Expectation Gap and Corporate Fraud

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Expectation Gap and Corporate Fraud: Is Public Opinion Reconcilable with Auditors’ Duties?

Jeffrey Cohena, Yuan Dingb, Cédric Lesagec,* and Hervé Stolowyc b

Carroll School of Management at Boston College, USA China-Europe International Business School (CEIBS), Shanghai, China c HEC Paris, France

a

This draft – October 28, 2010 – Please do not cite or circulate without permission – Comments welcome Acknowledgments. Cédric Lesage and Hervé Stolowy acknowledge the financial support of the HEC Foundation (Project F0802). They are members of the GREGHEC, CNRS Unit, UMR 2959. Yuan Ding acknowledges support from the CEIBS Research Funding and from Jiangsu Jinsheng Industry Co., Ltd. They also acknowledge Claire O’Hana for her able research assistance. *Corresponding author: e-mail address: lesage@hec.fr

Expectation Gap and Corporate Fraud: Is Public Opinion Reconcilable with Auditors’ Duties?

ABSTRACT. Based on evidence from press articles covering 39 corporate fraud cases that went public during the period 1998-2005, the objective of this paper is to examine whether the expectation gap between public opinion and auditing profession still exists and what are the elements that illustrate the existence of such a gap. Results suggest that the expectation gap still persists even after continuous efforts made by auditing profession to attenuate it. The most salient elements demonstrating the gap are related to managers’ personality traits. It appears that professional standards are reluctant to enumerate subjective personality traits as these elements are difficult to audit in an objective way. Implications for practice and research are discussed.

KEY WORDS: Expectation Gap; Corporate fraud, Personality traits, Fraud-related professional standards

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Expectation Gap and Corporate Fraud: Is Public Opinion Reconcilable with Auditors’ Duties?

Introduction First conceptualized by Liggio (1974), the “expectation gap” (EG) could be defined as “the differences between what the public expects from an audit and what the auditing profession prefers the audit objectives to be” (Sikka et al., 1998). One of the most important issues revolving around EG deals with auditors’ responsibilities for detecting and reporting fraud (Humphrey et al., 1992; Power, 1997; Dewing & Russell, 2001; Zikmund, 2008) as the public might view the audit as a guarantor against fraud while auditors view it as their professional duty to investigate for fraud but not necessarily detect fraud in every instance. The auditing profession regularly denounces EG because it damages their reputation and increases their litigation risk (Kaplan, 1987; Reckers et al., 2007; Zhang, 2007). In 1988, the AICPA issued auditing standards to attenuate the gap, amongst which the SAS 53 on fraud detection. They have been called “the nine expectation gap SAS” (Reekers & Schultz, 1993), as the profession wanted this new regulation to bridge EG. However, the auditing standard on fraud detection (SAS 53) did not close EG as it was expected to (Herdman & Neary, 1988) and the subsequent issuance by the AICPA of two more standards (SAS 82 in 1997 and SAS 99 in 2002) did not solve the issue neither (Zikmund, 2008). The causes of the persistence of EG are not clearly evident in the research literature. On one hand, many studies have tried to find causes from the side of auditing profession, like the difficulties in assessing their work (McNair, 1991), the mutations over the time of the auditor’s responsibilities (Burton & Fairfield, 1982; Brown & Burnaby, 1988; Tomassini, 1990; Huss, 1991; Humphrey et al., 1992; Mikol, 1993; Jeppesen, 1998; Sikka et al., 1998) and the self-regulation feature of the profession (Humphrey et al., 1991; Humphrey et al., 1992; Sikka et al., 1998). Power (1997) has also suggested that the reasons for the persistence of the EG lie with the profession side, as it originates in the differences between the operational level (the professional...
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