Judging Audit Quality in Light of Adverse Outcomes : Evidence of Outcome Bias and Reverse Outcome Bias

Considerable auditing research shows that individuals exhibit outcome effects when judging audit quality: They judge auditor negligence as more likely when given information about adverse audit outcomes. Many studies conclude that outcome information biases individuals against auditors, and/or attempt to improve their judgments by reducing outcome effects. Yet, individuals generally should judge auditors more harshly when given adverse outcomes. A key question is whether individuals' belief revision from adverse audit outcomes is too large (outcome bias) or too small (reverse outcome bias). We compare how individuals react to outcomes against how they should react to them (as a Bayesian judge), given their own prior beliefs. Combining outcome effects with Prospect Theory's probability weighting function, we predict that individuals' judgments of auditor negligence contain outcome bias when their own Bayesian probability of auditor negligence is relatively low, but also exhibit reverse outcome bias when their Bayesian probability of auditor negligence is relatively high. We find evidence of this in both rich and abstract settings, and in both hindsight and foresight. When individuals exhibit reverse outcome bias, it is harder to argue that the outcome information biased them against auditors, or that reducing outcome effects would improve their judgment quality. Our theory and findings suggest that the effect of adverse outcomes on judgments of auditor negligence is not as simple as once thought. The model for auditor negligence judgments should expand to include outcome bias and reverse outcome bias, where predicted by our combination of outcome effects and Prospect Theory