Auditor Conflict of Interest

The partner in charge of an audit of a client company has two functions; (1) as boss of the auditors who will check the company's records to ensure the accuracy of its accounting statements, (2) to manage the relationship between the auditing firm and its client, the management and audit committee of the board of directors.

It is not hard to see that these two responsibilities conflict. Performing the second function, and in particular to retain the business for the auditor, means being personally close to the very people whose actions are being checked. Most often the conflict is lived with, and no great harm results. But when stressed (think Enron), this conflict can bring catastrophe.

The conflict is not inevitable, however. Suppose an auditing firm were hired for a five-year, non-renewable contract. Then all parties know that the management cannot influence the auditors with the threat, real or implied, of losing the business if management doesn't like the audit. Function (2) of the partner in charge changes to be more about business and less about golf.

It can be anticipated that neither auditing firms nor their clients will like the reform. Management would lose a tool to influence the audit; auditors would lose the prospect of long-term business. Both would try to convince regulators and shareholders that costs would increase. If so, the extra cost would be in having fresh eyes look at the accounts of the company. And that's a benefit well worth the extra cost, if any.