Did Auditor Conflicted Self-Interest Kill Auditor Mandatory Rotation?

A year-end article in Accounting Today by Richard James laments the demise, in early 2014, of the Public Company Accounting Oversight Board’s (PCAOB) proposal to require mandatory rotation of public company auditors.

PCAOB regulates the accounting industry in America. PCAOB suggested a rule requiring auditors to rotate off audits of a public company after a few years. The basic idea was to strength the quality of audits—thereby improving the integrity and reliability of company financial statements—by removing the bias auditors have in favor of long-time clients.

The accounting industry, represented largely by the American Institute of Certified Public Accountants (AICPA), raised a ruckus. The accountants waged war, hiring big lobbying guns, and prevailed in getting PCAOB to back down.

The whole episode presents a case study of how conflicted self-interest impairs responsible decision-making, even in the case of those who are supposed to be the most independent and objective of decision-makers.

On the question of mandatory auditor rotation, the accounting industry was in a conflict of interest position. The industry sells independent judgment as its stock-in-trade. The CPAs should have recused themselves from the debate and lobbying which resulted in the PCAOB backing down on its mandatory auditor rotation proposal.

The conflict of interest is this: Mandatory auditor rotation would erode CPA firm profits. The first few years of the audit of a new client has a steep and costly learning curve. Auditors do not begin to make big profits on an audit until a few years into the audit. Whatever other consequences would flow from mandatory auditor rotation, the certain one would be less CPA firm profit.

A summary of the science demonstrating the corrupting influence of self-interest on auditor’s judgment is contained in writings by Harvard professor Max Bazerman and others. The studies date back to before Enron. Self-interest is so powerful it has the ability to blind even those who are intent on being objective and independent. That is the very reason that mandatory rotation was a good idea. The CPAs’ failure to recognize this is proof itself.

One can’t help but wonder whether, given its self-interest in the outcome, the AICPA should have recused itself from the auditor rotation debate. Might it have been more professional for the AICPA to note its position of conflicted self-interest, and leave the discussion to others who are truly independent of the outcome? Perhaps the audit profession’s lack of objectivity on the subject of auditor rotation is the strongest argument in favor of auditor rotation.

 

 

 

 

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