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

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.