The study investigates how mandatory audit firm rotation may affect the process of auditor-client negotiations that produce financial statements observed by the public. Standard setters should be cognizant of the possible implications of mandating rotation. Mandatory rotation will likely change the auditors’ and clients’ incentives and auditors and clients will likely change their negotiation strategies. This may result in less cooperation between auditors and clients and in fewer negotiations that end to the satisfaction of both parties (not only in the final audit year prior to rotation but also in non-final years).
Wang, K. J. and B. M. Tuttle. 2009. The Impact of Auditor Rotation on Auditor-client Negotiation. Accounting, Organizations, and Society 34 (2): 222-243.
This study is motivated by a demand for research on the potential effects of requiring mandatory rotation of audit firms following the Sarbanes-Oxley Act of 2002. While some believe that mandatory audit firm rotation is the only way to ensure auditor independence, most audit firms and their clients do not believe that mandatory audit firm rotation would impact auditor behavior. This study advances this debate by investigating how mandatory rotation may affect the process of auditor-client negotiations that produce financial statements. Auditor-client negotiation is important to auditing because it is a natural process of reconciling incentive-induced differences in financial reporting. Below are the objectives that the authors address in their study:
The authors collected their evidence via a laboratory negotiation experiment using an abstract setting. The data was collected prior to 2009. Participants were graduate business students and were randomly assigned the role of manager (i.e., client) or verifier (i.e., auditor). Participants were paired, one manager and one verifier, and completed a negotiation task. For half of the negotiation pairs, mandatory rotation was required after three periods and for the other half of the pairs there were no rotation requirements. Cash incentives were used to model the “real-world” incentives of clients and auditors. The negotiation process, auditor and verifier strategies, and outcomes were compared between these two groups.
The last 25 years has been an exciting and very productive period for judgment and decision making research in auditing. The author of the discussion believes this review study will help stimulate important audit judgment and decision making research. This line of
research is important because it has potential to make important contributis to the audit practice.
Nelson, M.W. and H. Tan. 2005. Judgment and Decision Making Research in Auditing: A Task, Person, and Interpersonal Perspective. Auditing: A Journal of Practice & Theory 24 (Supplement): 41-71.
Trotman, K. T. 2005. Discussion of Judgment and Decision Making Research in Auditing: A Task, Person, and Interpersonal Perspective. Auditing: A Journal of Practice & Theory 24 (Supplement): 73-87.
The purpose of the study is to review and discuss research in auditing specifically related to auditor judgment and decision making. This line of research uses a psychological lens to understand, evaluate, and improve auditors’ judgments and decisions. The authors
classify the research into three broad areas: (1) the audit task, (2) the auditor and his/her attributes, and (3) the interaction between auditor and other stakeholders in task performance. The authors synthesize the prior research and identify gaps and opportunities for future research.
The objective of the discussion paper is to build on the study by providing additional insights into areas of productive future research for judgment and decision making in auditing.
The authors review judgment and decision making research in auditing conducted over the past 25 years. Much of the research uses the laboratory experimental approach, but they also include some survey and field study approaches. The review primarily considers papers published in major accounting journals such as The Accounting Review; Journal of Accounting Research; Contemporary Accounting Research; Accounting, Organization and Society; and Auditing: A Journal of Practice & Theory, as well as some selected working papers.
The Audit Task:
Auditor Attributes:
Interpersonal Interactions:
Based on previous studies and preconceived notions, the finding that partners expressing their own views about the low likelihood of fraud had no effect on professional skepticism was surprising. This suggest that partner’s concern of not expressing this opinion to the team because it would lower the overall professional skepticism may be unwarranted. The evidence from this study indicates that partners can raise professional skepticism within the team by communicating management’s view of low likelihood of fraud, however it is not recommended for partners to use this approach every single time. Also, encouraging both outward and internal skeptical orientation can raise professional skepticism as well.
Harding, N, and K. T. Trotman. 2017. The Effect of Partner Communications of Fraud Likelihood and Skeptical Orientation on Auditors’ Professional Skepticism. Auditing, A Journal of Practice and Theory 36 (21): 111-131.
