Auditor's Independence Case Study

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Academy of Management Review 2006, Vol. 31, No. 1, 10–29.

CONFLICTS OF INTEREST AND THE CASE OF AUDITOR INDEPENDENCE: MORAL SEDUCTION AND STRATEGIC ISSUE CYCLING DON A. MOORE Carnegie Mellon University PHILIP E. TETLOCK University of California, Berkeley LLOYD TANLU MAX H. BAZERMAN Harvard University A series of financial scandals revealed a key weakness in the American business model: the failure of the U.S. auditing system to deliver true independence. We offer a two-tiered analysis of what went wrong. At the more micro tier, we advance moral seduction theory, explaining why professionals are often unaware of how morally compromised they have become by conflicts of interest. At the more macro tier, we offer issue-cycle theory, explaining why conflicts of interest of the sort that compromise major accounting firms are so pervasive.

People rely extensively on the advice of experts. Often, these experts face conflicts of interest between their own self-interest and their professional obligation to provide good advice. Conflicts of interest played a central role in the corporate scandals that shook America at the turn of the twenty-first century. Many companies have joined Enron and WorldCom in issuing earnings restatements as a result of inaccuracies in published financial reports. Adelphia, Bristol-Myers Squibb, FastTrack Savings & Loan, Rocky Mountain Electric, Mirant, Global Crossing, Halliburton, Qwest, AOL Time Warner, Tyco, and Xerox are some of the firms that have come under scrutiny for potentially corrupt management and a clear lack of independent financial monitoring. At the root of both this mismanagement and the failure of monitoring systems lie conflicts of interest. For example, stock options give upper management incentives to boost short-term stock prices at the expense of a company’s long-term viability. And auditors charged with independently reviewing a firm’s financial reports have often been found This article has benefited from the feedback of Art Brief, George Loewenstein, and three anonymous reviewers. It was supported by a grant from the American Accounting Association. 10

to be complicit with firm management in this effort (Levitt & Dwyer, 2002). Accounting firms have incentives to avoid providing negative audit opinions to the managers who hire them and pay their auditing fees. At large investment banks, research departments have become intertwined with sales departments; stock analysts seeking new business have recommended the stocks of current or potential clients to others. Happy clients boost the investment bank’s business, but members of the public who heed the analysts’ recommendations may not be served as well. The public receives lots of “strong buy” recommendations from analysts, a trend that increases short-term stock value at the expense of long-term investment safety (Cowen, Groysberg, & Healy, 2003). According to Laura Unger (2001), member of the Securities and Exchange Commission (SEC), in the year 2000, a period during which the stock market was in broad decline (the Dow Jones Industrial Average dropped 6 percent, the Standard & Poor’s 500 index dropped 10 percent, and the NASDAQ dropped 41 percent), 99 percent of brokerage analysts’ recommendations to their clients remained “strong buy,” “buy,” or “hold.” Physicians are charged with looking out for the best interest of their patients, a goal compromised by the common practice of giving re-


Moore, Tetlock, Tanlu, and Bazerman


ferrals to clinics and pharmacies in which they have ownership. In addition, biomedical and pharmaceutical manufacturers court physicians with free product samples, free meals, and free travel, in an attempt to influence which drugs they prescribe. Doctors are typically loath to admit that such conflicts of interest affect their judgment. Yet their very livelihood depend on another conflict of interest: prescribing services that they themselves will perform. We argue both that...
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