External auditor's ethical dilemma: Perceived threat to auditor's responsibility posed by the auditor's allegiance to corporate management
Abstract
Major accounting scandals and audit failures (such as Enron and WorldCom) during the turn of the century seriously impaired the public's confidence and trust in audited financial statements. This had cast a shadow on auditor independence, integrity and professional conduct, and led to the collapse of Arthur Andersen (AA), one of the then Big-5 public accounting firms. Some have argued that auditors align their interest with that of corporate management instead of investors and the general public because audit fees are paid by management. This leads to the following question: do auditors appear to compromise their independence and align with their clients' interest rather than shareholders' interest? Our examination of audit fees charged by the Big-5 to a sample of companies investigated by the Securities and Exchange Commission (SEC) reveals that auditors (except for AA) appear to recognize engagement risk at an increased level for SEC investigated audit clients. Accordingly, SEC investigated clients are charged higher audit fees than non-SEC investigated clients. However, AA appeared not to distinguish the engagement risk differences between its SEC investigated and non-SEC investigated clients. Results overall suggest that auditors fulfill their professional responsibility of serving the public interest by maintaining client-auditor independence and objectivity. Although the Sarbanes-Oxley Act of 2002 has been implemented, misleading and fraudulent financial reporting persist, which suggests that there is room for improving audit quality. Accordingly, we provide suggestions to strengthen both audit quality and professional conduct (particularly regarding auditor independence) to enhance the public's confidence in audited financial statements.