The research suggests auditors learn from experiences and improve
After the Enron scandal broke in 2001, Arthur Andersen — the accounting firm Enron had hired to audit the company’s financial statements — was investigated by the Department of Justice. Arthur Andersen quickly collapsed, and even though most of the firm’s 85,000 partners and staff weren’t directly responsible for what happened, they lost their jobs, their wealth tied to the company and their good reputations.
But in the long run, at least some of Arthur Andersen’s former auditors may be better off for the experience.
In a recent study, BYU Marriott School of Business accounting professor Tim Seidel and colleagues at other universities found that partners who worked at Arthur Andersen during its demise now provide higher quality audits than their peer partners at other accounting firms who did not.
Previous research has shown that early life experiences shape how CEOs later manage companies. Seidel’s team wanted to see if the same was true for Arthur Andersen employees. “How might watching your firm implode affect these auditors’ work 15 to 20 years later?” Seidel asked.
To find out, the team compared recent audits by 199 former Arthur Andersen employees — who are now partners in Big 4 accounting firms PwC, Deloitte, KPMG and Ernst & Young — to recent audits by 1,446 of their peers.
The researchers used three proxies that correlate with audit quality and found consistent evidence that former Arthur Andersen auditors appear to provide higher quality audits. Just 0.8% of their clients later issued financial restatements to correct mistakes that weren’t caught in the original audits, compared to 2.3% for peers’ clients. The propensity to report small profits (a sign that a company is manipulating earnings to avoid reporting a loss) was 12% for former Arthur Andersen employees’ clients compared to 14.8% for the others’ clients. Clients of former Arthur Andersen auditors also paid 4.4% higher fees, which indicates that the auditors invested more hours in verifying financial statements.
Seidel believes that former Arthur Andersen auditors are driven partly by a desire for redemption.
“Even today when Arthur Andersen is mentioned in accounting circles, there’s always a joke about shredding documents,” he said. “Former Andersen partners feel the salience of the collapse more. There’s an element of reputation-building and trying to reverse the stigmas attached to them. I’ve seen that come out as I’ve talked to people who worked there during the scandal.”
Former Arthur Andersen auditors may also do better work now because they know exactly how badly things can go when auditing gets sloppy or corrupt. They’re less likely to be swayed by clients’ pressure to approve financial statements and more likely to gather sufficient evidence before offering judgments.
“In our study, auditors who experienced Andersen’s demise firsthand developed greater professional skepticism, which plays a critical role in identifying potential misstatements, whether due to fraud or errors,” said Iowa State University professor Feng Guo, a co-author of the paper.
The research can provide valuable insight to accounting firms as they make hiring, training and assignment decisions.
“A lot of times auditors associated with offices who have done bad audits are seen as inferior, that there’s a contagion effect. This study shows that you should be careful about such judgments,” Seidel said.
“Our research suggests that auditors learn from their experience,” added co-author Ying Zhou, a professor at the University of Connecticut. “So audit firms could explore ways to simulate audit failure in auditor training.”
Seidel said that the research has implications beyond the realm of accounting, too. “As we’re dealing with people and trying to understand them, it’s good to remember that extreme experiences in their past really shape how they view the world and what they do.”
The paper was published in the journal Contemporary Accounting Research and was additionally co-authored by Ling Lei Lisic of Virginia Polytechnic Institute and State University, Jeffrey Pittman at Memorial University of Newfoundland and Mi Zhou at Virginia Commonwealth University.
Writer: Christie Allen