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Estimation risk and auditor conservatism

Clive S. Lennox () and Asad Kausar
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Clive S. Lennox: University of Southern California
Asad Kausar: Nanyang Technological University

Review of Accounting Studies, 2017, vol. 22, issue 1, No 5, 185-216

Abstract: Abstract Estimation risk occurs when individuals form beliefs about parameters that are unknown. We examine how auditors respond to the estimation risk that arises when they form beliefs about the likelihood of client bankruptcy. We argue that auditors are likely to become more conservative when facing higher estimation risk because they are risk-averse. We find that estimation risk is of first-order importance in explaining auditor behavior. In particular, auditors are more likely to issue going-concern opinions, are more likely to resign, and charge higher audit fees when the standard errors surrounding the point estimates of bankruptcy are larger. To our knowledge, this is the first study to quantify estimation risk using the variance-covariance matrix of coefficient estimates taken from a statistical prediction model.

Keywords: Accounting estimates; Estimation risk; Bankruptcy; Going concern opinion; Auditor resignations; Audit fees (search for similar items in EconPapers)
JEL-codes: M41 M42 G33 (search for similar items in EconPapers)
Date: 2017
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