The Impact of Non-Mandatory Corporate Governance on Auditors' Client Acceptance, Risk and Planning Judgments

Abstract

We examine the effect of non-mandatory corporate governance practices on a comprehensive set of audit judgments. We provide initial evidence on how auditors respond to corporate governance in an institutional environment where corporate governance is not mandated by law. Based on the agency and resource dependence theories, we hypothesise associations between corporate governance and auditors' judgments relating to client acceptance, risk assessments, and the extent and timing of substantive testing. Sixty Big 4 audit managers from Singapore are randomly assigned to one of three experimental conditions comprising weak, moderate and strong corporate governance. Our results show auditors make more favourable client acceptance judgments when corporate governance is stronger. Clients with stronger corporate governance are assessed as having lower control environment risk. After controlling for control environment risk, we find that stronger corporate governance increases auditors' reliance on the client's internal controls and reduces the extent of substantive tests. When corporate governance is stronger, we observe that auditors conduct more substantive testing during the interim period compared to the year-end. Our findings suggest that audit strategies are responsive to the strength of a client's corporate governance.

Keywords: agency theory, corporate governance, resource dependence, audit judgment, Sarbanes-Oxley Act

JEL Classification: M41, M49, G34, C91