Market Competition and Auditor Independence

Abstract

n the past two years, Australia and other jurisdictions have again witnessed a series of unsignalled corporate collapses. As with previous generations of corporate collapse several have been associated with questionable accounting policies and concerns with auditing quality. With the decomposition of the former global auditing firm once known as Arthur Andersen, the implications for the accounting profession are seen as more serious than ever before. Over many decades corporate community and regulators in Australia and other jurisdictions have implemented change after high profile company failures occur. Some of the implemented changes have, over time, enhanced the quality of auditing but we continue to see unsignalled corporate failures, prompting an ongoing perception that the audit process is not delivering a product of value to the market. This perception has been described as an ‘expectations gap’, which arises in part because what is expected by market participants is not realistic. However, of serious concern for the auditing profession is the fact that there remain instances where people with clear understanding of audit processes and realistic expectations of audit outcomes raise concerns about audit quality. This paper argues for the creation of a market-observable audit independence quality control process, developed under the scrutiny of market competition. Such an independence quality control process needs to infiltrate the culture of the audit firm and, critically, to underpin the culture and ethos of the audit processes. Two alternative versions of the model are proposed. One of these involves commissioning regular expert reviews focussed on independence. The second involves each firm that has publicly traded audit engagements establishing an Independence Control Board, composed of respected and knowledgeable individuals not in a position to benefit from the Board’s decisions. The model proposed to quality-control independence represents a ‘marketbased’ solution to the challenges currently facing the auditing profession in that they rely on audit suppliers to have processes visible to the market and to respond to market pressure. The paper argues that a market-based solution is likely to engender efficiencies and transparent quality enhancements that a regulated solution of the type proposed by the Ramsay (2001) Report, the Proposals for Reform Paper No. 9 (CLERP 9) of the Corporate Law Economic Reform Program (2002), and the HIH Royal Commission (2003) will struggle to deliver because of the subtlety and contingent nature of threats to independence.