Do Rewards Encourage Professional Skepticism?

Abstract

It is an open question whether auditors have credible incentives to exercise professional skepticism. We focus on costly skepticism: skepticism that is appropriate and generates incremental costs, but does not identify a misstatement. Costly skepticism is typically not rewarded by audit supervisors. We theorize and find that rewarding costly skepticism may backfire and decrease skepticism on subsequent audit tasks where evidential red flags are present. We reason that auditors interpret the reward as a non-credible, better-than-expected outcome, leading auditors to view subsequent tasks from a risk-averse gain frame. As a result, auditors self-interestedly seek to avoid the risks and effort of exercising additional skepticism. This effect decreases auditors’ sensitivity to red flags and auditors’ willingness to inform their manager about severe red flags, compromising audit quality. Encouragingly, auditors who have experienced a history of rewards for costly skepticism are more motivated to exercise skepticism. A survey finds that audit supervisors are likely to reward costly skepticism when their own supervisors encourage the behavior and promote consultation within the engagement team. Overall, our results suggest firms may benefit from a culture shift emphasizing credible rewards for costly skepticism, but that firms currently may not “get what they reward.”