herrbach - 2001 - audit quality, auditor behaviour and the psychological contract

This article was downloaded by: [University of Hong Kong Libraries] On: 29 July 2013, At: 20:30 Publisher: Routledge Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK European Accounting Review Publication details, including instructions for authors and subscription information: http://www.tandfonline.com/loi/rear20 Audit quality, auditor behaviour and the psychological contract Olivier Herrbach Published online: 10 Nov 2010. To cite this article: Olivier Herrbach (2001) Audit quality, auditor behaviour and the psychological contract, European Accounting Review, 10:4, 787-802, DOI: 10.1080/09638180127400 To link to this article: http://dx.doi.org/10.1080/09638180127400 PLEASE SCROLL DOWN FOR ARTICLE Taylor & Francis makes every effort to ensure the accuracy of all the information (the “Content”) contained in the publications on our platform. 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Terms & Conditions of access and use can be found at http:// www.tandfonline.com/page/terms-and-conditions Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 The European Accounting Review 2001, 10:4, 787–802 Audit quality, auditor behaviour and the psychological contract Olivier Herrbach Universite´ des Sciences Sociales de Toulouse ABSTRACT The quality of the opinion provided by audit  rms is an important determinant of their long-term survival. Howev er, audit quality is dif cult to gauge, which makes it particularly sensitive to the behaviour of the individuals who carry on audit work. Differences of interest between partners and other  rm members can then h ave adverse consequences on the work motivation of  eld auditors. In particular, audit quality reduction behaviours are de ned as actions taken by an auditor during an engagement that reduce evidence-gathering effectiveness inappropriately. These acts can threaten audit quality or damage the reputation of the profession. This paper, which is based on a survey of 170 audit seniors working in large audit  rms in France, uses a model based on ‘psychological contract’ assessment and affective commitment to account for audit quality reduction behavio urs by the respondents. The resul ts show that the psycholo- gical contract elements dealing with the profe ssional aspect of auditing are the most in uential, and that affective commitment is correlated to social but not to technical quality reduction behaviours. The perception, by the respondents, of the quality of the review process is also signi cant. Some implications of these results for the future of auditing are drawn. 1. INTRODUCTION At the social level, the recognition of audit quality by the economic environment is necessary to the long-term survival of audit  rms. The future of the profession largely depends on its ability to assert an d legitimize the value of audit methodologies and audit o utcomes (Carpenter and Dirsmith, 1993). Quality is also a fundamental element of the competitive game between audit  rms. Research has evidenced the reputational imp act of audit quality perceptions on the structure of the audit market (Moizer, 1997). However, audit quality is characterized by a strong ambiguity that makes it hardly demonstrable. Unlike many other economic activities – where quality can involve precise and relatively objective criteria allowing to de ne and measure it – audit quality is problematical Address for correspondence LIRHE, Universite ´ des Sciences Sociales, 31042 Toulouse Cedex, France. E-mail: herrbach@univ-tlse1.fr Copyright # 2001 European Accounting Association ISSN 0963-8180 print=1468-4497 online DOI: 10.1080=09638180020017087 Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 both intrinsically and for  nancial statement users (Warming-Rasmussen and Jensen, 1998). It is also widely questioned within the debate on the expectations gap, which casts doubt on the profession’s ability to properly carry on its social role (Sikka et al., 1998). Audit quality has been investigated within a variety of perspectives in the literature: independence (Jeppesen, 1988), ethics (Moizer, 1995) or judgement (Libby and Luft, 1993). Little research, however, has been devoted to the organizational aspects of audit performance (Power, 1995 ). This is unfortunate since research on the audit team (Pentland, 1993 ) or audit managers (Humphrey and Moizer, 1990) has given valuable insight into the audit process. Following Hopwood’s (1996) call for more research exploring the ‘black box’ of auditing, this paper addresses the impact of audit seniors’ behaviour on audit quality. More speci cally, it focuses on quality reduction behaviours of audit seniors, i.e. negligence behaviours that can challenge the quality of audit work or damage the image of the profession. In characterizing the relationship between the individual auditor and the au dit  rm as a ‘psychological con tract’, the paper aims to determine which elements of the psycholog ical contract are relevant to audit team members’ performance. The article is organized as follows. First, auditing is described as a double agency relationship where audit quality rests in part on the performance of audit team members (Section 2). Then, quality reduction behaviours by audit seniors are de ned (Section 3) and the empirical research on which the paper is based is outlined (Section 4). The results are presented in Section 5 and some implications for the future of auditing are drawn in Section 6. 