Mandatory Audit of Financial Reporting: A Failed Strategy for Dealing with Fraud

Building a Better Audit Profession: Align Incentives and Reduce Regulation

“…To be incentive-compatible, this third party should have to internalize both the cost of auditing and the cost of fraud. Jamal (2008) suggests that an insurance company could serve such a role. It is possible to think of other third parties -such as stock exchanges -that could also carry out this appointment function.…”

A Strategy for Dealing with Financial Reporting Fraud: Fewer Mandates, More Auditing*

“…But as the last 15 years have shown, markets left unregulated lead to incentives that cause managers of public companies to take actions that slowly but surely turn fraudulent (Harshbarger and Jois, 2007). Jamal's (2008) solution of deregulating auditing and accounting standards to turn them into marketplace vehicles would likely lead to similar results. What I advocate requires much more work and more thought -using the mass of research that we have developed over the past 40 years to understand the causes of the problems with the current approach to regulation and how we can have a smarter set of regulations (and regulators) that will result in a greater public good.…”

“…So, why not try Jamal's (2008) solution of competing accounting standard-setters, mandating financial statement fraud insurance for public companies, and letting the insurance companies (or other third parties) decide if they will hire auditors and how much work they will have auditors do? Besides the fact that general purpose audited financial statements are a public good as I have argued above and are used for more than just the interests of investors and potential investors, the only advantage that Jamal's proposal might have is that the costs of insurance might be more accurately (and higher in many cases) priced than auditors fees have been.…”

“…So much for what is agreed upon. It is how we interpret these points of agreement, the inferences we make from them, the evidence that Jamal (2008) does not think important, and the interpretation of the overall body of evidence that shape our conclusions as to what is appropriate public policy. Hence, in the remainder of this commentary, I first critique some of the key conclusions reached by Jamal (2008), and then sketch out the argument for a different approach for the audit profession, public accounting firms, and regulators to take that might achieve the desired public policy goal of reduction of the incidence of corporate malfeasance.…”

Renovating the Audit Profession: A Brief Rejoinder to Jamal

“…Further, the current system deals well with the 80 percent of the population that needs at least a small incentive to stay honest in face of temptation (see the evidence on the overall propensity to lie summarized in Salterio and Webb, 2006). 1 Hence, it does not make sense to follow Jamal's (2008b) solution and reconfigure the audit profession by changing completely the incentive system without trying to improve on a system that we know has a high rate of success. Jamal's (2008b) solution to "change the payer/incentives", now broadened to include third-party payers beyond just insurance companies but to stock exchanges as well (new to the latest draft of the paper), sounds simple.…”