Characteristics of Managerial Tone Priced by Auditors: Evidence based on Annual Letters to Shareholders of Large U.S. Firms

We examine the relationship between audit pricing and managerial tone as a proxy of source credibility. Prior research shows that source credibility influences auditors’ perceptions of client risk. Textually analyzing annual letters to shareholders of large U.S. firms, we find that characteristics of managerial tone that reflect impaired source credibility are associated with higher audit fees. Additional tests, including a change analysis and control variables for other managerial characteristics, future client performance, and aggressive accounting choices, corroborate and build on our inferences that managerial tone is a proxy for source credibility incremental to client firms’ financial condition. Our study extends the literature that uses corporate disclosures to measure managerial characteristics by showing that auditors price source credibility reflected in managerial tone. These findings are important because they empirically confirm that source credibility affects auditors’ assessments of engagement risk and that analysis of tone can inform researchers, auditors, and investors who seek to enhance effectiveness and objectivity in assessing source credibility based on managerial tone