Managing audits to manage earnings: The impact of baiting tactics on an auditor\u27s ability to uncover earnings management errors

This study examines an aspect of earnings management that I refer to as audit management. I define audit management as a client\u27s strategic use of techniques (e.g., baiting tactics) to prevent auditors from discovering earnings management during the audit. Specifically, I examine whether two baiting tactics, diversionary statements and distracting errors, affect an auditor\u27s ability to uncover an accounting error used to manage earnings. Auditors performed analytical review on financial statements that contained an earnings management error (i.e., an intentional error that results in the client meeting an earnings target). I manipulated whether management provided a diversionary statement that explicitly identified risk in other areas of the audit, and whether management seeded easier, distracting errors into those other areas, both of which were designed to lure the auditor away from the earnings management error. I found that when auditors were intentionally directed to error free accounts they were unlikely to uncover an earnings management error elsewhere in the financial statements. On the other hand, auditors were most accurate in identifying earnings management when they were directed to audit areas that contained distracting errors. These results suggest that managers can use certain baiting tactics to strategically manage the outcome of the audit, but that, in some circumstances, baiting tactics may actually make auditors more likely to uncover managed earnings