Conflict of interest

Topics: Audit, Big Four auditors, Auditor's report Pages: 45 (12325 words) Published: October 2, 2014
Working Paper # 03-115

Rev. 09/04

Conflicts of Interest and the
Case of Auditor
Independence: Moral
Seduction and Strategic Issue
Cycling
Don A. Moore
Carnegie Mellon University
Philip E. Tetlock
Haas School of Business
Lloyd Tanlu
Harvard Business School
Max H. Bazerman
Harvard Business School

This paper has benefited from the feedback of Art Brief, George Loewenstein, and three anonymous reviewers of an earlier version of the paper. This paper was supported by a grant from the American Accounting Association.

Copyright © 2003 Don A. Moore, Philip E. Tetlock, Lloyd Tanlu, and Max H. Bazerman. Working papers are in draft form. This working paper is distributed for purposes of comment and discussion only. It may not be reproduced without permission of the copyright holder. Copies of working papers are available from the author.

Conflict of Interest

Abstract
A series of financial scandals, climaxing in the 2002 bankruptcy of the Enron Corporation, 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 which explains 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 which explains why conflicts of interest of the sort that compromised major accounting firms are so pervasive. The latter theory depicts organizations as norm creators (not just followers) that: (a) relentlessly seek out rentseeking opportunities under rhetorical smokescreens designed to create attributional ambiguity about their intentions; (b) retreat only under intense pressure, such as that created when conflicts of interest lead to significant losses among important political constituencies; and (c) as soon as outrage wanes, reconcentrate their lobbying efforts to gain the upper hand against countervailing diffuse interests. We close by proposing potential solutions to conflicts of interest.

2

Conflict of Interest

Conflicts of Interest and the Case of Auditor Independence:
Moral Seduction and Strategic Issue Cycling

People rely extensively on the advice of experts. Often, these experts face conflicts of interest between their professional obligation to provide good advice and their own self-interest. Conflicts of interest have played a central role in the corporate scandals that shook America at the turn of the 21st 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 & Loans, Rocky Mountain Electric, Mirant Energy, 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 to be complicit with firm management in this effort. Accounting firms have incentives to avoid giving “bad news” to the managers who hire them and pay their auditing fees, not to mention their highly profitable consulting 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 as well served. The public receives lots of “Strong Buy” recommendations from...


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