The Case for Individual Audit Partner Accountability

By Honigsberg, Colleen | Vanderbilt Law Review, November 2019 | Go to article overview

The Case for Individual Audit Partner Accountability


Honigsberg, Colleen, Vanderbilt Law Review


Introduction

Nearly two decades ago, Congress adopted the Sarbanes-Oxley Act of 2002 to improve the quality of financial reporting. Yet 2018 provided evidence that accounting scandals remain all too common. From the United States,1 to the United Kingdom,2 to South Africa,3 the accounting profession saw a series of high-profile audit failures. Perhaps even more damaging to the integrity of the profession, it was revealed that KPMG cheated on its regulatory inspections by obtaining confidential information from its primary U.S. regulator, the Public Company Accounting Oversight Board ("PCAOB"), leading to a criminal investigation.4 And these are hardly isolated incidents: from 2005 to 2016, the PCAOB has found that anywhere from 14 to 33% of the audit opinions it inspected should not have been issued.5 It is time to ask: Despite the best efforts of Congress, regulators, corporate directors, and investors, why do significant audit failures persist?

In this Article, I argue that the answer to this question lies in part in the lack of accountability the law currently provides for individual auditors. I explain that the incentives provided by regulatory oversight, private enforcement, and firm-level reputational sanctions are unlikely to induce socially optimal levels of audit quality. Instead, individual reputational sanctions are more likely to give audit partners optimal incentives for care. Thus, lawmakers, corporate fiduciaries, and investors seeking to improve audit quality should focus on developing a market in the reputational brands of individual audit partners.

Individual brands are common in financial markets.6 Brokerdealers, for example, provide significant individual disclosure in an online database known as Brokercheck, and prior work shows that financial advisors' career outcomes are profoundly affected by these disclosures.7 Securities analysts-commonly grouped together with auditors as gatekeepers-disclose the name of the lead analyst(s) writing the report, again leading to significant reputational consequences for individual analysts.8 By contrast, accounting firms have fought mightily to resist providing market participants with information about individual auditors.

This Article argues that focusing on individual accountability would provide four important benefits. First, individual reputation markets for auditors would cause audit partners to more fully internalize the costs of an audit failure. Allowing audit partners to remain anonymous permits them to enjoy a disproportionate portion of the financial benefits provided by an audit client but share the costs of failure jointly with other partners of the firm-and those partners are imperfect monitors of one another's conduct. Requiring individual partners to take responsibility for their work will better align incentives and induce greater levels of effort.

Second, individual accountability will help mitigate a particular audit risk that has increased over the past decade: the reliance on overseas auditors. The limited research on the use of overseas audit participants suggests that they are associated with increased risk of audit failure.9 But studies also suggest that holding the lead partner to a higher level of accountability can, at least in part, counteract the increased risk by giving domestic partners strong incentives to monitor overseas work.10

Third, a robust market for individual auditors' reputation would make it easier for audit committees and investors to choose higherquality auditors. The evidence shows that there is significant variation in audit partner quality, even among partners at the same firm. Knowing this information would allow market participants to demand higher-quality auditors-while also imposing a penalty on audit partners who fail to protect investors.

Finally, building individual auditor reputation markets could increase competition without the need for aggressive regulatory action. Over 99% of the S&P 500 select one of the Big Four accounting firms,11 and commentators have increasingly taken aim at the oligopolistic structure of the industry. …

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