Professional skepticism is a key attribute for auditors, and as such firms have been exploring ways to enhance professional skepticism within audit teams. This study investigates the impact of partner communications, specifically partner attribution and skeptical orientation, on professional skepticism during fraud brainstorm meetings. Partner attribution refers to the following choices of communication regarding the likelihood of fraud:
The partner can also encourage different types of skeptical orientation. The two addressed in this paper are:
Participants in the two studies were comprised of 88 managers and seniors from the Big 4 firms. The first study examined the effects that partner attribution had on professional skepticism. Alternatively, the second study examined the effectiveness of encouraging outward versus internal skeptical orientation. The analysis included a 2x2+1 design for each of the two judgments.
The authors find the following related to partner attribution:
The authors find the following related to skeptical orientation:
http://commons.aaahq.org/groups/e5075f0eec/summary
Implications for the practicing audit community are developed from the findings that less experienced auditors are susceptible to the information choice effect. In situations where litigation risk is low (high) and the auditor has less experience, auditors place greater (lower) significance on information given to them by an external party than information they sought out themselves. More experienced auditors are not subject to the information choice effect. Additionally, more experienced auditors are confident in judgments based on information sought themselves, even in a setting with elevated litigation risk. The results of this study may interest audit clients providing information to auditors, auditors reviewing the work of less (more) experienced colleagues, auditors performing a critical self-review, and regulators reviewing the work of auditors.
Smith, S. D., W. B. Tayler, and D. F. Prawitt. 2016. The Effect of Information Choice on Auditors' Judgments and Confidence. Accounting Horizons 30 (3): 393–408.
During the course of an audit, auditors choose what information they need to search for; however, they obtain both sought and unsought information. These auditors must then use the information obtained to make judgements and decisions that ultimately lead to an audit opinion. Thus, the weight auditors place on the information obtained when making judgements and the auditors’ confidence in those judgements has important implications for audit quality. The authors of this paper investigate whether it matters if information is gotten by the auditor or given to the auditor. Understanding that the way in which information is received affects information processing, the authors examine how the auditors’ receipt of additional sought or unsought information impacts the auditors’ judgment and confidence in that judgement given judgements with different levels of importance (e.g., high vs. low litigation risk) and auditors with different levels of experience (e.g., high vs. low).
Evidence was obtained during the 2010’s through an experiment using 136 auditors as participants. Participants read a case and evaluated the likelihood of obsolescence in inventory. The researchers manipulated the (1) choice to acquire relevant information (i.e., given a choice or not given a choice) and (2) litigation risk levels (i.e., high or low). Furthermore, they measured auditor experience, and classified participants as more or less experienced based on number of years in public accounting.
The results of this study are important for firms to consider in hiring and training practices as the evidence supports increased perspective taking improves auditor performance and ultimately audit quality. Audit firms may benefit from hiring auditors with prior experience in the corporate world and involvement in financial-reporting, and should continue efforts to hire more “boomerangs.” Audit firms can measure dispositional (i.e., trait) perspective taking among current employees and use this measure in determining staffing assignments. In terms of training design, audit firms can consider implementing training targeted toward role-taking. Finally, audit firms can also encourage perspective taking in other ways, for example, by including perspective taking prompts in audit programs.
Church, B. K., M. Peytcheva, W. Yu, and O. Singtokul. 2015. Perspective taking in auditor-manager interactions: An experimental investigation of auditor behavior. Accounting, Organizations and Society 45: 40-51.
This study investigates how taking the perspective of client management affects auditors’ assessment of managers’ reporting choices and whether successful perspective taking can lead to enhanced financial-reporting quality and audit quality. Perspective taking involves taking the point of view of another, and understanding another’s thoughts, attitudes, or concerns in a specific situation. Perspective taking has been shown to improve individual judgment and decision making, thus the authors of this study investigate whether these benefits extend to the audit setting when auditors take on the role and perspective of client management. Audit firms have been increasing recruiting of former employees (or “boomerangs”), asserting the knowledge and experience auditors gain while in industry is an asset to the auditor and the firm. This study provides evidence supporting that prior role experience is a reason why “boomerangs” are successful.
