Skip to main content
SpringerLink
Log in

Client’s Bargaining Power and Audit Negotiation over Earnings: Evidence from Audit Processes in a Business Groups Environment

  • Published:
Group Decision and Negotiation Aims and scope Submit manuscript

Abstract

This paper identifies and analyzes contextual factors in the audit environment at the business group level, and finds that the structural complexity of business groups and business group owners’ controlling power are significant factors that may influence auditor behavior during the audit negotiation process. Using data for the pre-audit earnings that is uniquely available in South Korea, we find that business group affiliation and the existence of circular control links within business groups are significantly and positively associated with auditors’ agreement regarding earnings initially proposed by the management of client firms. We also find that both owners’ excessive voting rights over cash-flow rights and related party transactions are significantly positively associated with auditors’ agreement regarding the earnings initially proposed by the management of client firms. Our findings will help elucidate the contextual factors that can impact clients’ bargaining powers in audit negotiation processes.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2

Similar content being viewed by others

Notes

  1. The audit risk that comes from the transaction complexity between a business group and external parties (e.g., suppliers) differs from the risk associated with complex transactions between the member firms within a business group because it can be hard for an auditor to understand the economic substance of within-group transactions by examining them based on their economic appearance.

  2. For background information regarding the development and characteristics of large business groups in South Korea, see Kang and Kim (2014).

  3. Specifically, the disclosure regulation requires that firms disclose pre-audit financial information if one of the following three conditions occurs: (1) a change in one of the three pre-audit reporting items (i.e., sales, operating income, or net income) of 30% or more compared to the previous period; (2) a decrease in pre-audit capital stock of 50% or more; or (3) the pre-audit sales are less than 5 billion KRW (Korea Won).

  4. The total number of observations in this paper is 2015, and the business group-affiliated firms account for about 25% of total observations (i.e., 512 observations out of 2015). La Porta et al. (1999) report that 30% of the firms in the world is family-controlled. If we narrow down into the sample of South Korea, the ratio is consistently applied to the sample of this paper. It can be said that the proportion of business group-affiliated firms (i.e., 25%) is a similar rate as La Porta et al. (1999). Therefore, in this context, we believe that 512 observation out of 2015 (the ratio of 25%) is not too small. The ratio of 25% is also consistent with other prior studies using the Korean data sample.

References

  • Ashbaugh H, LaFond R, Mayhew BW (2003) Do nonaudit services compromise auditor independence? Further evidence. Account Rev 78:611–639

    Article  Google Scholar 

  • Brown HL, Wright AM (2008) Negotiation research in auditing. Account Horiz 22:91–109

    Article  Google Scholar 

  • Burgstahler D, Dichev I (1997) Earnings management to avoid earnings decreases and losses. J Account Econ 24:99–126

    Article  Google Scholar 

  • Carson E (2014) Globalization of auditing. The Routledge companion to auditing. Routledge, Abingdon

    Google Scholar 

  • Chen KY, Elder RJ, Liu J-L (2005) Auditor independence, audit quality and auditor–client negotiation outcomes: some evidence from Taiwan. J Contemp Account Econ 1:119–146

    Article  Google Scholar 

  • DeAngelo LE (1981a) Auditor independence, low balling, and disclosure regulation. J Account Econ 3:113–127

    Article  Google Scholar 

  • DeAngelo LE (1981b) Auditor size and audit quality. J Account Econ 3:183–199

    Article  Google Scholar 

  • DeFond ML, Jiambalvo J (1993) Factors related to auditor–client disagreements over income-increasing accounting methods. Contemp Account Res 9:415–431

    Article  Google Scholar 

  • El-Helaly M (2018) Related-party transactions: a review of the regulation, governance and auditing literature. Manag Audit J 33:779–806

    Article  Google Scholar 

  • Eshleman JD, Guo P (2014) Do Big4 auditors provide higher audit quality after controlling for the endogenous choice of auditor? Audit J Pract Theory 33:197–219

    Article  Google Scholar 

  • Frankel R, Johnson M, Nelson K (2002) The relation between auditors’ fees for non-audit services and earnings management. Account Rev 77:71–105

    Article  Google Scholar 

  • Friedman E, Johnson S, Mitton T (2003) Propping and tunneling. J Comp Econ 31:732–750

    Article  Google Scholar 

  • Geiger MA, Raghunandan K (2002) Auditor tenure and audit reporting failures. Audit J Pract Theory 21:67–78

    Article  Google Scholar 

  • Gibbins M, Salterio S, Webb A (2001) Evidence about auditor–client management negotiation concerning client’s financial reporting. J Account Res 39:535–563

    Article  Google Scholar 

  • Iyer VM, Rama DV (2004) Clients’ expectations on audit judgements: a note. Behav Res Account 16:63–74

    Article  Google Scholar 

  • Joh SW (2003) Corporate governance and firm profitability: evidence from Korea before the economic crisis. J Financ Econ 68:287–322

    Article  Google Scholar 

  • Kang PK, Kim YC (2014) South Korea’s efforts for structural changes in corporate governance of large Korean business groups after the Asian financial crisis. Int J Disclos Govern 11:211–230

