Earnings Management Pressure on Audit Clients: Auditor Response to Analyst Forecast Signals

Abstract

This study investigates whether auditors respond to earnings management pressure created by analyst forecasts. Analyst forecasts create an important earnings target for management, and professional standards direct auditors to consider how this pressure could affect their clients. Using annual analyst forecasts available during the planning phase of the audit, I examine whether this form of earnings management pressure affects clients’ financial statement misstatements. Next, I investigate whether auditors respond to earnings forecast pressure through audit fees and reporting delay. I find that higher levels of analyst forecast pressure increase the likelihood of client restatement. I also find that auditors charge higher audit fees and delay the issuance of the audit report in response to pressure from analyst expectations. Finally, I find that when audit clients are subject to high analyst forecast pressure, a high audit fee response by auditors mitigates the likelihood of client misstatements.