The participants in this experimental study were students at a public university, mostly at the undergraduate level in business or economics. The evidence for this study was collected prior to September 17, 2012. The authors conduct two multi-round experiments providing participants monetary incentives designed to mimic the auditing context. In the first experiment, participants either took on a manager role followed by an auditor role or remained in the auditor role for the entire experiment. In the second study, participants took on an auditor role for the entire experiment and perspective taking disposition was measured. The task involved estimating earnings and making decisions regarding accepting or rejecting manager reported earnings values.
The results of this study are important for both audit firms and regulators when considering the potential impact of mandatory audit firm rotation. Standard setters appear to increasingly advocate for auditors to utilize a mental frame in which they evaluate management assertions in terms of their level of dishonesty relative to verification their honesty. If this preference is ultimately paired with mandatory audit firm rotation, it could actually have a deleterious effect on audit quality. Conversely, this study finds that audit firm rotation can increase audit quality when auditors frame their mental representations of management’s assertions in terms of verification of their honest representations.
Bowlin, K. O., J. L. Hobson, and M. D. Piercey. 2015. The Effects of Auditor Rotation, Professional Skepticism, and Interactions with Managers on Audit Quality. The Accounting Review 90 (4): 1363-1393.
Regulators argue that audit firm rotation can improve audit quality by reducing the potential for longstanding auditor-client relationships to impair auditor independence. Standard setters have also recently noted that auditors often focus on verifying the honesty of management representations, and have encouraged auditors instead to evaluate them in terms of their potential dishonesty. This study examines whether the effects of auditor rotation on audit quality is dependent upon the mental frame used to evaluate either the honesty or dishonesty of management representations about the financial statements.
Mental frame refers to whether an auditor frames their assessments of management representations in terms of either their potential honesty or their potential dishonesty. Psychology research finds that individuals do not make subjective probability assessments, like the probably that management’s assertions are honest (dishonest), based on normative laws of probability, but rather on the amount of subjective psychological support that comes to mind. When decision makers feel relatively unfamiliar with, and therefore, less competent to evaluate, subjective probabilities these individuals often find it difficult to produce psychological support for the probably of their current assessment frame, making them less likely to choose the action associated with that mental frame.
The authors’ model the auditor-client relationship as a strategic game in which the auditor chooses a level of effort based on their perceived level of honesty within management’s financial statements whereas managers choose a level of honesty in reporting based on their perceived level of effort outlayed by the auditor. The researchers utilized an experimental economics experiment. The participants were undergraduate students who were tasked to repeatedly play a game for money designed to model this strategic interaction between auditors and clients. In the audit firm rotation condition the auditor was paired with a different manager each round. The evidence was gathered prior to October 2012.
By treating worse justified advice as though it were better justified advice, auditors are likely to overestimate the defensibility of their conclusions that are based on this advice. It also is worrisome that specialists appear to defensively resist well-justified, contrary advice from stronger social bond advisors. In response to a stronger social bond advisor’s better justified advice, specialists assess advisor competence to be higher and they assess the advice itself to be of higher quality, but they assign relatively low weight to the advice. This inconsistency implies that specialists may have difficulty accepting good advice even when they recognize its high quality.
Kadous, K., J. Leiby, and M. E. Peecher. 2013. How Do Auditors Weight Informal Contrary Advice? The Joint Influence of Advisor Social Bond and Advice Justifiability. Accounting Review 88 (6): 2061-2087.
Auditors regularly seek informal advice, including additional information, recommendations, and alternative perspectives about their initial judgments, from other auditors. Audit firms encourage advice seeking to enhance professional skepticism and improve professional judgment. Existing theory and evidence provide contrasting viewpoints. On the one hand, auditors recognize that following contrary advice can enhance the justifiability, or defensibility, of their judgments on ill-structured audit tasks such as determining the acceptability of management’s accounting policies. On the other hand, people generally discount contrary advice in nonauditing contexts, and auditors are prone to motivated reasoning.