    Article  Google Scholar 

  • Kang PK, Kim YC (2015) The impact of the ownership discrepancy between cash-flow rights and voting rights on firms’ soft asset investment decisions: evidence from large business groups in South Korea. Group Decis Negot 24:429–450

    Article  Google Scholar 

  • Khanna T, Rivkin JW (2001) Estimating the performance effects of business groups in emerging markets. Strateg Manag J 22:45–74

    Article  Google Scholar 

  • Kim JB, Yi CH (2006) Ownership structure, business group affiliation, listing status, and earnings management. Contemp Account Res 23:427–464

    Article  Google Scholar 

  • Kim KA, Nofsinger JR, Mohr DJ (2010) Corporate governance. Pearson, London

    Google Scholar 

  • Kleinman G, Palmon D (2000) A negotiation-oriented model of auditor–client relationships. Group Decis Negot 9:17–45

    Article  Google Scholar 

  • Kleinman G, Anadarajan A, Medinets A, Palmon D (2010) A theoretical model of cognitive factors that affect auditors’ performance and perceived independence. Int J Behav Account Finance 1:239–267

    Article  Google Scholar 

  • Kleinman G, Palmon D, Yoon K (2014) The relationship of cognitive effort, information acquisition preferences and risk to simulated auditor–client negotiation outcomes. Group Decis Negot 23:1319–1342

    Article  Google Scholar 

  • Krishnan J, Sami H, Zhang Y (2005) Does the provision of nonaudit services affect investor perceptions of auditor independence? Audit J Pract Theory 24:111–135

    Article  Google Scholar 

  • KRX (2012) Corporate disclosure guidebook for KOSPI market listed companies. Korea Exchange (Printed in Korean)

  • La Porta R, Lopez-De-Silanes F, Shileifer A (1999) Corporate ownership around the world. J Finance 54:471–517

    Article  Google Scholar 

  • Murnighan JK, Bazerman MH (1990) A perspective on negotiation research in accounting and auditing. Account Rev 65:642–657

    Google Scholar 

  • Nagy AL (2005) Mandatory audit firm turnover, financial reporting quality, and client bargaining power: the case of Arthur Andersen. Account Horiz 19:51–68

    Article  Google Scholar 

  • Nelson MW, Elliott JA, Tarpley RL (2002) Evidence from auditors about managers’ and auditors’ earnings management decisions. Account Rev 77:175–202

    Article  Google Scholar 

  • Palmrose ZV (1986) Audit fees and auditor size: further evidence. J Account Res 24:97–110

    Article  Google Scholar 

  • Rho JH, Bae GS (2013) The effect of the same auditor appointment by the main firm and the other member firms in a large business group on audit quality. Korean Account Rev 38:247–282 (Printed in Korean)

    Google Scholar 

  • Ronen J, Yaari V (2008) Earnings management: emerging insights in theory, practice, and research. Springer, Berlin

    Google Scholar 

  • Rubin JZ, Brown BR (1975) The social psychology of bargaining and negotiation. Academic Press, Cambridge

    Google Scholar 

  • Shockley RA (1981) Perceptions of auditors’ independence: an empirical analysis. Account Rev 56:785–800

    Google Scholar 

  • Simunic DA (1984) Auditing, consulting, and auditor independence. J Account Res 22:679–702

    Article  Google Scholar 

  • Teoh SH, Wong TJ (1993) Perceived auditor quality and the earnings response coefficient. Account Rev 68:346–366

    Google Scholar 

  • Watts RL, Zimmerman JL (1986) Positive accounting theory. Prentice-Hall, Upper Saddle River

    Google Scholar 

  • Yan A, Gray B (1994) Bargaining power, management control, and performance in United States–China joint ventures: a comparative case study. Acad Manag J 37:1478–1517

    Google Scholar 

  • Yiu DW, Lu Y, Bruton GD, Hoskisson RE (2007) Business groups: an integrated model to focus future research. J Manag Stud 44:1551–1579

    Article  Google Scholar 

  • Yon KH (2008) Extension of voluntary disclosure and suggestions for the increase in investor relation. Korea IR Service (Printed in Korean)

  • Zhang P (1999) A bargaining model of auditor reporting. Contemp Account Res 16:167–184

    Article  Google Scholar 

Download references

Acknowledgements

The authors thank Ann Medinets for her helpful comments and suggestions.

Author information

Authors and Affiliations

  1. Sogang Business School, Sogang University, 35 Baekbeom-ro, Mapo-gu, Seoul, 04107, South Korea

    Pyung Kyung Kang

  2. College of Business and Economics, Hanyang University, 55 Hanyangdaehak-ro, Sangnok-gu, Ansan-si, Gyeonggi-do, 15588, South Korea

    Yoo Chan Kim

  3. Rutgers Business School, Rutgers, The State University of New Jersey, 1 Washington Park, Newark, NJ, 07102, USA

    Dan Palmon

Authors
  1. Pyung Kyung Kang
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Yoo Chan Kim
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Dan Palmon
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Yoo Chan Kim.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Kang, P.K., Kim, Y.C. & Palmon, D. Client’s Bargaining Power and Audit Negotiation over Earnings: Evidence from Audit Processes in a Business Groups Environment. Group Decis Negot 29, 1207–1238 (2020). https://doi.org/10.1007/s10726-020-09702-1

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10726-020-09702-1

Keywords

Search

Navigation