Conflicts of interest in auditing a bigger problem than we think

Business

Conflicts of interest in auditing a bigger problem than we think

It creates fertile ground for self-serving bias - and that affects the morally pure and the impure alike

Richard Flockemann


It is a bad time to be an auditor in SA, with several of the big four accounting firms heavily involved in a string of corruption and fraud scandals. Why has this happened?
It is widely recognised that the root cause of these problems is the conflict of interest that is built into the auditing profession. While a number of regulatory changes are on the way designed to further curb such conflicts of interest, most of the proposed changes appear to reflect a misunderstanding of the problem.
Conflicts of interest in auditing stem from the fact that auditors are hired by the companies they audit, and that the accounting firms that auditors work for might provide a range of additional – and lucrative – services for that company. This gives auditors an incentive to keep their clients happy.
How do these incentives affect the quality of an auditor’s work? Whenever I ask accounting students this they tend to assume that conflicts of interest tempt auditors to consciously collude in deceiving stakeholders about the accuracy of a company’s financial statements. When I ask for suggestions to combat this problem, they usually favour introducing stricter oversight and tougher penalties to scare the unscrupulous away from this temptation. This is largely how the treasury is thinking about this problem, too.
However, the lesson from behavioural economics is that conflicts of interest affect us much more deeply than we assume. The danger of conflicts of interest is not only that they create temptations for the unscrupulous, but also that they create the preconditions for the self-serving bias to take hold.
The self-serving bias is a bias towards what we want to be true. It is the tendency to see things the way we want them to be, rather than the way they are. Research suggests that when the evidence at hand is ambiguous and complex, everyone – even the most morally pure of us – is susceptible to this bias.
Imagine that you really want Donald Trump to be guilty of colluding with the Russian state to influence the outcome of the 2016 US elections. In conditions of ambiguity, where the evidence at your disposal could reasonably be read either way, research implies that you will tend to honestly believe that he did collude with Russia, with a degree of confidence that outstrips the evidence. The same applies to those with desires going in the opposite direction.
This is exactly the point at which conflicts of interest become an issue for auditors. Auditors are forced to work in conditions where the evidence at their disposal is limited. By some estimates, it is not unusual for auditors to look at less than 5% of a company’s transactions, given the immensity of a company’s books. And the fact remains that auditors have reason to want to provide an opinion that makes their client happy. So even the most honest and careful auditor will have a tendency to interpret ambiguous evidence the way their client wants them to.
This makes the issue of conflicts of interest much more significant than the accounting students I spoke to assumed. It is not just unscrupulous auditors who will be prone to giving biased opinions: it is everyone. Moreover, since most people are not doing it deliberately, tactics designed to scare liars into reporting honestly will not prove effective.
So how do we solve the problem? Rooting out this bias would require seismic changes to the auditing incentive structure, and there is no political will for the enormous – and costly – disruption this would cause. In the absence of radical overhauls, the best auditors can do is limit the effect of the self-serving bias as much as possible. This has proven maddeningly difficult to do.
However, researchers have found that getting test subjects to focus on weaknesses in their own opinions, in addition to informing them about the self-serving biases, resulted in a significant lessening of the bias’s effect. This means auditors could use a cognitive strategy called “consider the opposite” – a mental game that requires players to ask themselves: what are some reasons my initial judgement might be wrong? The evidence suggests that re-evaluating the question from this perspective significantly offsets the bias.
However, the success of such strategies depends crucially on buy-in from auditors themselves. This is why the first step is to simultaneously tone down the moralising on the issue and increase education. Conflicts of interest do not pose a problem because auditors are especially greedy or incompetent. The self-serving bias is a bias that affects the morally pure and the impure, experts and lay people.
Auditors having to operate in an environment where there are conflicts of interest is a bit like having to work in an extremely loud, distracting workspace – it is simply not an environment conducive to producing your best work, no matter how qualified and well-intentioned you are.
• Flockemann lectures in the philosophy department of Rhodes University.

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