2. RESEARCH CONTEXT: AUDITING AS A DOU BLE AGENCY RELATIONSHIP As a monitorin g process set up to lift the asymmetry of information between management and other parties, auditing plays a key role in the agency relation- ship around the corporation. The introduction of an additional actor as controller cannot, however, completely solve the problems linked with such a relationship (Armstrong, 1991). Indeed, auditing can itself be characterized as a double agency relationship between  nancial statement users and audit  rms on the one hand, and the owners of the audit  rms (partners) and their employees (auditors) on the other hand. In th e  rst agency relationship,  nancial statement users (principals) rely on the opinion of the audit  rm (agent) without having access to the accounting system of the company, nor to the audit work performed (see Figure 1). Thi s situation gives rise to various prob lems linked with the economic, competitive and legal constraints faced by audit  rms (Sikka et al., 1998). In essence,  nancial statement users have to trust audit  rms to carry on their work properly and report its outcomes honestly. The second agency relationship involved in auditing deals with the production of audit work within the  rms. Audit  rms are hierarchical organizations where each lay er has a speci c role in the completion of the audit engagement. The 788 The European Accounting Review Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 evidence-gathering work carried on by employee auditors is largely dissociated from th e audit opinion, which is the responsibility of the partner. In th is situation, the audit partner (principal) builds his or her opinion on the basis of the audit  les prepared by the audit team (agents) without attending the preparation of the  les (see Figure 2). This paper deals with the second agency relationship, arising from the asymmetry of information and status differences between p artners and employee auditors. In the largest audit  rms, only a small number of auditors actually become partners. Many employees stay only three or four years with their  rm. Although the opinion of the partner rests on the professional performance of the audit team, employee auditor and partner interests are thus divergent, which can create tensions between these categories. 1 Research on audit  rms in the preceding decade (Dillard and Ferris, 1989) as well as more recently (Rebele et al., 1996) has evidenced weak satisfaction lev els of auditors at the lower ranks of  rm hierarchy. Faced with a heavy workload under strict budgetary conditions, auditors can be tempted to engage in various quality reduction behaviours. Figure 1 Auditing as an agency relationship between  nancial statement users and audit  rms Figure 2 Auditing as an agency relationship between pa rtner and audit team Audit quality, auditor behaviour and the psychologica l con tract 789 Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 3. QUALITY REDUCTION BEHAVIOURS OF AUDIT SENIORS At the technical level, an act of audit quality reduction can be de ned as poor execution of an audit procedure that reduces the level of evidence gathered for the audit, so that the collected evidence is unreliable, false or inadequate quantita- tively or qualitatively. This evidence no longer allows coverage of the risk linked to the  nancial statements. Audit quality reduction behaviours have been presented in several published articles (McNair, 1991; Malon e and Roberts, 1996; Otley and Pierce, 19 96) and their descrip tion will be left out of the scope of this paper. These behaviours are: · reduction of work below what would normally be considered reasonable; · super cial review of client documents; · acceptance of weak client explanations; · failure to research an accounting principle; · failure to pursue a questionable item; · false sign-off. These behaviours are linked to one aspect of audit quality: the pro per execution of audit work programmes. By lowering the care and scepticism involved in auditing, they threaten the outcome of the engagement and the validity of the audit opinion. However, beside this technical dimen sion o f audit work, the existence and justi cation of aud iting are largely dependent on the image generated by the profession (Carpenter and Dirsmith, 1993 ). Therefore, the preservation of a high level of apparent ‘professionalism’ is an important element in the social image of auditing . In that sense, apparent auditor behaviour is as important as work methods or technical competence, all the more so since behavioural aspects are more visible (Grey, 1998) (see Figure 3). To enhance