Browsing by Author "Smith, J. Reed"

Now showing 1 - 4 of 4
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    The Effects of Auditor Tenure on Fraud and Its Detection
    (American Accounting Association, 2019-01-29) Patterson, Evelyn R.; Smith, J. Reed; Tiras, Samuel L; Kelley School of Business
    We examine the strategic effects of auditor tenure on the auditor's testing strategy and the manager's inclination to commit fraud. Most empirical studies conclude that longer tenure improves audit quality. Proponents of restricting tenure argue that longer tenure impairs auditor independence and a "fresh look" from a new auditor results in higher audit quality. Validating this argument requires testing whether the observed difference in audit quality between a continuing auditor and a change in auditors is less than the theoretically expected difference in audit quality without impairment. Our findings provide the guidance necessary for developing such tests. Our results show that audit risk (the probability that fraud exists and goes undetected) is lower in both periods for the continuing auditor than with a change in auditors. More importantly, we show that across both periods, expected undetected fraud is lower for the continuing auditor than with a change in auditors.
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    Electronic data interchange and enterprise resource planning technology in supply chain contracts
    (Elsevier, 2020-04) Smith, J. Reed; Yost, Jeffrey; Lopez, Harold; Kelley School of Business
    We examine a model of supply chain contracting with a purchaser that desires to acquire as much of a product as possible at as low a price as possible. The supplier in our model has private information about its limited capacity. We compare two models of information. In the first, the supplier observes capacity and reports the capacity to the purchaser in exchange for a purchase commitment. We designate this contract as the “Supply Chain” contract. In the second, the purchaser is directly linked to the supplier’s ERP system using Electronic Data Interchange (EDI). This linkage avoids information asymmetry. We refer to this contract as the“Full Information” contract. While the Full Information contract is economically more efficient, the supplier would be reticent to agree to this contract. We propose a third contract, which we call the “Hybrid” contract, that awards the purchaser the efficiency gains available in the Full Information contract, but which provides the supplier the same profits as in the Supply Chain contract. The purchaser, however, would still prefer the Full Information contract to the Hybrid contract. We then add an additional dimension to the problem by allowing the supplier to invest in capacity. We find that due to the increased investment under the Hybrid contract, the purchaser may actually prefer the Hybrid contract to the Full Information contract-as long as the information asymmetry is not too great.
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    How Changes in Expectations of Earnings Affect the Associations of Earnings Overstatements and Audit Effort with Audit Risk and Market Price
    (Wiley, 2022) Patterson, Evelyn R.; Smith, J. Reed; Tiras, Samuel L.; Kelley School of Business - Indianapolis
    In this study, we provide theoretical guidance for both analytical research and empirical research by considering how changing expectations of earnings affect a dishonest manager's strategy to overstate earnings and an auditor's strategy to exert effort in a two-period setting. We expect our study's insights on changing economic conditions to help shape future research. We model the manager type as either honest or dishonest, which allows us to differentiate audit risk from audit effort. The key takeaways for future research are the insights on how changes in payoffs and expected earnings affect the associations that involve earnings overstatements and audit effort with audit risk and market price. For instance, researchers typically assume audit effort and audit risk are negatively associated, but we find the association can be positive when, for example, the auditor chooses a period 2 strategy based on the changes in period 1 game parameters. The results of our study provide two additional key insights on the design of future empirical tests. First, by dichotomizing, we show the importance of estimating the intercept in the market pricing equation when studying earnings quality, because market price also adjusts for expected bias through changes in the intercept. Second, our multiperiod setting demonstrates that the effects from a change in the manager's or auditor's incentives in period 1 may reverse in period 2. Empirical studies typically examine the contemporaneous effects of these changes on market price and/or audit risk but fail to identify the cross-temporal effects we document in our study.
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    The Interrelation between Audit Quality and Managerial Reporting Choices and Its Effects on Financial Reporting Quality
    (Wiley, 2019-03-13) Patterson, Evelyn R.; Smith, J. Reed; Tiras, Samuel L.; Kelley School of Business
    Two distinct lines of research have been dedicated to empirically testing how financial reporting quality (measured as the earnings response coefficient or ERC) is associated with management's choice of reporting bias and with audit quality. However, researchers have yet to consider how ERCs are affected by either the auditor's reaction to changes in the manager's reporting bias or the manager's reaction to changes in audit quality. Our study provides theoretical guidance on these interrelations and how changes in the manager's or the auditor's incentives affect both reporting bias and audit quality. Specifically, when the manager's cost (benefit) of reporting bias increases (decreases), we find that expected bias decreases, inducing the auditor to react by reducing audit quality. Because we also find that the association between expected audit quality and ERCs is always positive, changes in managerial incentives for biased reporting lead to a positive association between ERCs and expected reporting bias. When the cost of auditing decreases or the cost of auditor liability increases, we find that expected audit quality increases, inducing the manager to react by decreasing reporting bias. In this case, changes in the costs of audit quality lead to a negative association between ERCs and expected reporting bias. Finally, we demonstrate the impact of our theoretical findings by focusing on the empirical observations documented in the extant literature on managerial ownership and accounting expertise on the audit committee. In light of our framework, we provide new interpretations of these empirical observations and new predictions for future research.