Can audit deliver? A multi-angle investigation of how core structures shape auditor competence and independence

Abstract

The requirement for an independent external audit of corporate financial statements emanates primarily from the risk that corporate management may misrepresent the economic performance and financial position of the entity. Yet, despite being highly trained and regulated, auditors often fail to detect/report significant financial statement fraud by their corporate clients. Research in auditing, however, has been predominantly relational, studying the incremental impact of certain variables on imperfect proxies of audit quality. There has been limited direct examination of the typical auditor mindset, behaviour, and approach, and how these are shaped by an entire framework of core, often invariable, structures, thereby hindering the ability of research to contribute meaningfully to audit policy. The current study answers this call and contributes to the literature on both auditor independence and competence, the two dimensions of auditor effectiveness.

A multi-angle qualitative investigation based on the UK context, guided by a critical realist philosophy, was deployed for the research. This consisted predominantly of auditor interviews, alongside the analysis of archival documents on the UK audit context. Auditors’ approach and the underlying forces were also compared to those of activist short sellers who have often successfully detected and reported material accounting fraud while auditors have failed to do so. This was achieved through a small-n archival case study, researcher and media interviews with short sellers and a review of other archival documents on the short selling industry.

The theoretical framework applied to interpret the research findings was one that draws on institutional theory and resource dependence theory to explain institutionalised organisations’ behaviour. Specifically, the research finds that the expectations of the client board, i.e., those that audit firms depend on for their contract, diverge from those of the beneficiaries of the statutory audit which creates a conflict between their institutional aims and their operational objectives. Consequently, audit firms engage in multiple resistance strategies as they try to meet institutional requirements to retain their audit licence and avoid regulatory and legal repercussions while also meeting client board expectations, to ensure their survival and success. These strategies include implementing institutional prescriptions and demonstrating compliance, but not embodying them in spirit, as well as constraining the expectations and methodology embedded within auditing standards. As such, the study also demonstrates that auditor independence and auditor competence are not unconnected concepts. Recommendations are therefore made for a change to auditors’ contracting arrangements to address their restrictive resource dependence as well as changes to auditing standards, to ensure audit can truly deliver on societal expectations. Other less radical remedies are also presented.

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ORCID for Oliver Marnet: orcid.org/0000-0001-9450-2332

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