Academic journal article Accounting Horizons

Antecedents and Consequences of Independence Risk: Framework for Analysis

Academic journal article Accounting Horizons

Antecedents and Consequences of Independence Risk: Framework for Analysis

Article excerpt

SYNOPSIS: This paper presents a framework that explains how certain incentives affecting independence risk interact with situational factors to affect actual or perceived audit quality. We articulate the combined effects of direct incentives, indirect incentives, and judgment-based decisions involving difficult accounting issues, materiality, and audit conduct. We then identify a variety of factors that may mitigate independence risk, including corporate governance mechanisms, regulatory oversight, auditing firm policies, auditing firm culture, and individual auditor characteristics. Finally, we discuss the effects of independence risk on various stakeholders, and propose actions that should be taken by the auditing profession, auditing firms, regulators, and researchers.

Key Words: Auditor, Independence risk, Conceptual framework.


This paper examines certain incentives that may affect independence risk and proposes a framework for analyzing how these incentives interact with situational factors to affect actual or perceived audit quality in the public capital markets. Fundamental to this framework is the notion of independence risk, which we define as the risk that an auditor's independence may be compromised or may be perceived to be compromised. [1] The framework also explains how various factors may mitigate the effect of independence risk on actual or perceived audit quality, and identifies how stakeholders may be affected should these mitigating factors fail. Developing this framework should provide direction for further research to assist the auditing profession, auditing firms, and regulators as they address auditor independence issues.

This paper contributes to the literature on auditor independence in the following ways. First, it presents the antecedents and consequences of independence risk in a unified framework. In so doing, the framework provides insight on the multifaceted factors affecting independence risk and the factors that might potentially mitigate it. One temptation in discussing independence risk is to focus on just a single factor in isolation. For example, a discussion might focus on how family relationships could affect independence risk or on whether regulation is an appropriate method of mitigating independence risk. However, only by considering concurrently the various antecedents and consequences of independence risk can insights be gained about their combined effects. Although regulation alone might not effectively mitigate independence risk, regulation combined with professional training and high ethical standards might be effective. Second, The framework demonstrates how various areas of literature relate to one an other. For example, the framework addresses the relationship between auditor incentives, including the literature on "lowballing" begun by DeAngelo (1981), and judgment-based decision situations in auditing such as book-or-waive decisions discussed by Wright and Wright (1997).

Developing a framework for understanding independence risk is important because independence is the most fundamental and vital asset possessed by the auditing profession. Without unquestioned independence, audits have little value. In the context of public capital markets, the value of an audit arises from its role in addressing an inherent conflict of interest in those markets. This conflict is between those seeking capital in the market place and those providing capital. Those seeking capital want to raise it on the most favorable terms to themselves; those providing capital want to do so on the most favorable terms to themselves. In public capital markets, capital seekers generally possess inside information about the issuing company and the prospects for its future success that are not available to capital providers. Because those seeking capital also have the ability to mislead capital providers about the issuer's prospects for future success, capital providers are inherently disadvantaged in their abili ty to control, negotiate, or evaluate the terms of offerings and trading prices in public capital markets. …

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