Observations on the Role of Commodification, Independence and Governance in the Accounting Industry

23 Pages Posted: 8 Dec 2003

See all articles by Jonathan R. Macey

Jonathan R. Macey

Yale Law School

Hillary A. Sale

Georgetown University Law Center; Georgetown University - Robert Emmett McDonough School of Business


In this Article, we argue the internal corporate governance structure of the big accounting firm is fundamentally flawed, and that this flaw contributed to the current crisis of confidence in the integrity of public reporting. The incentive structure within accounting firms makes it virtually impossible for auditors to be independent of significant clients like Enron. The result has been a change in the balance of economic power between accounting firms and their clients - individual audit partners suffer from client capture. In addition, to their lack of independence, accounting firms and partners lack accountability in part due to the advent of the limited liability partnership structure. Despite these problems, federal securities laws and regulations require auditors to provide independent audits to companies. The result has been the commodification of audits and a market in which audits are bought and sold. As a consequence, audits no longer serve the economic purpose for which they were required - providing information that protects investors and leads to the efficient pricing of securities.

Although the provisions of the Sarbanes-Oxley Act offer some help in resolving the capture, governance, and commodification concerns we raise, we conclude that more is needed. Sarbanes-Oxley established the Public Company Accounting Oversight Board. This Board is to register the public accounting firms, set standards for their reports, inspect and investigate the firms, and, when appropriate, sanction firms and individuals. To be successful, the Board will have to replace the incentive system eliminated with the creation of LLPs with its own set of rules and standards, which it will have to enforce vigorously. In addition, Sarbanes-Oxley provides new standards for auditor independence, establishing a requirement that audit firms rotate the partners assigned to clients in order to prevent capture. We conclude that this provision is less likely to achieve its goal, as long as client satisfaction remains the dominant measure of partner performance. Instead, we argue that until lead audit partners are confident that they can fire dishonest clients without fear that doing so will result in the destruction of their own careers, the problems that contributed to the Enron and other significant corporate failures will continue to exist.

Keywords: Enron, Corporate Governance, Securities Law, Securities Regulation, Corporate Law, Sarbanes-Oxley

Suggested Citation

Macey, Jonathan R. and Sale, Hillary A., Observations on the Role of Commodification, Independence and Governance in the Accounting Industry. Yale Law & Economics Research Paper No. 294; and Villanova Law/Public Policy Research Paper No. 2003-18. Available at SSRN: https://ssrn.com/abstract=474741 or http://dx.doi.org/10.2139/ssrn.474741

Jonathan R. Macey (Contact Author)

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
+203-432-7913 (Phone)
+203-4871 (Fax)

Hillary A. Sale

Georgetown University Law Center ( email )

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

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