The authors expect that auditors’ willingness to use contrary advice is a joint function of their social bond with their advisor and advice justifiability. “Social bond” refers to auditors’ subjective sense of interpersonal closeness or connectedness toward their advisor. The authors examine the influence of advice justifiability on advice weighting for three reasons.
88 audit seniors from a Big 4 firm completed the experimental task at a national training session. Their audit experience ranged from 30 to 96 months, with a mean (standard deviation) experience of 39 months (10 months). The evidence was gathered prior to August 2010.
The authors find that non-specialist auditors rely on the predicted trust heuristic. When advice comes from a stronger social bond advisor, they weight it relatively heavily and do not differentiate better from worse justified advice. Non-specialists also fail to objectively assess the quality of advice, and they optimistically assess specific attributes of advice coming from stronger social bond advisors, inaccurately equating better and worse justified advice. They do this even though they are able to distinguish advice justifiability and weight the advice accordingly when it comes from a weaker social bond auditor.
In contrast, specialists do not rely on a trust heuristic in weighting advice, but they weight advice inconsistently with their own assessments of its quality. Specialists put less weight on better justified advice despite assessing its quality to be higher when it comes from a stronger social bond advisor. This inconsistency appears defensive in nature. The authors find that contrary advice has promise for reducing auditors’ motivated reasoning in that auditors significantly weight it in each condition. Informal contrary advice helps auditors to see an alternative point of view.
The primary finding from the study is that average effects can mask real differences in participants’ cognitive capacity. Thus, the fundamental issue is not whether reflective cognitive capacity is malleable. Rather, the issue is this: can participants whose thinking dispositions predispose them to avoid being reflective—to avoid reevaluating their initial responses and subsequently consider alternative theories (rules)—enhance their ability to engage in reflective thinking? Future accounting behavioral research, especially studies that provide participants with feedback and an opportunity to learn, should include measures of reflective cognitive capacity (either the Need for Cognition scale or the Cognitive Reflection Test) in order to improve explained variance and more rigorously test techniques used to train accounting professionals.
Viator, R. E., Bagley, P. L., Barnes, B. G., & Harp, N. L. 2014. Measuring Reflective Cognitive Capacity: A Methodological Recommendation for Accounting Research of Feedback Effects. Behavioral Research In Accounting 26 (2): 131-160.
This study investigates whether measures of reflective cognitive capacity can differentiate which participants are more or less likely to benefit from feedback intervention. This is important because if participants systematically differ in their ability to reflect, and accounting researchers omit controlling for such variation, then accounting academe’s recommendations regarding the effectiveness of various feedback intervention techniques are likely to be overstated. In other words, such recommendations might not be applicable to those accounting professionals who are less inclined to engage in reflective thinking. This potential methodological issue relates to studies in managerial accounting settings and financial information processing, as well as audit judgments.
This study provides results from four separate experiments of feedback effects. These studies were conducted across a two-year period, utilizing four separate accounting participant pools, all enrolled in a Master’s of Science in Accounting program, employing different feedback mechanisms, and examining different measures of performance. In each of the four studies, reflective cognitive capacity is measured using the Need for Cognition scale; in the latter two studies, the Cognitive Reflection Test, recently reported in the behavioral economics literature is used. The evidence was gathered prior to April 2014.
Across all four experiments, the results consistently document that variations in participants' reflective cognitive capacity explain differences in post-feedback performance. Based on four different experiments, conducted across a two-year period, the results provide strong evidence that the NFC and CRT measures could reasonably partition participants into two groups: those that are more likely, versus those that are less likely, to benefit from feedback intervention. The incremental benefit derived from controlling for differences in reflective cognitive capacity certainly exceeds the incremental cost. Based on an analysis of adjusted means, participants with relatively high reflective cognitive capacity improved their performance after receiving summary outcome feedback, whereas participants with relatively low reflective cognitive capacity did not improve.
