of improbably smooth earnings growth, no one has accused them of any illegal accounting, though they did settle a suit in 2009 by the SEC for accounting violations for accounting violations that occurred earlier in the decade. KPMG, the auditor, has not been charged in the case (Norris, 2009). Note that both earnings smoothing and 105 transaction GE’s Lehman’s Repo were both deliberately misleading. Nevertheless, neither action unequivocally violates GAAP or the law. Given this discretion and the fact that management oversees the audit, why auditors always report as management would like? How can audits be, in any don’t real sense, “independent”? We are hardly the first to have noted the potential problems induced by management overseeing the Healy and Palepu, 2001, for a “independent audit” (see review). The received literature includes four lines of argument as to why the private market might deliver high-quality, independent audits even when the conflicted manager is responsible for contracting for the service: (i) commitment to professionalism; (ii) the market disciplining effects of reputation; (iii) the deterrence of legal liability; and (iv) owner oversight of auditors. We now discuss, in turn, each of these lines of argument, considering the basic theories and their potential weaknesses. Professionalism The rhetoric of the accounting profession surrounding issues of independence has traditionally emphasized the notion of professionalism and character. Thus, for example, representing the accounting profession, Gary Shamis testified before the SEC in 2000 that rules limiting the ability of auditors to cross-sell consulting services were are professionals that follow our code of ethics and practice unnecessary because: “We
of improbably smooth earnings growth, no one has accused them of any illegal accounting, though they did settle a suit in 2009 by the SEC for accounting violations for accounting violations that occurred earlier in the decade. KPMG, the auditor, has not been charged in the case (Norris, 2009). Note that both GE’s earnings smoothing and Lehman’s Repo 105 transaction were both deliberately misleading. Nevertheless, neither action unequivocally violates GAAP or the law. Given this discretion and the fact that management oversees the audit, why don’t auditors always report as management would like? How can audits be, in any real sense, “independent”? We are hardly the first to have noted the potential problems induced by management overseeing the “independent audit” (see Healy and Palepu, 2001, for a review). The received literature includes four lines of argument as to why the private market might deliver high-quality, independent audits even when the conflicted manager is responsible for contracting for the service: (i) commitment to professionalism; (ii) the market disciplining effects of reputation; (iii) the deterrence of legal liability; and (iv) owner oversight of auditors. We now discuss, in turn, each of these lines of argument, considering the basic theories and their potential weaknesses. Professionalism The rhetoric of the accounting profession surrounding issues of independence has traditionally emphasized the notion of professionalism and character. Thus, for example, representing the accounting profession, Gary Shamis testified before the SEC in 2000 that rules limiting the ability of auditors to cross-sell consulting services were unnecessary because: “We are professionals that follow our code of ethics and practice
AB-JAK_20110531-jn.docx