Investigating the influence of auditors’ materiality threshold disclosures on employees’ decisions to report financial misconduct, the article The Unintended Consequences of Audit Materiality Disclosures on Whistleblowing Intentions by Mackenzie M. Festa, D. Kip Holderness, Jr., Megan M. Jones, and Richard A. Riley, Jr. highlights a critical organizational dynamic. Although these disclosures aim to improve transparency and support investor decision-making, the study reveals their potential unintended impact on employee whistleblowing behavior.
The research centers on the premise that materiality, as a quantitative threshold, serves as an anchor influencing individuals’ perception of the seriousness of financial misconduct. Using an experimental design involving executive MBA students, the authors examine how materiality disclosure interacts with the magnitude of earnings manipulation to affect whistleblowing intentions. Participants were presented with scenarios involving either above- or below-materiality earnings manipulations, with or without disclosed materiality thresholds.
The findings reveal a significant interaction between materiality disclosures and the amount of earnings manipulation. Specifically, whistleblowing intentions were significantly lower for below-materiality manipulations when auditors disclosed their materiality thresholds compared to when no thresholds were disclosed. This suggests that materiality disclosures may inadvertently discourage employees from reporting smaller financial manipulations, despite their potential qualitative importance. However, for above-materiality manipulations, materiality disclosures did not significantly impact whistleblowing intentions, as participants were already inclined to report such egregious cases.
The study also highlights the role of materiality knowledge in moderating the anchoring effect. Participants who understood the concept of materiality were more likely to anchor their whistleblowing decisions on disclosed thresholds, further decreasing the likelihood of reporting below-materiality manipulations. This underscores the complexity of implementing materiality disclosures without inadvertently dampening organizational whistleblowing efforts.
These findings have important implications for auditors, regulators, and organizations. Regulators considering mandatory materiality disclosures must weigh the potential benefits to investor decision-making against the risk of discouraging employee whistleblowing on smaller, yet meaningful, instances of financial misconduct. Auditors are advised to emphasize the qualitative aspects of materiality during their interactions with client personnel to mitigate the anchoring effects of disclosed thresholds. Furthermore, organizations should provide comprehensive antifraud training to help employees recognize the importance of reporting all instances of misconduct, regardless of materiality.
For a more detailed examination of these findings, the article is available in Accounting Horizons here.