The Economics of Setting Auditing Standards

49 Pages Posted: 23 Apr 2011 Last revised: 29 Sep 2012

See all articles by Minlei Ye

Minlei Ye

University of Toronto

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business

Date Written: June 20, 2012

Abstract

This paper develops a theory of the negotiating positions, or preferences over auditing standards, of the interest groups that may set such standards. Specifically, we consider how the preferences of auditors as standard setters may differ from the preferences of investors. We represent auditing standards by two properties: toughness and vagueness. Toughness is the level of audit effort required by the standards. Vagueness is the uncertainty of audit effort levels that could be considered by different parties as “in compliance” with the standards. Our model predicts that auditors and investors would consider both toughness and vagueness in influencing or setting auditing standards, since preferences over vagueness depend on the level of toughness. We model the market as composed of auditors with different wealth levels and investors with various investment projects and optimal standards will vary across these parties. We show that as a result of such tensions, auditing standards with a degree of vagueness are preferred. By analyzing the economic incentives of different potential standard setters, we help explain how auditing standards have developed in the real world and lay out the foundation for future research on the standards.

Keywords: Auditing standards, vagueness, toughness, auditor liability

JEL Classification: M42, M48

Suggested Citation

Ye, Minlei and Simunic, Dan A., The Economics of Setting Auditing Standards (June 20, 2012). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1815707 or http://dx.doi.org/10.2139/ssrn.1815707

Minlei Ye (Contact Author)

University of Toronto ( email )

Toronto, Ontario M5S 3G8
Canada

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
416-486-5361 (Phone)
416-486-6158 (Fax)

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