The Familiarity Threat and Auditor Independence

Abstract

Although legally auditors are answerable to shareholders, considerable doubt has been cast on their independence from the directors of the company which is audited. Recently, increasing competition amongst auditors and the growing importance to fee income of non‐audit work has been identified as factors which may further erode this assumed independence. Another factor which has been implicit in many studies of auditor independence is the close nature of the relationship between the auditor and the directors of the company. This has been termed the ‘Familiarity Threat’.This article, based on a questionnaire survey of UK finance directors, investigates three aspects of the auditor/director relationship where the ‘Familiarity Threat’ may be present. First is the appointment method and the characteristics which directors consider to be preferable in selecting an auditing firm. Secondly is the duration of the auditors’ appointment and the frequency of contact between the lead partner and the finance director. Finally, is the finance directors’ perception of the nature of the relationship they enjoy with the auditors. For each of these aspects the responses from finance directors from independent public limited companies are compared to those of private companies to ascertain whether the ‘Familiarity Threat’ is more prevalent where certain public responsibilities are not imposed. Where appropriate, the responses are also analysed by the finance directors’ opinions on the probity of non‐audit work to ascertain whether this is an important variable as claimed in the literature.The analysis demonstrates that, although present directors are influential in the appointment process and the personal chemistry between the directors and auditors is the most important desirable characteristic, the finance directors of independent public limited companies would appear to be more aware of their responsibilities to shareholders. However, many relationships are long established with over 40% of both private and independent public limited companies in the survey retaining their auditors for over 10 years. As far as frequency of contact is concerned, public limited companies were visited more frequently by their auditors and this was unaffected by finance directors’ opinions on the probity of non‐audit work. Finally, approximately 75% of finance directors claimed to enjoy a professional and amicable relationship with their auditors and these responses are unaffected by the type of company or opinions on non‐audit work.The article concludes that there is the potential for the ‘Familiarity Threat’ to be present in both private and independent public limited companies, but its influence may be exaggerated particularly in respect of non‐audit work. It recommends that if controls are to be introduced to ensure the threat is kept to a minimum it would be best to concentrate on the selection and appointment process and the duration of auditors’ term of office.