Do Misstatement Correction Disclosures Reflect Impaired Auditor Independence?

Abstract

Management has strong incentives to avoid correcting accounting misstatements through restatements, but auditor incentives are less clear. Using misstatement corrections disclosed in annual financial statements from 2006 to 2017, I investigate whether disclosures of misstatement corrections potentially reflect impaired auditor independence. I find that economically important clients and clients of non-specialist auditors are more likely to disclose misstatements as revisions or adjustments rather than as restatements. I also find that the magnitudes of disclosed revisions and adjustments are more likely to exceed traditional materiality thresholds for economically important clients and clients of non-specialist auditors. These relationships are strongest when audit offices experience negative client growth, when audit markets have high competition, when the auditor in the year of correction was also the auditor in the year of misstatement, and when the corrections have negative effects on financial statements. Overall, my study suggests that misstatement correction disclosures may reflect impaired auditor independence. As such, investors and regulators should exercise substantial skepticism as they identify and evaluate disclosures of misstatement corrections.