a study of employee auditors’ quality reduction behaviours, it is therefore relevant to consider behaviours that are not directly linked to audit work in itself, but to the more social aspects of auditing. This re ects auditors’ position not only as technicians, but also as individuals bound to present a fac¸ade of Figure 3 The duality of audit quality 790 The European Accounting Review Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 professionalism both outside and inside the  rm with respect to peers, subordi- nates and supervisors. In this paper, which is part of a larger re search centred on the audit team, only behaviours within the audit team are considered, i.e. those involving day-t o-day interactions between team memb ers at the client’s premises or over lunch. Other approaches could be possible, especially those dealing with the sometimes complex relationships of  eld auditors with members of the audited company (Pasewark et al., 1995) or the hierarchy of the audit  rm (Dirsmith and Covaleski, 1985). However, these other aspects of professionalism were left out of this study. The  rst series of behaviours taken into account in this study, which focuses on audit seniors’ role attributes, are: · to supervise a team member inadequately, although supervision is an important element in seniors’ j ob; · to  ll out staff performance appraisals too rapidly, which limits the ef ciency of the formalized evaluation system of the  rms; · to put the audit team under excessive pressure, which threatens team members’ motivation or satisfaction. These behaviours mainly affect the audit team, but indirectly involve the  rm because of their possible impact on the attitudes and morale of team members. Other behaviours directly affect the  rm by runn ing against profes sional values. The non-professional behaviours studied in this research are the following: · to talk about looking for another job in th e presence of the audit team, which shows to others a lack of motivation for auditing and commitment to the  rm; · to gossip about the  rm or its hierarchy, which can harm the cohesion of the  rm; · to cast doubt on the  rm’s methods in the presence of th e audit team, which challenges the ef ciency or effectiveness of the  rm; · to cast doubt on the effectiveness of an audit, or of auditing in general, which challenges the social usefulness of auditing. 4. RESEARCH MODEL From an economics or legal perspective, the nature of the agency relationship between the auditor and his or her  rm can be analysed as involving a ‘work contract’. From a social exchange theory perspective, however, the relationship between individual auditors and their  rms can more largely be characterized as a ‘psychological contract’ in which an auditor exchanges adequate performance against various forms of compensation (Rousseau and Parks, 1993). The psychological contract is a description of the exchange relationship between the employee and the organization that has recently received much attention in the organizational behaviour literature (cf. the Special Issue of the Jou rnal of Organizational Behavior in 1998). It consists in the perception, by the employee, Audit quality, auditor behaviour and the psychologica l con tract 791 Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 of the reciprocal obligations (promises) between himself or herself and the organization. These ‘promises’ are different from mere ‘expectations’ because some reasons (for example, recruiter statements du ring a job interview) make the employee believe that they will be ful lled . The contract is said to be ‘psycho- logical’ because its elements are not necessarily explicit and precise, but can take an ambiguous, undete rmined or implicit character. The work contract and other formalized elements (manuals, internal rules, etc.) play a role in the psychological contract of the employee, but are only a part of it. The psychological contract involves periodic reassessments, by the employee, of the exchange relationship with the employer (Shore and Tetrick, 1994). These assessments can lead to attitu dinal and=or behavioural outcomes. More speci - cally, this research studies the impact o f psychologi cal contract breach or ful lment as an explanatory factor of quality reduction behaviours by audit seniors. Based on Robin son (1996) and a literature review on auditing, ten elements that could be the employer’s contribution in the psychological contract between auditors and their  rms were identi ed: · job security ; · a high salary; · performance-based pay; · interesting work; · an international experience; · career opportunities within the  rm; · career opportunities outside the  rm; · quality professional training; · work autonomy; · enjoyable human environment (two aspects: with colleagues and within the  rm in general). This study seeks to establish a link between the assessment of each of these elements of the psychological contract and qu ality reduction behaviours by audit seniors. As the evaluation of the psychological contract is an essentially