Study Reveals Divergence in Auditor and Investor Perceptions
Research conducted by scholars at North Carolina State University’s Poole College of Management indicates a significant disparity in how auditors and investors perceive the materiality of corporate misconduct. The study reveals that auditors, when thinking from an investment perspective, are more inclined to view executive wrongdoing as a serious concern for investors. Conversely, in their professional roles, auditors often regard such incidents as less significant to their companies’ financial health.
Eileen Taylor, a professor of accounting and co-author of the study, describes this phenomenon as an “expectation gap.” This gap arises from differing definitions of materiality, which, according to the Public Company Accounting Oversight Board (PCAOB), pertains to information that could substantially influence an investor’s decision-making process.
The research paper titled “The Relevance and Materiality of Illegal Acts: Examining Auditor and Investor Judgments,” aims to quantify this expectation gap. The authors conducted a survey involving 163 participants, predominantly consisting of current and former audit professionals. Respondents were divided into two groups: one assumed the role of auditors, while the other took on the investor perspective. Findings indicate that auditors were less likely to associate illegal actions by corporate leaders with their firms’ financial statements, whereas investors maintained a strong belief in the correlation between a CEO’s unlawful behavior and the company’s performance.
Changing Standards and Industry Pressures
Traditionally, auditors have focused strictly on a company’s financial documents when assessing material issues. However, there is increasing public demand for auditors to consider management behavior in their evaluations. Taylor notes that this shift creates a dilemma for auditors, as they fear accountability for not reporting illegal acts while also risking their relationships with clients if they do.
Taylor elaborated on this tension, emphasizing that the compensation structure for auditors, who are often paid by the very companies they audit, complicates their independence and decision-making.
Her findings were published in The Journal of Business Ethics, where she discussed the implications of the expectation gap and potential strategies for addressing it.
Addressing the Expectation Gap
One of Taylor’s recommendations for bridging the expectation gap involves forming focus groups of investors to gather their views on the issue. She suggests that auditors, due to their training and inherent biases, may struggle to adopt a broader perspective when evaluating corporate behavior.
Taylor expressed that the longstanding disconnect between public expectations and professional practices presents a challenge for the auditing field. She pointed out that companies often expect auditors to limit their focus to financial data, which can lead to conflicts of interest.
She highlighted that while auditors may dismiss a CEO’s personal misconduct as unrelated to their professional duties, investors perceive such actions as indicative of management’s overall integrity. This disconnect raises questions about the trustworthiness of corporate leadership from an investor standpoint.
Future Research Directions
Looking ahead, Taylor’s research trajectory includes an examination of environmental, social, and governance (ESG) reporting. She referenced a case involving an automaker that misrepresented battery life, exploring differences in perceptions among auditors, investors, and consumers regarding the integrity of such disclosures. This upcoming study will investigate similar themes as the current paper but will focus on the less regulated realm of ESG and sustainability reporting.
Taylor’s work, co-authored with Nicole S. Wright from James Madison University, aims to enhance understanding of how perceptions of materiality can impact both auditing practices and investor confidence.
Source: NC State University. Photo: NC State University.
