Seeing is believing? Executives' facial trustworthiness, auditor tenure, and audit fees

Accountancy

Tien-Shih Hsieh, Jeong-Bon Kim, Ray R. Wang, Zhihong Wang

Published in Journal of Accounting and Economics, February 2020

New research by Professor Jeong Bon Kim, Chair Professor at the Department of Accountancy and co-authors examines whether auditors' perceptions of client executives' facial trustworthiness are associated with their audit fee decisions. 
To test the hypothesis, a machine-learning-based face-detection algorithm is deployed in the study to measure executives' facial trustworthiness. 
“Our results suggest that auditors charge 5.6% less audit fee to firms with trustworthy-looking CFOs than to those with untrustworthy-looking CFOs in initial audit engagements,” says Professor Kim.
Theoretically, audit fee is a function of audit efforts and litigation risks. Empirical evidence has also shown that management integrity is an important factor in auditors’ decision making when assessing inherent risks and control risks associated with audit engagements. AS 2110 also requires auditors to make judgments about the integrity of their clients' management team, including CEOs and CFOs, based on face-to-face communication and interactions. Thus, auditors may rely heavily on their interactions with client firms' management when judging audit risks and estimating audit hours to make audit fee decisions. 
Prior psychology and neuroscience studies document that facial trustworthiness perceptions may affect observers' decision-making process.  People may rapidly perceive character and personality from an individual's facial appearance. A glance, a few spoken words are sufficient to tell us a story about a highly complex matter. When interacting with client firms’ management, auditors’ judgment on audit risks are likely to be affected by how they perceive the trustworthiness of client firms’ management team. Thus, Kim and co-authors hypothesize that auditors’ fee decisions could be affected by the facial trustworthiness of their client management teams. 
“We also find that auditor tenure plays a mediator role to weaken the negative association between CFOs' facial trustworthiness and audit fee. In other words, with more experiences of working with a client, this cognitive bias fades away,” adds Kim.
Further analysis suggests this negative association between CFO facial trustworthiness and a client’s audit fee is less likely to be driven by the client’s financial reporting quality or their litigation risk.