cognitive process (Morrison and Robinson 19 97), an affective construct was also included as an independent variable: the affective dimension of organizational commitment (Allen and Meyer, 1990). This construct measures the level of affective attach- ment between i ndividuals and their organiza tions. Two contextual variables are also studied. First, the perception of quality control in the  rm (the assessment, by each auditor, of the ef ciency of the review process) is included since prior research has evidenced its impact on auditor behaviour (Malone and Roberts, 1996; Otley and Pierce, 19 96). Second, the frequency of underreported time (time worked, but not charged by the auditor) is also includ ed, as it has been shown to be a p ervasive element in audit  rms that can be resented (McNair, 1991). The tested model is shown in Figure 4 . This research is based on an anonymous questionnaire sent to French audit seniors. 2 In France, employee auditors begin their careers as assistants for two 792 The European Accounting Review Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 years and are then promoted to senior for another two years. At this stage only some of them are pursuing a professional quali cation – as this really becomes an issue only at the manager level – but all of them hold a university degree in some business-related  eld. The reason for the choice of this study population is twofold. First, it is a pivotal rank in the hierarchical structure of audit  rms. Also, the socialization of indivi duals of this rank is suf ciently advanced (two to four years of experience) to have stabilized attitud es and behav iours, wh ich authorizes a static research model. The questionnaire was launched in autumn 1998. It was sent to auditors working in the large international audit  rms (Big Five) and two of the largest French  rms. A total of 395 questionnaires were sent and 170 exploitable questionnaires were received (43%). This response rate is very high for a mail survey in France and ensures suf cient external validity of the results. In this research, psychological contract assessments were measured using a method based on Robinson (1996) which compares between the perceptions, by each respondent, of  rm promises and their ful lment. For each of the ten elements of the psychological contract, its evaluation is a variable that is negative when a contract breach occurs and positive otherwise. The perc eption of the quality of the review process was measured by two items: ‘The review process in my  rm is effective in ensuring complete aud it work’ and ‘The review process in my  rm is effectiv e in ensuring honest audit work’. The frequency of the behaviours was measured by asking auditors how often they engage in each quality reduction behaviour (Very often, Often, Sometimes, Rarely, Never). This scale is the one used by other research on the subject (Otley and Pierce, 1996). Underreporte d time was measured in the same way. The self-reported frequencies of the behaviours (in per cent of answers) are shown in Tables 1 to 3. It appears that the most severe behaviour (false sign-off ) is the less frequent and a large proportion of auditors say the y never commit it. Other behaviours are more frequent. Among them, failure to pursue a questionable item is the least Figure 4 Research model Audit quality, auditor behaviour and the psychologica l con tract 793 Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 common, which is reassuring as this is the basis of audit work. In general, the frequencies observed in this study are a little larger than those measured in the USA (Malone and Roberts, 1996) and Ireland (Otley and Pierce, 1996). It is dif cult to conclude, however, that French auditors are more negligent than their American and Irish colleagues as cultural biases may have affected the answers or the understanding of the questions. Only false sign-offs are more frequently admitted by American and Irish auditors. Given the sensitivity of th is question, this result also has to be taken with care. The proportion of respondents who neglect at least ‘Sometimes’ their duties linked with team management is quite high. This result is in line with prior research that has highlighted the problems linked with the evaluation systems in audit  rms (Hunt, 1995) and the lack of emphasis  rms put on team management Table 1 Audit quality reduction behaviours Behaviour Very often Often Sometimes Rarely Never Reduction of work below what is considered reasonable 1 12 40 37 10 Super cial review of client document 2 14 39 37 8 Acceptance of weak client explanation 2 9 34 37 18 Failure to research an accounting principle 2 16 22 41 19 Failure to pursue a questionable item 1 6 18 42 33 False sign-off 0 0 2 6 92 Table 2 Te am mismanageme nt Behaviour Very often Often Sometimes Rarely Never Supervise a team member inadequately 5 18 41 31 5 Fill out staff performance appraisals too rapidly 6 17 33 35 9 Put the audit team under excessive pressure 3 9 28 48 12 Table 3 Non-professional behaviours Behaviour Very often Often Sometimes Rarely Never Talk about looking for another job in presence of the audit team 5 17 29 24 25 Gossip about the  rm or its hierarchy 5 14 29 32 20 Cast doubt on the  rm’s methods in presence of the audit team 1 11 29 33 26 Cast doubt on the effectiveness of an audit, or auditing in general 2 10 27 35 27 794 The European Accounting Review Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 [...]