Can auditors be independent? – Experimental evidence on the effects of client type

Recent regulatory initiatives stress that an independent oversight board, rather than the management board, should be the client of the auditor. In an experiment, we test whether the type of client affects auditors’ independence. Unique features of the German institutional setting enable us to realistically vary the type of auditors’ client as our treatment variable: we portray the client either as the management preferring aggressive accounting or the oversight board preferring conservative accounting. We measure auditors’ perceived client retention incentives and accountability pressure in a post-experiment questionnaire to capture potential threats to independence. We find that the type of auditors’ client affects auditors’ behaviour contingent on the degree of the perceived threats to independence. Our findings imply that both client retention incentives and accountability pressure represent distinctive threats to auditors’ independence and that the effectiveness of an oversight board in enhancing auditors’ independence depends on the underlying threat

Hedge accounting incentives for cash flow hedges of forecasted transactions

Abstract US GAAP as well as IAS (IFRS) contain specific accounting regulations for hedging activities. Basically the hedge accounting rules ensure that an offsetting gain or loss from a hedging instrument affects earnings in the same period as the gain or loss from the hedged item. However, due to the way hedge accounting rules are set up, their application turns out to be an option rather than an obligation for firms. Recognizing this fact, the paper analyses corporate incentives for hedge accounting in the presence of a moral hazard problem. We consider a two-period LEN-type agency model with a risk averse agent and a risk neutral principal. The principal decides upon hedging and motivates effort through an incentive contract based on accounting income. We find that in such a setting the principal strictly prefers hedging as opposed to no hedging. Whether he prefers hedge accounting or not depends on how the firm's overall risk exposure is allocated over periods. If risk exposures differ largely over periods the principal prefers hedge accounting. Otherwise no hedge accounting is preferred.