Client Confusion: Who Does the Auditor Work For?
The auditing profession increasingly sees “client satisfaction” as a measure of a quality audit. Researchers Christopher Koch and Steven Salterio conducted a study that looked at whether this approach makes auditors more or less willing to push back against aggressive accounting practices. In this conversation with Smith Business Insight, Salterio, the Stephen J.R. Smith Chair of Accounting and Auditing at Smith School of Business, discusses what the study found, how the commercial pressures on auditing firms began, and how auditing firms are reacting.
The Effects of Supply and Demand
Back in the 1920s and 30s, there was a severe shortage of accountants and auditors, so if an auditor lost a client for standing up to them, it was no big deal. They could always replace them with another. The fact that it was client management paying the auditor did not really matter at a time when there was a shortage of public accountants.
We saw this again, between 2003 and 2008, when there was a tremendous shortage of auditors due to the need to audit systems of internal control. Once again, auditors were more than willing to quit clients simply because they had more work than they could manage.
But since the mid-1970s onward, there have been way more auditors available than there are audit clients, and this has brought commercial pressures to the forefront. Then the U.S. government, followed by other governments, moved to de-professionalize auditing. They allowed solicitation of each others’ clients, allowed advertising, and eased rules requiring the auditor to, at a minimum, cover the full cost of his engagement.
Given the fact that auditors must earn a living, pricing pressures arose. And because variable costs of an audit are relatively small compared to the fixed cost of running an audit firm, firms can justify a relatively low price on any given engagement. The problem is that when you start pricing all your engagements low, you do not recover your fixed costs, and this is where the firms get into trouble. You have to start figuring out what you’re going to cut, and what tends to get cut is the amount of time allocated to the audit.
Overlooking the Auditor’s Real Customer
What we looked at in this research was the rise of marketing in audit firms based on customer relationship management, which is advocated as a way professional services firms should market themselves. For most professional service firms, good interactions with customers makes sense. They’re there to do the bidding of their clients. Lawyers are there to be advocates. Engineers are there to design things that will work for the client.
In the case of an auditor, it's a different service because you’re being paid by one person — the firm that’s being audited — but your prime area of responsibility is to people you never see, the shareholders of the firm. The shareholder doesn’t sign the check. And audit committees backed off their new responsibility in the early 2000’s to hire, fire, and compensate the auditor. That went away as soon as financial troubles hit in 2008-2009. Suddenly the audit committees shifted their role back to being a cheerleader for the firm as opposed to being a cheerleader for the auditor. So when you start practising customer relationship management, the customer you’re actually in a relationship with is the same person who may have an incentive to lie to you.
Our research asks, If you teach your auditors to treat client management as customers, will it affect the quality of the audit? The underlying “trick” to customer relationship management is identification with the customer. Unfortunately, when you’re supposed to be checking up on the customer — as in the case of the auditors — having greater identification with the customer probably isn’t the best perspective to take.
What the study found, both in our sample of audit partners in Germany combined with old data from colleagues in the U.S that had studied a similar setting, is that implicit pressure did reduce the amount of scrutiny that the auditors were giving to client accounting that was relatively aggressive.
Are U.S. Auditors in Denial?
German audit partners were intrigued to learn about our study. They responded very positively. When we present these results in North America, we get a lot more push back. I think the Germans are more aware of the commercial pressures because they’re so much more recent in Germany. In North America, the commercial pressures have been there since the 1970s.
Canada is the in-between story, but it’s becoming more Americanized every day. A lot of that is because of the reorganization of audit firms on a North American-wide basis. There still is a residue of that professionalism spirit, but the moment you get into cross-border audits, where the Canadian firm is cross-listed in the U.S., a lot of that reticence disappears.
It's almost like audit firms are in two parts in Canada. There is the more traditional, professional-orientated audit that’s done on Canadian-only listed clients. Then there are the Canadian-based audits of cross-border listed firms that suffer from all the problems that American auditors have encountered in the U.S.
— Interview by Alan Morantz