Are auditors involved in preparing the financial reports of the firms they audit?

• Applicant: Professor Dr. Martin Nienhaus
• Subject Area: Accounting and Finance
• Term: from 2018 to 2020
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 395387084

This study uses a novel approach based on textual analysis to test whether firms with the same auditor have textually more similar management reports than firms with a different auditor. The presence of textual similarities should be a large concern about the role of the auditor as an economic agent in the financial reporting process: If auditors are involved in preparing financial reports, this may severely impair the value of audits. Such involvement would lead to self-inspection by the auditors, which fundamentally questions their objectivity and independence, and stands in stark contrast to the ethical requirements of the International Standards on Auditing (ISA).For our analysis, we exploit a unique institutional setting. In Germany, most private (and public) firms are mandated to prepare management reports, which are also subject to a mandatory audit. Unlike private firms in the US, private firms in Germany must also make their financial statements and management reports publicly available. Hence, we have access to a unique dataset of audited management reports from private and public firms. Another feature of our setting is that auditors sign the audit opinion with their names. This allows us to identify individual auditors and not just audit firms, as under the current regulations in the US. Using the detailed data of actual individual auditors´ names, we can also isolate whether the auditor´s influence originates at the individual, office, or firm level. We also conduct personal in-depth interviews with auditors to gain a deeper understanding of the underlying mechanisms of auditor-driven textual similarity.Our results may be of interest to the auditing profession because our findings could signal potential auditor independence issues. Moreover, our findings speak to the role of auditing in two specific contexts in which prior research is scant because of data limitations: the auditing of private firms and the auditing of qualitative management reports. We shed light on the potential consequences of audits in these two contexts.

• DFG Programme: Research Grants