Aggressive Reporting and Probabilistic Auditing in a Principles-Based Environment

Suzanne H. Bijkerk, Vladimir Karamychev and Otto Swank ()
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Suzanne H. Bijkerk: Erasmus University Rotterdam

No 13-131/VII, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We analyze the reporting strategies of firms and the investigation strategies of auditors in an archetype principles-based financial reporting system. To this end, we add a verification stage to a standard cheap-talk game, and apply the resulting game to financial reporting. We show that for a principles-based system to work properly, firms should bear a sufficient share of the cost of a thorough investigation. Furthermore, we find that a principles-based system is a mixed blessing. On the one hand, it leads to a plausible investigation strategy of the auditor, in which "suspected" reports receive most attention. On the other hand, a principles-based system only indirectly weakens firms' incentives to report aggressively.

Keywords: Cheap Talk; Financial Reporting; Principles-based Regulation; Stochastic Auditing (search for similar items in EconPapers)
JEL-codes: D82 M42 (search for similar items in EconPapers)
Date: 2013-09-05
New Economics Papers: this item is included in nep-acc
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20130131

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