The role of enforcement in the decision making of preparers and auditors of financial statements

This thesis investigates the role of financial reporting enforcement in the decision making of financial statement preparers and auditors. Enforcement bodies are governmental or private agencies that have the authority to review audited financial statements of listed corporations. Enforcement, in general, describes the supervision of listed firms by such agencies with the objective of ensuring compliance with accounting standards. Prior literature indicates that the introduction of enforcement mechanisms is associated with positive capital market effects such as increasing liquidity. Moreover, error announcements by enforcers result in significant negative market reactions for the censured firms. Hence, enforcement provides additional incentives for firms to prepare error-free financial statements. Moving beyond capital market effects, it is the aim of this thesis to provide evidence on the direct effects of enforcement on the decision making of involved stakeholders. This thesis includes three studies which examine the influence of enforcement on disclosure and accounting choices of managers and auditors. The first study "Firm Disclosures about Enforcement Reviews", in a descriptive and exploratory investigation of the annual reports of German firms subject to enforcement scrutiny from 2006 to 2016, finds that managers voluntarily disclose information about enforcement reviews even when the reviews are still ongoing. Content analyses reveal that these disclosures are potentially associated with strategic considerations. For instance, the study provides weak evidence that market reactions to error announcements are mitigated by pre-emptive voluntary disclosure about the ongoing reviews. The second study "Auditor Conservatism in the Presence of Financial Reporting Enforcement" utilises an experimental design to test whether the likelihood of being subject to an enforcement review increases an auditor's tendency to require conservative accounting choices from his/her client. The findings suggest that the expectation of an enforcement review and its likelihood are not associated with more conservative behaviour by the auditor. However, auditors who were directly affected by enforcement reviews in the past are more likely to make more conservative decisions. The third and final study "The Role of Enforcement in Shaping Conservative Accounting Choices" tests and finds in a cross-country setting that substantive changes in enforcement regulation are associated with increases in accounting conservatism. Moreover, findings suggest that the impact of enforcement on accounting conservatism is stronger for firms with weak corporate governance than for firms with strong corporate governance. In conclusion, this thesis supplies evidence that enforcement plays a significant role in the decision making of both managers and auditors. It influences managers' disclosure and accounting choices, while it may have an impact on auditors' accounting choices if auditors have had direct experience with enforcement reviews in the past. The thesis' findings suggest that the strengthening of enforcement institutions is associated with higher accounting conservatism. Increasing the frequency of enforcement reviews, on the other hand, may enhance auditor conservatism as it will result in more auditors having been directly affected by enforcement reviews -- abstract.