Realigning Auditors' Accountability: Experimental Evidence

What is it about?

This paper uses experimental markets to examine how the current structure of the auditing market might create inappropriate accountability relationships between auditors and their clients. This accountability may lead auditors to act in ways that benefit their clients rather than the investors of the company. We find that simply removing auditors' accountability to client management alone does not significantly increase audit quality, nor does simply focusing auditors on their accountability to investors. Rather, it is necessary to both remove auditors' economic accountability to client management and focus them on their accountability to investors to significantly improve audit quality.

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Why is it important?

This is important because research finds that managers still retain significant influence in auditor selection, despite regulatory requirements that audit committees perform this function. Further, a significant proportion of companies have CEOs who are also Chairman of the Board of Directors, which increases their influence over auditor selection. Our research shows that auditors who are selected by - and accountable to - management provide significantly lower audit quality than auditors who are not accountable to management and are focused on their accountability to investors. Given the potential impact of audit failures on financial markets, this evidence speaks to the necessity of restructuring the accountability relationships inherent in the current auditing market.

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