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Monitoring by Auditors: Case of Public Housing Authorities
Barbara Grein, Drexel University
Stefanie L Tate, University of New Hampshire
ABSTRACT. We provide new evidence on whether auditors constrain manipulation in financial reporting. Monitoring by an independent auditor has long been seen as a means of reducing opportunism by managers. However, the spectacular audit failures in the early part of the century (i.e. Enron, WorldCom, and Health South) raise concerns as to the extent auditors' constraint. We develop tests of the degree of auditor constraint for a unique dataset of public housing authorities. In cross-sectional regressions of audited discretionary accruals on unaudited discretionary accruals and controls for firm performance and size, we find that audited discretionary accruals are significantly lower than unaudited. Further, it appears that auditors constrain discretionary accruals when management has clear incentives to increase financial performance but that auditors are less vigorous in constraining discretionary accruals when management has incentives to decrease income and other measures.
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