Published papers

This study examines how audit risk (the probability of false acceptance) and its components change when the auditor obtains audit evidence in an acceptance sampling model. Inherent risk and audit risk increase with audit evidence if the auditee has a sufficiently strong incentive for committing fraud. Detection risk always increases when audit evidence is introduced. If the auditor has a sufficiently strong incentive for avoiding false rejection, audit risk also increases with audit evidence. The analysis indicates that requiring auditors to obtain information is not effective in preventing material misstatements in at least some instances.

It has been reported in the literature on strategic auditing that audit risk (the probability of audit failure) may increase when the auditor obtains information, whereas conditions for such cases have not been identified as yet. This paper provides simple models to analyze the general tendencies of exogenous parameters for such cases. The analysis shows that audit risk increases with more information if the auditee has a sufficiently strong incentive to commit fraud. If the auditee is penalized by auditor rejection even when he does not commit fraud, the detection risk increases with more information. In this case, if the auditor has a sufficiently strong incentive to avoid false rejection, audit risk increases with more information.

Why do 60% of target boards voluntarily solicit and pay for seemingly worthless 'Texas-wide' fairness opinions while 40% of their peers do not? Our new insight is that target boards speak to more than one shareholder generation through fairness opinions. We model fairness opinions as a cheap-talk game between a board of directors and public shareholders. In the core game, a board issues a fairness opinion to communicate with two shareholder generations: existing shareholders voting on the proposed sale of their shares, and potential after-market buyers who would buy if the present transaction fails. The game yields two distinct equilibria: one where the board issues no fairness opinions and one where Texas-wide fairness opinions emerge as equilibrium messages. The core game assumes that: (i) shareholders know the status of the board's private incentive; (ii) the proposed buyer sets a fixed bid equal to the ex ante expected value of the firm; and (iii) shareholders have no information about the target that the board does not have. We relax each of these three assumptions and prove that the conclusions drawn from the core game continue to hold. We conclude that three factors determine the width of fairness opinions: the board's private incentives; information asymmetry between the board and shareholders; and transactions costs incurred by after-market buyers if the current bid fails.