Conflict of Interest

Topics: Auditor's report, Audit, External auditor Pages: 38 (13112 words) Published: January 20, 2013
Conflict of Interest 1 Running head: CONFLICT OF INTEREST

Auditor Independence, Conflict of Interest, and the Unconscious Intrusion of Bias Don A. Moore Carnegie Mellon University 5000 Forbes Avenue Pittsburgh, PA 15213 Phone: 412-268-5968 Fax: 412-269-7345

George Loewenstein Carnegie Mellon University Lloyd Tanlu Harvard University Max H. Bazerman Harvard University

The authors gratefully acknowledge the financial support of the American Accounting Association and the generous assistance of an anonymous Big 4 accounting firm for providing participants in the first experiment. Helpful comments were received from Daylian Cain, Paul Healy, and from seminar participants at Harvard University and at the Olin School at Washington University. Thanks to Jeff Crilley, Corey Fallon, Erin Morgan, Wemi Peters, and Sam Swift for help collecting the data. Correspondence should be addressed via electronic mail to:

Conflict of Interest 2

Abstract Information about the financial health of public companies provided by auditors ideally allows investors to make informed decisions and enhances the efficiency of financial markets. However, under the current system auditors are hired and fired by the companies they audit, which introduces incentives for biases that favor the audited companies. Three experiments demonstrate bias in auditors' judgments, and show that these biases are not easily corrected because auditors are not fully aware of them. The first experiment demonstrates that the judgments of professional auditors tend to be biased in favor of their clients. The second and third experiments explore more closely the psychological processes underlying the bias. The results suggest that the closeness of the relationship between auditor and client may have a particularly strong biasing influence on auditors' private judgments.

Key words: Conflict of interest; Auditor independence; Self-serving bias; Motivated reasoning

Conflict of Interest 3

Auditor Independence, Conflict of Interest, and the Unconscious Intrusion of Bias By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This "public watchdog" function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust. -Chief Justice Warren Burger, writing on behalf of a unanimous United States Supreme Court in the case of United States v. Arthur Young & Co. (1984)

Independence is central to the function served by auditors. Although managers may have an interest in exaggerating, misrepresenting, or falsifying reports of their firm’s performance, an independent audit report is supposed to provide a credible, unbiased appraisal of the firm's financial status. The importance of auditor independence is reflected in the Code of Professional Ethics of the American Institute of Certified Public Accountants (AICPA) and has been reinforced by numerous legal decisions, such as that rendered by the U.S. Supreme Court in the opening quote. Recent events, however, have led many to question whether the modern practice of public accounting is independent enough. In the wake of a number of accounting scandals, the U.S. Securities and Exchange Commission (SEC) conducted a series of hearings on auditor independence in 2000. The SEC instituted modest changes to disclosure rules after the 2000 hearings and the issue receded from the public agenda until the failure of the Enron Corporation and the role of its auditor, Arthur Andersen, in that failure brought the issue of auditor independence to the fore. In analyzing the...
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