Lingering lessons of Enron fiasco: Auditors' concern for reputation can backfire

Jun 14, 2010

New research shows that concern about preserving their good reputation can lead auditors to conceal the kind of irregularities that brought down not only Enron but the auditing firm Arthur Anderson, according to the Management Insights feature in the current issue of Management Science, a flagship journal of the Institute for Operations Research and the Management Sciences (INFORMS).

"The Auditor's Slippery Slope: An Analysis of Reputational Incentives" is by Carlos Corona of the University of Texas and Ramandeep S. Randhaw of the University of Southern California.

, a regular feature of the journal, is a digest of important research in business, management, operations research, and . It appears in every issue of the monthly journal.

The authors consider whether the auditor-client contract should be subject to term limits.

The WorldCom and Enron debacles at the turn of the last century were a black eye for Arthur Andersen and the auditing community and led to the auditing restrictions included in the Sarbanes-Oxley Act of 2002, which requires auditors to remain more autonomous.

Auditors' concerns about their reputation are commonly perceived as having a positive effect on execution of their monitoring and attesting functions. The authors demonstrate that this concern can actually have the opposite effect.

Using to analyze manager and auditor relationships, they illustrate how reputational concerns can actually induce an auditing firm to misreport.

Early undetected or unreported slight misconduct by a manager places the auditor in a bad position in future periods, when admission of prior transgressions tarnishes the auditor's reputation. They find that a strategic manager can lead the auditors down a slippery slope, with managerial fraud increasing as the length of the audit firm's contract progresses. In this scenario, as company fraud increases, the probability that the auditor will report it decreases. Ironically, the stronger the auditor's current reputation, the stronger is the incentive to misreport after the reporting omission of initial malfeasance.

The authors' lesson for management is that long-term relationships between auditing firms and clients can lead to inaccurate reporting despite - or perhaps because of - the auditing firm's good .

Explore further: What happened to savings for the future?

More information: The current issue of Management Insights is available at http://mansci.journal.informs.org/cgi/reprint/56/6/iv.

add to favorites email to friend print save as pdf

Related Stories

Recommended for you

Industrial clusters fuel economies, according to study

Dec 22, 2014

Experts have long theorized that having a cluster of firms within a given industry helps a region's economy grow. Now a study co-authored by an MIT professor shows empirically that clusters of almost all ...

Economic output less dependent on road transportation

Dec 22, 2014

For the past 10 years, motorization in the U.S. has been on the decline, due mainly to more telecommuting, greater use of public transit, increased urbanization of the population and changes in the ages of drivers.

User comments : 0

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.