... evaluation of the psychological contract regarding high pay and the frequency of audit quality reduction behaviours There are at least two ways to interpret this result One possible explanation could be that the less conscientious auditors may feel satis ed with their pay in view of the performance level they have, while on the other hand at least some of the more conscientious auditors may feel that they are... some of the issues involved may be known by the client who may wonder why Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 Audit quality, auditor behaviour and the psychological contract 799 they were not detected and question the effort put into the engagement by the audit team As such, quality reductions can be a threat to the credibility of the rm More generally, the reputation... risk The frequencies of audit quality behaviours reported here and in other studies show that there seems to be as much ‘ exibility’ in the completion of audit procedures by audit seniors as there is in their selection during the audit planning process Audit quality reduction behaviours therefore seem to be unavoidable and it could be argued that the important issue is not to eliminate them altogether,... enough given their effort Another explanation– if it is assumed that the best evaluations about this contract element are made by those auditors who are indeed better paid, and that these individuals are considered the best by the rms – could be that the auditors who are the most rewarded nancially by their rms are those who can best handle the constraints of their engagements, even at the cost of being... Libraries] at 20:30 29 July 2013 Audit quality, auditor behaviour and the psychological contract 795 aspects (Emby and Etherington, 1996) It seems that budget pressure is particularly signi cant in this area, more than on audit quality reduction behaviours If this is reassuring in some respect, one may wonder about the consequences on audit team motivation Non-professional behaviours are a little less... answers The amount of auditors who cast doubt on auditing is quite high, though A higher belief of auditors in their job could have been expected However, it is dif cult to tell whether these beliefs are genuine or are merely another instance of what Dirsmith and Covaleski (1985) call the auditor s occupational hazard of being a cynic’ 5 RESULTS In order to test the link between quality reductions and the. .. is positive in a way, but the new methodologies also depend more on the conscience of individual auditors The results of the statistical analysis show that the most signi cant variable in the model is the perceived level of the quality control system of the rms This illustrates the importance of the review process in audit rms Now, the major change in work methodologies that audit rms are currently undergoing... about the validity of the selfreported measures Despite its limitations, this study has made several contributions to our understanding of auditing It is a reminder that audit quality – whatever the actual de nition of that problematical concept may be – is dependent upon the Downloaded by [University of Hong Kong Libraries] at 20:30 29 July 2013 Audit quality, auditor behaviour and the psychological contract. .. supported by the results for the variable Underreported Time Auditors who do more underreported time also do not differ in AQRB, although they do for non-professional behaviours The squared multiple correlation of the dependent variable TEAM is 0.27 The GFI, AGFI and RMR of the model are 0.99, 0.93 and 0.043, respectively, which are all acceptable The results are mostly in line with those of the other variables,... to make sure their impact remains limited NOTES 1 The nature of the relationship between an auditor and his or her rm largely varies according to the rank of the individual Therefore, the agency relationship model presented here may no longer be valid as such for higher-level non-partner auditors, like senior managers However, it remains a good framework for assistants, seniors and even the more junior . 787–802 Audit quality, auditor behaviour and the psychological contract Olivier Herrbach Universite´ des Sciences Sociales de Toulouse ABSTRACT The quality of the opinion provided by audit . nancial statement users and audit  rms on the one hand, and the owners of the audit  rms (partners) and their employees (auditors) on the other hand. In th e  rst agency relationship,  nancial. instructions for authors and subscription information: http://www.tandfonline.com/loi/rear20 Audit quality, auditor behaviour and the psychological contract Olivier Herrbach Published online: