Impact of the CFO's affiliation on auditor independence

Abstract

PurposeThe purpose of this paper is to examine the potential impact of two affiliation factors, as encapsulated by the chief financial officer's (CFO) prior organizational (alumnus vs non‐alumnus) and professional background (audit vs non‐audit ex‐partner), on auditor independence in post‐Enron and post‐HIH era.Design/methodology/approachThe study is a 2×2 factorial between subjects experimental design with 52 audit partners and managers as participants. The two manipulated independent variables are client CFO prior firm affiliation (alumni vs non‐alumni) and professional background (audit partner vs non‐audit partner providing taxation, accounting and other non‐audit services).FindingsThe results of the study do not appear to signal loss of independence and professional skepticism in auditors' judgment when dealing with an alumni or ex‐auditor CFO. On average, auditors' endorsement of the client's preferred aggressive accounting treatment is low and the audit adjustment is material and significantly greater than the client's proposed adjustment.Originality/valueThe 2001 corporate collapses of Enron in the USA and HIH in Australia have reshaped the auditing profession. HIH, the most publicized corporate fraud in Australia resulting in estimated losses of $5 billion, was partly blamed on Arthur Andersen yielding to management's aggressive accounting policies and failure to display independence as a result of close relationships between the former partners and the audit team. As distinct from a number of prior studies conducted pre‐Enron and pre‐HIH, the results of this study, conducted with experienced audit professionals in Australia, do not support a loss of independence and professional skepticism by auditors in the current post‐Enron and post‐HIH environment and are consistent with the findings of the only other recent experimental study by Kerler III and Killough examining the closeness of the auditor‐client relationship. The results are also consistent with results of recent archival studies which find a decline in earnings management behavior, either because of reduced management incentives or reduced auditor willingness to consent. The evidence of this study lends supports to the latter explanation.