The Economics of Audit Quality Private Incentives and the Regulation
This book focuses on market mechanisms which protect quality in the provision of audit services. The role of public regulation is thus situated in the context defmed by the presence of these safeguard mechanisms. The book aims to contribute to a better un
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The Economics of Audit Quality Private Incentives and the Regulation of Audit and Non-Audit Services
by
Benito Arrufiada Pompeu Fabra University, Barcelona
SPRINGER SCIENCE+BUSINESS MEDIA, LLC
Library of Congress Cataloging-in-Publication Data
ISBN 978-1-4757-6728-5 (eBook) ISBN 978-1-4419-5082-6 DOI 10.1007/978-1-4757-6728-5
Printed on acid-free paper
All Rights Reserved © 1999 Springer Science+Business Media New York
Originally published by Kluwer Academic Publishers, Boston in 1999 No part of the material protected by this copyright notice may be reproduced or
utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without written permission from the copyright owner.
To Marisa with gratitude for her love, support and patience
Contents
1
Auditing quality
3
1.1
The demand for financial auditing
3
1.1.1 Financial auditing as a contractual facilitator 1.1.2 Empirical evidence
4
1.2 The dimensions of quality 1.2.1 Technical competence and independence 1.2.2 The importance of professional judgement and the danger of inducing "defensive auditing"
7 8 8 9
1.3 The conflict with third parties and among clients regarding auditor independence
15
2
The safeguard of quality
19
2.1
General analysis of safeguarding mechanisms
20
2.1.1 Explicit and implicit safeguards 2.1.2 The role of quasi-rents in the safeguard of quality 2.1.3 Formal analysis of quality assurance
20 20 21
Strategies adopted to create quality-safeguarding incentives
24
2.2.1
25
2.2
Low-cost strategies
v
Contents
VI
2.3
2.2.2 High-cost strategies
32
The "last period" problem and its consequences for auditing quality
35
2.4 The regulation of quality: Attainable objectives
37
2.4.1 Independence failures in professional practice 2.4.2 Regulation as a facilitator of judicial and market controls 2.4.3 Fragmentation versus safeguard regulatory strategies
37 38 40
3
Auditor independence as an economic decision
43
3.1
Concepts of auditor independence
43
3.2 Economic factors behind auditor independence
44
3.3 The cost of independence: the loss of client-specific assets
49
3.3.1 3.3.2 3.3.3 3.3.4
Volume of quasi-rents to be received by the auditor Specific assets caused by excess capacity Probability of auditor switching Value of client-specific assets when only auditing services are provided
3.4 The costs of dependence 3.4.1 3.4.2 3.4.3 3.4.4
The loss of quasi-rents associated with current clients The loss of quasi-rents linked to potential clients Losses related to professional and criminal liability The role of risk aversion
49 53 54 55 57 58 59
60 64
4
The supply of non-audit services by auditors
69
4.1
Definition and types of non-audit services: the importance of a general analysis
69
4.2 Economies of scope 4.2.1 Auditing technology and firms' complexity 4.2.2 The supply of non-audit services as a natural consequence of modem auditing 4.2.3 Origin and types of economies of scope
71 71 73 74
Con
