Realigning Auditors' Incentives
25 Pages Posted: 1 Nov 2005 Last revised: 14 Jul 2016
Date Written: January 10, 2003
Accounting reforms for careless audits have not come to grips with the basic problem affecting the accounting industry, which is that accounting firms work for the companies they audit. A lax audit can be conceived of as a multi-period game, in which the immediate and future payoffs to the auditors from cooperating with management in questionable accounting practices exceed the discounted possibility of judgments and sanctions. To alter this payoff structure, it is necessary to reevaluate the employment tie between auditors and public companies. The Article evaluates three proposals to sever that tie: mandatory rotation of audit firms, the system of statutory auditors found in continental Europe, and a proposal to have auditors work for malpractice insurers who insure financial statements.
Keywords: auditor, accounting scandals
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