Auditor independence, self-interested behavior and ethics: some experimental evidence

Haim Falk, Bernadette Lynn, Stuart Mestelman, Mohamed Shehata 

Journal of Accounting and Public Policy 18 (1999) 395-428

Abstract

Our paper presents the results obtained in a laboratory environment in which subjects revealed their beliefs about an uncertain state of the world and then participated in a simple task which required them to report on whether the report of a second party is consistent with the subjects’ beliefs. Because maintaining prior judgements (audit independence) which were in disagreement with the second party’s decision (a potential

for a qualified audit opinion) were costly to the subject, a situation was created in which the subject might compromise her beliefs at a price. The results suggest that amoral, selfinterested profit-maximizing behavior does not generally characterize the subjects in this experiment. Furthermore, subjects compromise their beliefs less often, i.e., breach independence, the higher their scores on a Defining Issues Test, but more often, the greater the cost of adhering to their beliefs. © 1999 Elsevier Science Inc. All rights reserved.

Full text download

A model of corporate rent-seeking through tax legislation

Journal of Accounting and Public Policy 18 (1999) 375-394

Michael G. Williams a, Charles W. Swenson

Abstract

An analytic model is developed to examine the role of rent-seeking expenses on tax legislation. Rent-seeking expenses are found to be only a fraction of the tax benefits at stake. Rent-seeking expenses increase when firms cannot cooperate, when very general tax legislation is proposed, and when there is legislative support for tax cuts. © 1999 Elsevier Science Inc. All rights reserved.

Full text download

Discussion of ``economic analysis of accountants’ ethical standards: the case of audit opinion shopping''

Comment

Journal of Accounting and Public Policy 18 (1999) 365-373

Charles J. Coate

Abstract

In his paper, Cushing (Cushing, B.E., (1999). Economics analysis of accountants’ ethical standards: The case of audit opinion shopping. Journal of Accounting and Public Policy 18 (4/5)) argues for an increasing role of ``laissez-faire'' approaches to professional accounting ethics. To formally present his argument, Cushing (1999) employs a classic auditor±client dispute over a financial reporting issue; the dispute’s resolution is framed within a prisoner’s dilemma game. Three increasingly sophisticated models are used to examine both strict (explicit rules and monitoring) and laissez-faire (moral training and leadership) approaches to induce ethical auditor play within the prisoner’s dilemma game. My comments are an effort to consider if Cushing's (1999) arguments for a laissezfaire approach are practicable. To do this I first relate Cushing's (1999) arguments to the theoretical attributes of a profession. Second, I extend his arguments to include ethical disposition. Two bases of ethical disposition are discussed, moral reasoning theory and the persona of individuals. I conclude that a movement toward a laissez-faire approach to ethics is a strategy the profession should not ignore. © 1999 Elsevier Science Inc. All rights reserved.

Full text download

Economic analysis of accountants' ethical standards: The case of audit opinion shopping

Journal of Accounting and Public Policy 18 (1999) 339±363

Barry E. Cushing

Abstract

The public accounting profession presently employs a strict system of ethical standards that relies upon explicit rules plus monitoring and enforcement procedures that penalize violations of the rules. An alternative approach to ethical standards that the public accounting profession may wish to consider is a laissez faire approach. Instead of rules and penalties to enforce desired behaviors, the laissez faire approach utilizes moral training and leadership to motivate professional accountants to act in the public interest, for the sake of the profession as a whole. The theoretical basis for the laissez faire approach is a growing body of evidence in economics and related disciplines that people often take actions to further the collective welfare of a group despite a detrimental effect on their own selfish interests. This paper offers a framework for examining the relative economic merits of the strict and laissez faire approaches to ethical standards within the accounting profession. The framework is based on game theory, and the setting employed in the paper involves opinion shopping by audit clients. The paper finds that the effectiveness of a laissez faire approach to ethical standards, at least in the opinion shopping scenario, is related to (a) the ethical climate, which refers to the likelihood a given independent auditor will choose the ethical action, (b) the frequency of independent auditor rotation, which reduces the economic advantage of being the incumbent auditor, (c) the explicitness of Generally Accepted Accounting Principles (GAAP), which reduces uncertainty over whether or not a particular act is ethical, (d) the availability of opportunities to discuss ethical choices with rival auditors, and (e) disclosure requirements associated with auditor±client disputes over material accounting issues.©1999 Elsevier Science Inc. All rights reserved.

Full text download

Research in ethics and economic behavior in accounting

Guest Editorial

Journal of Accounting and Public Policy 18 (1999) 335-338 

Frances L. Ayres, Dipankar Ghosh

Important in recent years. To promote ethical behavior organizations have used techniques such as ethics hotlines, code of ethics, appointed ethics officers, and undertaken other ways of encouraging ethical behavior (Morf et al., 1999, especially pp. 265, 269).

