Improving Experienced Auditors’ Detection of Deception in CEO Narratives

• DOI: http://doi.org/10.1111/1475-679X.12181
• Published date: 01 December 2017
• Date: 01 December 2017

DOI: 10.1111/1475-679X.12181

Journal of Accounting Research

Vol. 55 No. 5 December 2017

Printed in U.S.A.

Improving Experienced Auditors’

Detection of Deception in CEO

Narratives

JESSEN L. HOBSON,

∗WILLIAM J. MAYEW,

†

MARK E. PEECHER,

∗AND MOHAN VENKATACHALAM

†

Received 9 July 2015; accepted 20 June 2017

ABSTRACT

We experimentally study the deception detection capabilities of experienced

auditors, using CEO narratives from earnings conference calls as case ma-

terials. We randomly assign narratives of fraud and nonfraud companies to

auditors as well as the presence versus absence of an instruction explaining

that cognitive dissonance in speech is helpful for detecting deception. We

predict this instruction will weaken auditors’ learned tendency to overlook

fraud cues. We find that auditors’ deception judgments are less accurate for

∗Department of Accountancy, University of Illinois at Urbana-Champaign; †Fuqua School

of Business, Duke University.

Accepted by Douglas Skinner. Recipient of the 2016–2017 Glen McLaughlin Prize

for Research in Accounting Ethics from the Steed School of Accounting (University of

Oklahoma). We are grateful to the accounting professionals from various audit firms who

participated in the study. We appreciate helpful comments from two anonymous reviewers;

Spencer Anderson, Scott Asay, Clara Chen, Jon Davis, Brooke Elliott, Scott Emett, Kevin Jack-

son, Joseph Johnson, Tracie Majors, Terence Ng, Matt Pickard, Mike Ricci, Chad Simon,

Jason Smith, Hun-Tong Tan, Mark Zimbelman; reviewers and participants at the 2015 Au-

diting Section Midyear Meeting, the Brigham Young University Accounting Symposium, the

2014 Accountancy Conference the University of S˜

ao Paulo, the 2015 EDEN Doctoral Seminar

in Audit Research (London), the 2015 Financial Accounting and Reporting Section Midyear

Meeting, the 2015 Southeast Summer Accounting Research Conference, and the 2015 Inter-

national Symposium on Audit Research (Boston); and workshop participants at the University

of Chicago, Lehigh University, Nanyang Technological University, the University of Illinois at

Urbana-Champaign, and the University of Oklahoma. We thank EB Altiero and Chris Calvin

for their helpful research assistance.

1137

Copyright C, University of Chicago on behalf of the Accounting Research Center,2017

1138 J.L.HOBSON,W.J.MAYEW,M.PEECHER,AND M.VENKATACHALAM

fraud companies than for nonfraud companies, unless they receive this in-

struction. We also find that instructed auditors more extensively describe red

flags for fraud companies and more accurately identify specific sentences in

narratives that pertain to underlying frauds. These findings indicate that in-

structing experienced auditors to be alert for cognitive dissonance in CEO

narratives can activate deception detection capabilities.

JEL codes: M41; M42; M48

Keywords: deception detection; earnings conference call; fraud; audit

1. Introduction

Despite their duty to provide reasonable assurance that financial statements

are free of material misstatement (AS Nos. 8–15, PCAOB [2010], AS No. 16,

PCAOB [2012]), auditors are seldom the first party to detect fraud (Dyck,

Morse, and Zingales [2010]). It is therefore unsurprising that audit stake-

holders have expressed interest in understanding and improving auditors’

deception detection capability (PCAOB [2007], Hogan et al. [2008], CAQ

[2010], PCAOB [2013], Christensen et al. [2016]). In this study, we ob-

tain access to auditors with extensive experience, equaling 24 years on aver-

age, and experimentally examine their deception detection capability in a

CEO narrative setting. The narratives we use are from question and answer

(Q&A) portions of public companies’ earnings conference calls, which the

Public Company Accounting Oversight Board (PCAOB) recommends au-

ditors review to help assess misstatement risk (AS No. 12, PCAOB [2010]).

The vast psychology literature on deception detection, including studies

of experts in other domains, provides reason to be pessimistic about experi-

enced auditors’ ability to detect deception. Experienced police officers and

judges only rarely exceed chance or novice performance levels in detecting

deception (Bond and DePaulo [2006, 2008], Vrij et al. [2006]). Inferring

how well experienced auditors detect deception based only on such stud-

ies is difficult given the uniqueness of the audit setting. Auditors tend to

repeatedly interact with a given client year after year as part of the annual

audit, whereas police officers tend to interact with a given suspect only dur-

ing a given investigation. And, police officers are not paid by the criminal

suspects they investigate, whereas clients pay their auditors.

Theory and findings from prior psychology and auditing research sug-

gest auditors learn to avoid false positives about fraud rather than to acquire

and evaluate evidence objectively to reach accurate deception judgments

(Friedrich [1993]). Brazel et al. [2016] show that audit supervisors penal-

ize subordinates who act on their skeptical beliefs. Other authors document

that auditors use motivated reasoning that favors allowing aggressive ac-

counting methods (Bazerman, Morgan, and Loewenstein [1997], Kadous,

Kennedy, and Peecher [2003]), collect less evidence in order to avoid

unpleasant interactions with management (Nelson [2009], Bennett and

Hatfield [2013]), and become more reluctant skeptics with greater