Intended and Unintended Consequences of Continuous Auditing

1
Intended and Unintended Consequences of
Continuous Auditing Performance-Based
Incentives on Managers Judgments

• Presented by Elaine Mauldin
• Co-Authors Jim Hunton Pat Wheeler

2
Motivation

• Organizations use combinations of incentives and
  monitoring to align agents (division managers)
  and principals (top management) interests.
• Continuous Auditing is monitoring that can
  increase internal audit timeliness and coverage,
  but
• Internal management support is sometimes an
  obstacle to more widespread implementation.
• Kogan, Sudit, and Vasarhelyi (1999) suggest there
  may be unintended effects on managers.
• We explore how CA interacts with bonus incentives
  to provide some evidence about both intended and
  unintended effects of CA.

3
Theory Interaction of Incentives and Monitoring

• Common agency problem is managerial myopia
  (Graham et al. 2005)
• Desire to achieve higher current earnings at the
  expense of longer-term total earnings.
• Real earnings management decisions (Bushee 1998).
• Project investment decisions (Bhojraj and Libby
  2005).
• Incentives and monitoring have been found,
  individually and jointly, to impact managerial
  myopia, positively or negatively.
• We focus on interaction effects.

4
Interaction Effects

• Both monitoring and incentives are generally
  implemented Part of Agency Contracting.
• Interaction effects between monitoring and bonus
  incentives are unclear
• Banker et al. (1996) short-term bonus incentives
  are less effective at improving performance with
  high levels of supervisory monitoring
• Suggest monitoring can reduce incentive effects
• Frederickson et al. (1999) outcome evaluation
  schemes more effective when reporting feedback is
  more frequent
• Suggest monitoring can enhance incentive effects

5
H1a/b Intended Effects - Reduced Earnings
Management

• Short term incentives commonly implemented to
  encourage high effort also increase earnings
  management behavior (e.g., Gaver et al. 1995),
  unlike Long term Incentives
• Increased frequency of monitoring decreases
  earnings management
• Increased transparency

6
H2a/b Unintended Effects - Risky Project
Continuation

• Short term incentives less willingness to
  continue risky projects than long term
  incentives.
• Increased audit frequency increases risk aversion
  and managerial myopia, most severely when
  combined with short term incentives.

7
Method

• 2 2 between-participants experiment
• Auditing frequency - periodic or continuous.
• Incentive horizon - short-term or long-term.
• Evaluate a project and make two decisions
• Change quality control expenditures (earnings
  management setting).
• Recommend continuing/discontinuing the project.

8
Demographic Profile (Table 1) 72 Managers
Mean Std. Dev.
Age 40.57 6.10
Yrs of experience 16.38 6.08
Yrs in current position 8.79 5.67
Level of current position Middle manager Upper manager 31 41 43 57
Current job function General management Finance/accounting/internal audit 39 33 54 46
Industry Manufacturing Retail Transportation Other 25 19 16 12 35 26 22 17
Size of employer Large Medium Small 39 27 6 54 38 8
9
Willingness to Change Quality Control
Expenditures (Figure 1)
10
Willingness to Continue or Discontinue the
Project (Figure 2)
11
Debriefing Items (Table 5)
Mean (Std. Dev.) Mean (Std. Dev.) ANOVA
Periodic Continuous P
Job Stress 0.17(0.38) -2.59(1.14) .01
Trust in Supervisor 3.31(1.21) -3.68(1.00) .01
Evaluation Apprehension 0.43(0.61) -3.51(1.17) .01
Managerial Autonomy 3.03(1.15) -3.57(1.07) .01
Short-term/Long-term Focus 3.00(1.00) -3.78(1.08) .01
Motivation to Work Hard 2.66(0.94) -1.16(2.21) .01
Risk Taking Propensity 2.82(0.94) -3.70(0.97) .01
Organizational Commitment 0.09(0.28) -1.59(0.83) .01
12
Contributions

• Demonstrate that more frequent internal reporting
  can trigger suboptimal resource allocation
• Extends Bhojraj and Libby (2005) more frequent
  external reporting induced suboptimal resource
  allocation in the presence of stock market
  pressure.
• Contribute to managerial research in incentives
• Reveal heretofore unexplored interactions between
  continuous auditing and incentive horizon.
• Extend the auditing and accounting IS
  literatures
• Revealing both positive and negative
  ramifications of implementing the processes and
  technologies involved with continuous auditing.
• Redesign incentives.
• Training.