Professional norms in tax practice also have significant ethical dimensions. The widely accepted view among accountants is that, while tax evasion is unethical, tax avoidance is expected and is considered a building block of sound tax planning. The problem lies in determining where one ends and the other begins. For example, we have heard comments that suggest that officials of large corporations view their tax return as a first offer, and spend years negotiating with the Internal Revenue Service to reach final settlements on their tax returns.

Despite the increasing interest in ethics among the business community, and the significant cost to shareholders of lapses in ethics, ethics-related academic research in accounting has been limited. In large part, we feel this stems from a research paradigm focusing on descriptive as opposed to prescriptive research, in addition to a belief that ethical issues are not conducive to economic modeling or empirical research. A notable exception is a paper by Eric Noreen (1988, pp. 363-364) in which he argues that ethical behavior can coincide with maximization of economic welfare. He (1988, pp. 363-364) focuses on ethical behavior as a utilitarian concept, and argues that efficient economic exchange is facilitated by voluntary compliance with a set of mutually agreed upon rules of behavior. Compliance is encouraged by cultural expectations that are expressed as a part of religion, behavior norms (conscience), and even biological survival (see Noreen, 1988, pp. 364-369). Codes of ethics also serve as a means of encouraging and describing ethical behavior (Loeb 1971, p. 4; 1984, p. 53).

full text download

Accounting ethics research

Editorial

Journal of Accounting and Public Policy 18 (1999) 333-334

I first began doing research on accounting ethics in 1969 (see, e.g., Loeb, 1970) when the topic was not a particularly fashionable area for academic research (see discussion in Previts and Merino, 1998, pp. 339-340). In the last decade there has been an increase in academic accounting ethics research. This increased interest in academic accounting ethics research may be due to a number of factors such as the Tread way Commission report (1987) and the activities of the American Accounting Association in the areas relating to accounting ethics (see, e.g., Loeb and Rockness, 1992, especially pp. 485-487; Ayres and Ghosh, 1996, p. 77). The three main articles and comment that follow are drawn from a conference entitled ``Ethics and Economic Behavior in Accounting and Taxation'' that was held at the University of Oklahoma in April of 1997 (see Ayres and Ghosh, 1996, 1999). The conference coordinators, Professors Frances L. Ayres and Dipankar Ghosh, are also Special Associate Editors for this partial special theme issue that relates to ``economic behavior'' and accounting ethics (Ayres and Ghosh, 1996, 1999). An important issue relating to accounting ethics research is defining what is accounting ethics research. I view the conference directed by Professors Ayres and Ghosh and this partial special theme issue as part of an ongoing effort to better define the young and hopefully growing field of academic accounting ethics research.

Full text download 

Audit committee activity and agency costs

Research Note

Journal of Accounting and Public Policy 18 (1999) 311-332

Paul Collier, Alan Gregory 

Abstract

Menon and Williams indicate that many United States (US) over-the-counter (OTC) firms which form audit committees appear not to rely on them (cf. Menon, K., Williams, J.D. 1994. Journal of Accounting and Public Policy, 13(2), 121-139). Reliance on audit committees appears to depend upon board composition, while audit committee activity is associated with firm size. In this paper, we compare the US experience and evidence on audit committees and monitoring with the position in the United Kingdom (UK), where there has been a steady growth in the number of major companies voluntarily forming audit committees over the last 15 years (Collier, P.A. 1996. Accounting, Business and Financial History 6(2), 121-140). We contend that the dataset is best analyzed using the Heckman procedure (cf. Heckman, J.A. 1979. Econometrica 47(1), 153-161) which captures the two stages of the decision on audit committee activity. Our results show little support from the UK data for the findings of Menon and Williams (cf. Menon and Williams, 1994. Journal of Accounting and Public Policy 13(2), 121-139). However, consistent with their agency theoretic perspective of monitoring, we found that high quality (Big Six) auditors, and to some degree leverage have akan positive relationship with audit committee activity. Contrary to an agency theoretic expectation, we found that audit committee activity is reduced in firms that combine the role of chairman and chief executive. On the basis of this result we explored the impact of insiders (executive directors) and found that their presence on an audit committee had a significant negative impact on audit committee activity. This result suggests that the emphasis placed by the US Securities and Exchange Commission (SEC) (Staff Report on Corporate Accountability, US Government Printing Office, Washington, DC, 1980, p. 491) and the Cadbury Committee (Committee on the Financial Aspects of Corporate Governance. 1992. Report of the Committee on the Financial Aspects of Corporate Governance. Gee, London) on the independence of audit committee members may be well founded. The reduction in audit committee activity that arises from the combination of the role of chairman and chief executive officer, and the presence of insiders on the audit committee, has important policy implications. Indeed, in the UK, both practices are the subject of recommendations in the Hampel Committee report Hampel Committee 1998. Committee on Corporate Governance. Gee, London. ©1999 Elsevier Science Inc. All rights reserved.

Full text download