The results of this study provide an improved understanding of the joint effects of identity strength and salience on auditor judgments. Even in a setting with no prior auditor-client history, auditors who more strongly identify with the clients (i.e., share common values) agree more with the client. This is informative to debates about auditor rotation and independence, as it highlights short-tenure independence threats that rotation is unlikely to mitigate. Fortunately, the results also suggest heightening professional identity salience is a cost-effective alternative to auditor rotation to maintain auditor independence, even when auditor tenure is short.
For more information on this study, please contact Tim Bauer.
Bauer, T. D. 2015. The effects of client identity strength and professional identity salience on auditor judgments. The Accounting Review 90 (1): 95-114.
Considerable accounting research, as well as recent proposed and mandated audit regulation has focused on auditor independence threats arising over long auditor tenure. Psychology research, however, suggests independence threats also likely arise when auditor tenure is short because auditors can quickly develop a strong client identity (i.e., overlap of norms and values), due to extensive auditor-client interaction. Rotation can even accelerate strong identity formation because it can increase bidding for clients and research has shown auditors try to strengthen social bonds with clients during the client acquisition process. This raises questions about the effectiveness of mandatory audit partner or firm rotation to address independence concerns.
Relying on Social Identity Theory (SIT), this paper examines mechanisms for promoting auditor independence that can be implemented regardless of auditor tenure or rotation. Specifically, SIT suggests arousing an auditor’s identity as a professional (i.e., by increasing its salience) can promote auditor independence in mind, and mitigate threats to auditor judgment quality that stem from a stronger client identity.
Two experiments are used to test hypotheses, in a setting with no prior auditor-client history.
Our analysis of fear helps better understand the relationship between comfort, confidence and fear in the audit process from the perspective of risk. On one hand, it suggests that confidence (self-confidence, confidence in work instrument and confidence in colleagues) without fear is a risky cocktail for auditors, who will not be sufficiently vigilant in carrying out their mission. On the other hand, it shows that fear without confidence is also a dangerous combination, which may induce auditors to maintain at a distance (and thus ignore) the inherent risks of their responsibilities. Ultimately, a sense of fear curbed by confidence and a sense of confidence tempered by fear is what enables public accountants to develop their ‘practical intelligence’, and thus to become comfortable without overlooking the risks of their job. Accordingly, the main implication which falls out of our study is the necessity for audit firms and audit regulators to create the conditions for the development among auditors of the right mix of fear and confidence.
For more information on this study, please contact Henri Guénin-Paracini.
Guénin-Paracini, H., Malsch B. and A. Paillé-Marché. 2014. Fear and risk in the audit process. Accounting, Organizations and Society 39 (4): 264-288
While a number of studies have highlighted the role played by the feeling of comfort in audit work, comfort, in real audit settings, only arises at the very end of the audit task. The rest of the time, auditors seek to feel comfortable, but are inhabited primarily by fear. This became apparent to us in the course of an ethnographic study aimed at better understanding the work performed by auditors in the field. Of course, fear is not experienced by auditors all day long; it varies in intensity from individual to individual and depending on the circumstances; however, in general, public accountants have to deal with this emotion. If one considers that fear is the emotional experience of risk, this should hardly come as a surprise. In the post-Enron climate and after the enactment of the Sarbanes-Oxley Act, the risks associated with auditing have increased dramatically. Yet, associated with the perception of risk, the experience of fear and the role that fear plays in risk management processes have largely been overlooked in the literature. Our paper aims to ‘emotionalize’ and challenge the dominant cognitive orientation adopted by academics and regulators in their understanding of audit risks and auditors’ skepticism. It seeks better understand the role played by fear in audit practice, focusing specifically on the following questions: 1) What exactly is it that auditors worry about? 2) How do auditors manage fear in the field? 3) How does fear shape, and how is it shaped by, auditors’ work activity?
The research evidence was collected as part of a field study.
The psychodynamics of work theory of Dejours was used to interpret the data.