New research from the University of Denver’s Daniels College of Business

New research from the University of Denver’s Daniels College of Business looks at the connection between the perceived credibility of company management and audit engagement fees. In a new study, “Characteristics of Managerial Tone Priced by Auditors: Evidence Based on Annual Letters to Shareholders of Large U.S. Firms,” researchers found that if auditors perceive their clients’ management credibility as low, then they charge higher audit fees.

The study, recently published in Auditing: A Journal of Practice & Theory, examines the relationship between audit pricing and managerial tone as a proxy of source credibility. Adam Greiner and Lorenzo Patelli, associate professors of accountancy at Daniels, and Matteo Pedrini, professor of corporate strategy at the Catholic University of the Sacred Heart, are the authors of the study.

Lorenzo Patelli

“The findings of our study have both theoretical and practical implications,” Greiner says. “They provide supporting evidence that management tone at the top (measured by linguistic tone) affects auditor risk assessments. More importantly, they suggest that by improving and updating assessments of managerial tone with more systematic methods and publicly available disclosures, investors, auditors and analysts could develop more sophisticated judgments about management’s source credibility using auditors’ pricing decisions.”

The researchers used DICTION software to textually analyze CEO annual letters to shareholders, using letters written between 2008 and 2013 from the largest U.S. firms by revenue, which resulted in 2,416 observations for 298 firms.

“Managerial characteristics such as credibility are expressed through actions that are often unknown to company outsiders,” says Patelli. “Language is one signal that can reveal managerial characteristics.”

The study shows that characteristics of the language used in the CEO annual letters to shareholders are associated with auditors’ risk assessments as measured by audit fees. This link is important because, while auditors are privy to a wealth of information (including private information) through their close interactions with firm executives, outsiders can only rely on publicly available information. The study suggests that computer-based linguistic software can uncover variables connected with managerial credibility.

Adam Greiner

Adam Greiner

“To the extent auditors’ perceptions of a client’s management team are somewhat subjective, computerized textual analyses offer objective, efficient and systematic evidence for investors and analysts to draw inferences about the credibility of managerial tone,” Greiner says. “Also, disseminating efficient and objective textual analysis packages and linguistic statistical techniques to audit team members might assist them with assessments of management’s source credibility, especially among less experienced personnel.”

About the authors:
Adam Greiner is an associate professor at the Daniels College of Business. His research examines managers’ accounting choices and voluntary disclosures in settings relevant to standard setters, auditors and the capital markets. Greiner’s research has appeared in a wide range of academic journals, including Auditing: A Journal of Practice & Theory, Accounting Horizons, Journal of Accounting, Auditing and Finance, Advances in Accounting, and Journal of Forensic and Investigative Accounting.

Lorenzo Patelli is an associate professor in the School of Accountancy and serves as interim director of the Institute for Enterprise Ethics at the Daniels College of Business. He also serves on the Editorial Board of Advances in Management Accounting and on the Committee on Ethics of the Institute of Management Accountants.