Auditor's Independence Case Study
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
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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