Auditor’s Dilemma: “Client Satisfaction” Turns a Discerning Mind to Mush
- Auditing firms are responding to commercial pressures by adopting customer relationship management practices aimed at boosting client satisfaction.
- Researchers found that the greater the auditor’s afﬁnity for the client, the smaller the adjustment to the financial statement the auditor proposed. Further, auditors who experienced greater explicit client pressure proposed smaller adjustments to client accounting compared to auditors experiencing weaker implicit client pressure.
- But if auditors perceived the client pressure was too intense and felt their self-image as an independent professional was compromised, they pushed back by proposing larger adjustments to client accounting than those proposed by auditors who perceived client pressure to be weaker.
Accounting scandals, from Enron in the U.S. to Livent in Canada, generally follow a familiar story arc: an early focus on rogue executives, commiseration with victims, finger pointing at regulators. Inevitably, the uncomfortable question is asked: Where were the auditors?
The answer is rarely straightforward, particularly for small-scale cases of aggressive accounting that don’t hit the front page. Some say that auditors are inherently compromised because they are paid by the people that they must hold to account.
But others say there is an even more subtle force at play that may limit how well an auditor can rein in a client intent on fudging an annual report: the very business model of auditing firms.
Since the 1980s when markets were deregulated to allow auditors to advertise and solicit other firms’ clients, audit firms have adopted the marketing principle of “keeping your customer close.” Customer relationship management, based on boosting client satisfaction, was the way to grow the business.
That got Christopher Koch, of Johannes Gutenberg University Mainz, and Steven Salterio, of Smith School of Business, wondering: Does customer relationship management increase the affinity auditors feel for their client? And, if so, does the commitment to “client satisfaction” lead to a greater likelihood of an auditor accepting a client’s questionable accounting approach?
“The underlying ‘trick’ to customer relationship management is identification with the customer,” says Salterio, the Stephen J.R. Smith Chair of Accounting and Auditing at Smith School of Business. “Unfortunately, when you’re supposed to be checking up on the customer — as in the case of auditors — having greater identification with the customer probably isn’t the best perspective to take.”
Studying German Auditors
Koch and Salterio set out to test their theory. Their main study focused on 144 German auditors with at least four years of experience in signing audit opinions. In a controlled setting, the auditors were presented with one of several versions of a case that had problematic issues, such as outright errors or tricky judgment calls.
The auditors in the study were encouraged to see the facts through the eyes of the client or their own firm, and were subjected to varying forms of explicit or implicit client pressure. In one version, client managers asked the auditor to evaluate the audit adjustments in light of the client’s merger discussions, but neither explicitly requested that adjustments be waived nor explicitly linked it to continued auditor tenure. In the second version, the client explicitly said that any additional changes should be waived and explicitly linked the auditor’s continued engagement with successful merger talks.
The researchers then measured the auditors’ afﬁnity for client relationship management using a well-accepted scale that measures attitudes.
The results confirmed what the researchers suspected. “Our quasi-experiment with highly experienced auditors shows that both client pressure and audit firm pressure did reduce the amount of scrutiny that the auditors were giving to client accounting that was relatively aggressive,” they report in The Accounting Review.
"We encourage regulators to look much closer at firm-wide management issues that can affect individual audit quality as opposed to assuming that the firm itself is a positive force for audit quality"
Specifically, the researchers found that the greater the auditor’s afﬁnity for the client, the smaller the adjustment to the financial statement the auditor proposed. Further, they showed that auditors who experienced greater explicit client pressure proposed smaller adjustments to client accounting compared to auditors experiencing weaker implicit client pressure.
But they also found there was a tipping point. If the auditors perceived the client pressure was too intense and felt their self-image as an independent professional was compromised, they pushed back by proposing larger adjustments to client accounting than those proposed by auditors who perceived client pressure to be weaker. In fact, auditors who had a greater affinity for the client’s interests also developed a greater sensitivity to perceived client pressure intensity.
In a unique research twist, the researchers validated their conclusions in a U.S. setting. They re-analyzed data from an experiment conducted with American auditors in 2003, accounting for greater intensity of client pressure. They found the American auditors behaved much like their German counterparts: As auditors perceived greater client pressure, they were less willing to accept the client’s preferred aggressive accounting policy.
“If we can trigger this in the laboratory when there is no money on the table,” says Salterio, “then when there is really money on the table and you promote customer relationship management, you’re going to get even stronger identification with the client.”
Regulators, Take Notice
Salterio is quick to say that it is not a matter of rogue auditors acting in an underhanded manner.
“I’ve never met an auditor who wants to be bribed,” he says. “But I have met a lot of auditors who really identify with client management.”
The findings are timely considering the efforts in many countries to develop standardized measures of audit quality. As the researchers note, some have suggested adding client service quality measures as indicators of audit quality. Given the results of this study, equating client satisfaction with audit quality would risk embedding a form of client relationship that actually undermines quality audits.
The study’s findings also give regulatory authorities an impetus to view an audit firm’s management practices as part of a root-cause analysis of audit quality problems. “Regulators have finally begun to realize that there are systematic issues with audit quality, and it's not at the individual engagement level,” says Salterio. “We’re trying to encourage regulators to look much closer at firm-wide management issues that can affect individual audit quality as opposed to assuming that the firm itself is a positive force for audit quality.”
— Alan Morantz