Aggressive Reporting and Probabilistic Auditing in a Principles-Based Environment

Speaker

Suzanne Bijkerk

Erasmus School of Economics (ESE), Erasmus University Rotterdam

Abstract

We analyse 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.

This seminar is organised by the Erasmus Accounting Research Group.