Colleen Honigsberg is an Associate Professor of Law at Stanford Law School. This post is based on her recent article, recently published in the Vanderbilt Law Review.
Theory suggests that regulatory oversight, private enforcement, and reputational risk provide auditors with incentives to perform high-quality work. Yet 2018 provided evidence that accounting scandals remain all too common. From the United States, to the United Kingdom, to South Africa, 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. 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. It is time to ask: Despite the best efforts of Congress, regulators, corporate directors, and investors, why do significant audit failures persist?
In my article The Case for Individual Audit Partner Accountability, published in the Vanderbilt Law Review, 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 current structure of regulatory oversight, private enforcement, and reputation risk are unlikely to induce socially optimal levels of audit quality, and I suggest that we reconsider the role of reputation. To date, the reputational incentives have focused almost exclusively on the audit firm, but recent disclosures make it possible for us to identify the name of the individual partner leading the audit. Using this information, along with additional information that I suggest regulators should make publicly available, we can establish a market for individual audit partners’ brands—a market that can hold individual auditors responsible for their mistakes. I argue that 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.
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