David E.

Wallin, 1992

Legal Recourse
The Demanding for
Auditing

Hidayah Asfaro
Saragih
1606939072

Kenny Fernando
1506810036

Nadia Fitriati
1606939103

Accounting Information

Economic
Transcastions

Reports

Assertions about
Past Performance,
Current Conditions and
Future Prospects
Important Role in
Decentralized Economiy

Jensen &
Meckling,
1976

Wallin
Dye 1985,
Dopuch & King 1991, 1992
Grissman 1982,
1992, Wallin 1990
Baiman 1979;
Hart 1980,
Baiman et al
Miglrom 1981,
1987;. Blazenko Robert 1986
dan Scott 1986;
Evans 1980;
Scott 1984

Legal Recourse and

Demand for Auditing

Experimental Research: Environments

Permitting Fraudulent Disclosure

Research: Fraudulent
Disclosures when unknown
Need Auditing to Provide
Value to The Economy
Divergent Preferences

Previous Research

Research at Glance
How Legal Recourse and Auditing reduce
frequency of manipulation and fraudulent of
reports

Auditing:

Legal Recourse:

Purported to
provide value to
economy
Reduce divergent
preference of
management
Provide Credibility
to Managerial
Disclosures
Expected to
improve firms
prospects

Allowing investors
to sue when
disclosures are
believed to have
been fraudulent
Threat of lawsuit
will cause less
frequent
fraudulent reports

Managerial Disclosure
(Accounting Information & Firm
Information)
Effective Allocation of Resources

Theory in Case:
Some theories which apply in the research include when:

A
No Auditing/
No Legal
Recourse

B
Auditing
Available/ No
Legal Recourse

C
No Auditing/
Legal Recourse
Available

D
Auditing
Available/
Legal Recourse
Available

No Auditing/ No
Legal Recourse
In
this
situation,
two
decisions
managers
can
make: 1) effort and 2)
disclosure.
However,
investors can anticipate that
managers would select the
disclosure
that
produces
largest p* regardless of q
the
disclosure
becomes
uninformative and ignored,
resulting dominant strategy
to shirk (e0).
Investors
anticipate
price firm by:

and

X1 =
High

X0 = Low

P*= (1-o)q0 + oq1

50%

PROBABILITY

Auditing Available/No Legal

Recourse
Managers:

Releas
e
Purchase audit, cost

Dont purchase audit

Dont
release

Investor knows the firm

quality
(q1 or q0)
Investors are informed,
investors value q0

Investors are
informed

Purchase of auditing provides antifraud rule and produce equilibrium

with high effort (e1)
Expected compensation to a manager selecting:
Net-of-effort increase in expected
compensation by selecting e1 = (1-0)(q1-q0) -
e0 = (1-0)q0 + 0q1
e1 = (1-1)q0 + 1q1
Manager will not shirk when auditing has been purchased and the
investors will know firm value with certainty.

No Auditing/Legal Recourse
Available
Managers always disclose d=q1 when q=q1 but there is a
probability of managers disclose d=q1 when q=q0.
There is a probability of for purchasing investor consider
bringing suit when the manager issues d=q 1 and s0
obtains. If the investor sues and the manager has lied,
investor is awarded damages = p*-qo.
At equilibrium, the manager and investors will know , the
range of , and . The threat of a lawsuit both reduces the
frequency of lying (since 0 < 1) and allows the manager to
reap the entire benefit of higher effort (net of expected
legal costs). The manager will exert higher effort.

Auditing Available/Legal
Recourse Available
The solution and conclusion depend on the
relative levels of their cost. The general
observation is:
When ; the manager is better off with
no
audit purchases.

A: No Auditing/No Legal Recourse

B: Auditing Available/No Legal Recourse
C: No Auditing/Legal Recourse Available
D Auditing/Legal Recourse Available

Method
Experimental Design

Subjects of This Research

First Market Series:

University of Arizona
undergraduate students

Second Market Series:

Ohio State University undergraduate students

There are 32 experiments

which are separated into two
series:

Method
Instruction
s and
training

The first
market

Instruction
s and
training
for the
second
market

9 actions and rules:

1. Buyers
were
randomly
assigned
(with
replacement) redemption values.
2. Cells B and D only: Seller selected whether to
purchase auditing. Buyers were informed of
this choice.
3. Seller selected either the default or alternate
bin. Actual quality was determined and
observed by the seller.
4. Seller
selected
and
buyers
observed
disclosure.
5. Cells B and D only: Seller selected whether to
release the audit report if auditing was

The
second
market

The postexperimen
tal phase

6. Buyers submitted bids to purchase asset.

7. Winning bidder was determined, bids were
displayed, the lottery was played, and the
outcome (won or lost) of the lottery was
displayed.
8. Cells C and D only: If the asset was disclosed
as high and lost, the buyer who purchased it
selected whether to bring suit. If litigation
took place, the winner of the lawsuit was
determined.
9. Cash balances were updated.

Hypotheses
Effort selection

H1a
:The proportion of high effort is greater when auditing is available than when it is
not.
H1b
:The proportion of high effort is greater when legal recourse is available than when
it is not.
H1c
:When both auditing and legal recourse are available, the proportion of high effort is
no greater
than when auditing alone or legal recourse alone is available

Audit purchases

H2a
:When no legal recourse is available, auditing is purchased when available.
H2b
:When auditing is available, the proportion of audit purchases is less when legal
recourse is available than when it is not.

Audit purchases with

effort selection

H3a
:When no legal recourse is available, the proportion of high effort is greater when
auditing is purchased.
H3b
:When legal recourse is available, the proportion of high effort is unaffected by the
presence of
auditing.

The level of fraudulent

disclosure
Economic efficiency

H4

:The proportion of fraudulent disclosure is lower when legal recourse is present.

H5a
:Economic efficiency is higher when auditing is available than when it is not.
H5b
:Economic efficiency is higher when legal recourse is available than when it is not.
H5c
:When both auditing and legal recourse are available, economic efficiency is no
higher than when
auditing alone or legal recourse alone is available.

Cell Results of 4 Conditions - Tables

A, B, C, D

This is a sample text.

Enter your text here
C & D contain frequency of
lawsuit table
Mean Bid Ratio (match bids
to underlying quality)

Resul
t

Proportion High Effort,

Truthfulness
Early (1-15) & Late (16-Late)

Effort Selection
Over Time

Statistical Result

Summary of Hypotheses Result

Summary of Result

Economic Efficiency
Formula to calculate
MB =
GB =
NB = C(vi) C(li)
MB = Maximum Benefit
GB = Gross Benefit
NB = Net Benefit
e = Effort
HRV = Highest Redemption Value
WRV = Redemption Value of Winning
C = Cost
v = Auditing
l = Legal Cost

Result of Economic Efficiency

120
120
80
80

160
160
200
200

40
40

Economic Efficiency

00

km/h 240
240
9 9 9 9 9

Conclusio
n
No Auditing/ No
Legal Recourse

One Available
of Auditing/ Legal
Recourse

Low Cooperation
Lowest Effort of Sellers
Overbidding by Buyers

Truthfulness of Disclosure
Increase Effort

Auditing and
Legal Recourse
Available

Tendency of overbid reduced

Truthfulness increased
Efficiency of Resources Allocation
Increase Economic Efficiency