The Professionalization of Public Accounting: A Social Dilemma Perspective

Abstract

This study uses a social dilemma model of auditing and a model of cooperative regulatory enforcement to provide a framework within which the evolution of self‐regulation in the U.S. accounting profession is studied. From a social dilemma perspective, individual public accounting firms are best off, in a single period sense, by providing a low quality audit product, which is defined in terms of the degree of auditor acquiescence to managers' accounting method discretion. However, firms' collective welfare is maximized by high quality auditing. The cooperative regulatory model employed is premised on the existence of a plausible government threat of punishments and invasive regulations, which motivates self‐regulation in an industry. We argue that prior to enactment of the securities acts, public accounting firms faced a social dilemma in which there were limited incentives for high quality auditing either voluntarily or through the establishment of self‐regulation. The securities acts provided a plausible threat to which the accounting industry responded by implementing self‐regulation in order to avoid invasive and costly government regulation. After the emergence of the accounting profession, there occurred a long period of cooperative regulation with the SEC. Management discretion over accounting methods increased during this time period and audit quality correspondingly decreased, suggesting possible inefficient capture of the SEC. Evidence of an evolution towards a tripartite form of regulation appeared in the 1970s when the SEC and public accounting began to be critically reviewed by Congress. From this time to the present, new regulatory threats have motivated a series of self‐regulatory responses by public accounting to improve audit quality.