This effect is also not limited to standard legal phrases in the reports, such that auditors seem to actively influence the year-on-year updating of their clients’ management reports and notes. This is an important and potentially alarming finding.
Furthermore, Martin Nienhaus, one of the senior researchers, comments that the identification strategy and research design are extremely rigorous and reliable, and duly recognised by a publication in a FT50 journal, which has a tough review process.
The research project was also funded by the DFG (German Research Foundation), a highly reputable foundation and also subject to a thorough review process.
To verify these findings, the authors conducted several interviews with auditors, who confirmed the plausibility of the results.
Having established that auditors have a significant influence on their clients’ narrative disclosures, they further analysed how this involvement affects the objectivity of audits, and ultimately, the quality of narrative disclosures. In this regard, the study has good news for stakeholders and regulators.
For a start, the analyses suggest that management reports that are strongly influenced by audit partners tend in fact to be of higher quality. Specifically, these reports had fewer redundancies and more forward-looking information.
Furthermore, the narratives were also found to be more useful for predicting the future profitability of client firms, and not biased or misleading.
In addition, many, and particularly smaller client firms, do not have the expertise and resources to prepare high-quality narrative disclosures, and often rely on their auditor for that task.
Don't fear the auditor
Overall, it seems the role of auditors extends way beyond simply auditing financial reports, and they play a crucial role in the preparation of the narrative sections, thereby ensuring authentic and fundamentally useful narrative disclosures.
In this regard, the fear that auditor involvement jeopardises the quality of narrative disclosures seems unjustified, at least in the case of narrative disclosures.
Nienhaus comments that these auditors in fact have a strong ethical orientation. It requires a lot of effort and commitment to become a certified auditor, so that few of them, he argues, would be willing to breach codes of ethics and the law in this context.
This is an encouraging revelation, as it seems we can rely more on auditor integrity and honesty than recent scandals might imply.
Although there are always black sheep out there, and there will always be breaches of laws and ethics, this study paints a less bleak picture than the Wirecards, Enrons and Lehmans of this world would lead us to believe.
Brian Bloch is a freelance journalist based in Germany
