Newswise — With each new accounting scandal, from Enron to Lehman Brothers, the inevitable question is asked: Where were the auditors?

Some say that auditors are inherently compromised because they are paid by the people they must hold to account. But new research suggests that there is an even more subtle force at play: the very business model of auditing firms that makes auditors identify too closely with their clients.

Since the 1980s, when markets were deregulated to allow auditors to advertise and solicit other firms’ clients, firms have adopted the marketing principle of “keeping your customer close.” Customer relationship management, based on boosting client satisfaction, was the way to grow the business.

“The underlying ‘trick’ to customer relationship management is identification with the customer,” says Steve Salterio, the Stephen J.R. Smith Chair of Accounting and Auditing at Smith School of Business. “Unfortunately, when you’re supposed to be checking up on the customer — as in the case of auditors — having greater identification with the customer probably isn’t the best perspective to take.”

Salterio teamed up with Christopher Koch of Johannes Gutenberg University Mainz to see if the commitment to “client satisfaction” led to a greater likelihood of an auditor accepting a client’s questionable accounting approach.

Their main study focused on 144 German auditors with at least four years of experience in signing audit opinions. In a controlled setting, the auditors were presented with one of several versions of a case that had problematic issues, such as outright errors or tricky judgment calls. The auditors in the study were encouraged to see the facts through the eyes of the client or their own firm, and were subjected to varying forms of explicit or implicit client pressure. The researchers then measured the auditors’ affinity for client relationship management using a well-accepted scale that measures attitudes.

The results confirmed what the researchers suspected. As Salterio and Koch report in The Accounting Review, the greater the auditor’s affinity for the client, the smaller the adjustment to the financial statement the auditor proposed. And auditors who experienced greater explicit client pressure proposed smaller adjustments to client accounting compared to auditors experiencing weaker implicit client pressure.

But they also found there was a tipping point. If the auditors perceived the client pressure was too intense and felt their self-image as an independent professional was compromised, they pushed back by proposing larger adjustments to client accounting than those proposed by auditors who perceived client pressure to be weaker.

In a unique research twist, the researchers validated their conclusions in a U.S. setting. They re-analyzed data from an experiment conducted with American auditors in 2003, accounting for greater intensity of client pressure. They found the American auditors behaved much like their German counterparts.

“If we can trigger this in the laboratory when there is no money on the table,” says Salterio, “then when there is really money on the table and you promote customer relationship management, you’re going to get even stronger identification with the client.”

Salterio is quick to say that it is not a matter of rogue auditors acting in an underhanded manner.

“I’ve never met an auditor who wants to be bribed,” he says. “But I have met a lot of auditors who really identify with client management.”

The findings are timely considering the efforts in many countries to develop standardized measures of audit quality. As the researchers note, some have suggested adding client service quality measures as indicators of audit quality. Given the results of this study, equating client satisfaction with audit quality would risk embedding a form of client relationship that actually undermines quality audits.

The study’s findings also give regulatory authorities an impetus to view an audit firm’s management practices as part of a root-cause analysis of audit quality problems. “Regulators have finally begun to realize that there are systematic issues with audit quality, and it's not at the individual engagement level,” says Salterio. “We’re trying to encourage regulators to look much closer at firm-wide management issues that can affect individual audit quality as opposed to assuming that the firm itself is a positive force for audit quality.”

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Steve Salterio can comment on this research and on the state of auditing. He can be reached at [email protected] or (613) 533-6589

 

 

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