Auditor’s Pre-Negotiation Information, Accuracy of Financial Reports and Consulting Services

Yun Zhang
Yale University

Abstract: The financial reporting process is modeled as a negotiation game between an auditor and a manager. Counterintuitively, exogenously giving an auditor more pre-negotiation information can lead to less accurate financial reports by lowering the likelihood of a negotiation breakdown. The auditor’s access to pre-negotiation information is then endogenized by allowing the manager to strategically influence this information. This paper characterizes manager’s strategic information delegation decisions. There are two main implications. First, an auditor can prefer a higher liability in order to convince the manager to provide more pre-negotiation information. Second, consistent with conjectured knowledge spillovers, consulting services are treated as a particular means for the manager to credibly convey information to the auditor. With this consulting interpretation, a manager’s incentives to influence auditor’s information can create the association between auditor-provided consulting services and absolute abnormal accruals, even when auditor independence is not an issue.

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