Masterclass - Assessing and addressing fraud risk based on earnings calls - Prof. Dr. Mark Peecher

On December 4th. professor Mark Peecher gave a masterclass titled: "Assessing and addressing fraud risk based on earnings calls: effects of focusing auditors on fraud vs. on management's dissonance".

What was this Masterclass about?
Listening to earnings calls has the potential to improve auditors’ exercise of professional skepticism, as these calls can reveal signs of aggressive financial reporting or even fraud. Prior research shows that experienced audit partners in the United States can detect signs of deception in earnings calls at rates well above chance, but only if instructed to watch for signs of dissonance in management as opposed to watch for signs of fraud. Thus, while experienced auditors appear to have an ability to detect signs of deception, they appear to subconsciously suppress this ability due to the aversive nature of fraud and disincentives for suspecting fraudulent financial reporting. A limitation of prior research is that the auditors were listening to earnings call of non-clients, and it could be that auditors psychologically are more reluctant to see and respond to fraud indicators at their clients.

The project team addresses this limitation and advances the literature by conducting a field experiment in which 184 auditors listen to their own clients’ earnings calls in the midst of audit engagements. They examine how auditors alter their assessment of the risk of material misstatement, including fraud risk, their plans for addressing these assessed misstatement risks, and the correlation between these two. Rather than focusing only on experienced audit partners, the team uses auditors with a wide range of audit experience. Further, they also use a control group of auditors listening to the same earnings calls for non-clients.

Preliminary results indicate that what auditors think they learn from earnings calls differs markedly based whether or not they are instructed to focus on fraud indicators, focus on indicators of dissonance in managers, or both. They find that prompting auditors to focus on fraud actually reduces auditor concern about fraud risk unless accompanied also by a dissonance prompt. Prompting a focus on management dissonance, by contrast, results in an increase in auditors’ assessed risk of material misstatement and strengthens the correlation among assessing and addressing risk.

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