized. It is interesting to note that
firm to their negotiation position and concede less. few audit partners receive training in negotiations;
However, the general negotiation literature sug- indeed, only 28% of the auditors in the study by
gests that use of relative power within negotiations Hatfield et al. (2010) received significant training
requires time. That is, a rigid and non-concessionary in negotiations, and much of that was related to
strategy takes time (e.g., time to go back and forth fee negotiations. Research has demonstrated that
and hold firm for a period). Client negotiators, who auditors can improve their negotiation outcomes if
already concede to a greater extent than auditors, they explicitly consider their position as well as that
have less room and less reason to change their of the client prior to entering discussions with their
strategies when time runs short. Bennett et al. (in client (Trotman, Wright, & Wright, 2005). In general,
press) predicted and found that auditors are more auditors should heed the warnings of Gillan (2007)
affected by deadline pressure than their client and Bazerman, Loewenstein, and Moore (2002) that
counterparts. Furthermore, they demonstrated that many of the problems experienced by auditors in
auditors changed their strategies–—became more recent years cannot be resolved with regulations or
concessionary and relied on their relative power penalties for unethical behavior, but rather only via
less–—while under deadline pressure, whereas the explicit consideration of the unconscious biases that
client participants did not. lead to suboptimal audit judgments.
BUSHOR-1195; No. of Pages 6
6 ACCOUNTING MATTERS