How Do Reward Versus Penalty Framed Incentives Affect Auditor Judgments and Actions in Diagnostic Tasks?

Abstract

To motivate auditors to increase audit quality, regulators primarily introduce penalty-framed incentives. Researchers propose that more reward-framed incentives are needed to motivate auditors to supply high audit quality. We examine how incentive frames affect auditors’ risk judgments and testing actions in diagnostic tasks that are key to discerning whether a misstatement is present. We find that participants are more likely to test a potential misstatement under a reward versus penalty frame due to an action bias towards testing. However, participants increase testing primarily when a misstatement is absent. Therefore, a reward versus penalty frame results in more false alarms, with no improvement in misstatement detection. Our study suggests that providing auditors reward- versus penalty-framed incentives can increase testing but at the cost of audit efficiency.