Author: Victor van der Winden Student #: S1383477
Supervisor: Dr. S. Girdhar Co-assessor: Dr. T.A. Marra June 20, 2017
Wordcount chapter 1 -5: 11.955
THE INFLUENCE OF REG ULATOR ENFORCEMENT
STYLE ON AUDIT FIRM’S COMPLIANCE RESPONSE :
AUDIT PA RTNERS’ PERSPECTIVES ON THE EFFECT OF
AFM OVERSIG HT IN THE NETHERLANDS
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Abstract:
In 2006 the Netherlands Authority for the Financial Markets (AFM) was charged with the regulation of the audit profession. Before 2006 the audit profession in the Netherlands was self-regulated. A transition from self-regulation to external oversight often involves a struggle for power and can have unintended consequences. The AFM is dissatisfied with the development of audit quality they perceive to have taken place since the introduction of their regulatory
oversight. Audit clients express dissatisfaction on the development of auditors’ service since the introduction of regulatory oversight too. This raises the question of how the Dutch audit
profession responded to the introduction of regulatory oversight by the AFM. This study
employs in-depth interviews to investigate the auditors’ perceptions on the influence the AFM’s regulatory oversight has had on audit practice. The slippery-slope framework is used to
understand how the perception of the regulator’s enforcement style influences the compliance behavior displayed by Dutch audit firms. Interviews with audit partners and directors reveal that the regulator is found to deploy a coercive enforcement style. The coercive enforcement style has inhibited the development of trust and led to an antagonistic compliance climate. Audit firms responded to the regulatory oversight in this antagonistic compliance climate by an increased focus on visible means of compliance, on form rather than substance, explicitly focused on their predications of the regulator’s expectations. Audit practice is reported to have changed by a reduced reliance on internal controls and analytical reviews of figures, as these where found harder to justify to the regulator. Auditors report that they perceive these compliance responses to be a threat to audit quality. This shows that a regulator’s enforcement style heavily influences the compliance response of the audit firms to the point where managing inspection risk becomes a primary focus. It is concluded that auditors perceive that the coercive regulation style
employed by the regulator may increase displayed compliance but reduce audit quality, its primary goal.
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Preface
Today, almost nine years after starting the Master Accountancy & Controlling the day has come for me to hand in my thesis. After completing the courses of both the Accountancy and the Controlling profile and an additional course in Quality Management, I was struggling with my initial thesis. Together with a fellow student I had taken on what proved to be a nearly
impossible challenge. When the company involved withdrew its support, my fellow student’s business began to take off and I received an attractive job offer, we abandoned the project. In the following years, I remained enrolled at university and often thought about starting another thesis project. However, a combination of four significant reorganisations, one of the largest and most ambitious SAP implementations ever attempted and the numerous related change
processes, provided me with an excuse to focus on other matters. These projects satisfied my desire to explore and discover, to manage projects and crises, and to solve complex problems. However, over the years enthusiasm turned in to a sense of obligation. I allowed myself to be completely absorbed by my work.
After a period in which death, divorce and illness plagued my friends and family, my eyes were opened. I wanted to live my life differently. In the summer of 2016, I decided to start working towards the life I wished to live. Completing my Master degree was something I felt I needed to do in order to move forward. I took the course Research in Accounting and Control and
committed to finishing my thesis in 2017.
During the winter of 2016 I completed the course successfully and completed a research
proposal. At work, the fourth reorganization came into effect and I received new assignments for my team in another series of change projects. After completing the annual statements for 2016 and the statutory audit in February, I went to a series of project meetings in the UK. At the final night in my hotel room, after the obligatory dinner and drinks session, I set out to write my teams priorities for the year to come. Suddenly, it felt like my brain just shut down. The following morning, I travelled home in a daze.
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What friends and family had seen coming for a long time had happened. I had suffered what is commonly referred to as a ‘burnout’. I was completely incapable to keep my brain in check, my thoughts and emotions were moving from one extreme to another. I felt exhausted as I had never felt before. The period that followed is one that I will remember for the rest of my life. After a few weeks, against all professional advice, I continued to work on this thesis. I had committed to this thesis and I was determined to complete it. Every moment of concentration was hard fought for. These last few months felt as the last four miles of an underprepared marathon. Completely exhausted, determination forcing me towards a finish line, that seemed to move away from me with every step I took. During my, underprepared, first marathon it was a stranger that laid a hand on my shoulder and pushed me forwards, when I considered to stop running and continue walking the last miles. During this thesis, I knew the hands that pushed me forwards very well. My gratitude to Judith, my girlfriend, for her continuous support and love, is beyond words. I can only begin to understand what she has endured with me. For better, for worse, in sickness and in health, I trust there are good times to come. Rik, my fellow student that I started a thesis with all those years ago, is now one of my closest friends. I am thankful for his friendship. Of course, I am also very thankful to all the interviewees that were willing to participate, despite the concerns that their organisations had. I would like to thank Sakshi Girdhar for her guidance and feedback. Finally, I would like to express my gratitude to be alive and to be able to experience this process. It has been an extraordinary educational experience.
Victor van der Winden
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CONTENTS
1. Introduction ... 5 2. Literature ... 8 3. Research Design ... 19 4. Results ... 22 4. Discussion ... 37 5. Conclusions ... 40 References ... 435/49
1. INTRODUCTION
In 2002 the Sarbanes – Oxley act established the Public Company Accounting Oversight Board (PCAOB) in the aftermath of the Worldcom and Enron collapses (Hazgui & Gendron, 2015). As Hancher and Moran (1989) noted changes in regulatory systems are often triggered by economic or politic crises. Before 2002 Auditing Practice was mostly self-regulated, after a series of auditing and accounting scandals many countries instituted governmental regulators, such as the PCAOB in United States and the Australian Securities and Investments Commission (ASIC) in Australia (Dowling et al. 2015). The Netherlands followed suit in 2006 when the Authority for the Financial Markets (AFM) was charged with the responsibility of supervising licensed audit firms (AFM 2014). The responsibility for oversight of the auditing practice shifted from the profession itself to governmental regulators (Kinney 2005).
The existence of an external regulator overseeing the audit profession creates an incentive for audit firms to behave in way that satisfies the regulator (Francis, 2011). The newly created or appointed regulator itself has an incentive to establish and expand their legitimacy as overseer (Dowling et al. 2015). In such a changed regulatory environment, parties will seek to define their relative roles (Canning and O’Dwyer, 2013; Hazgui and Gendron, 2015). As Hancher and Moran (1989, p. 4) note: “Regulation is indisputably a political process and it thus exhibits one of the defining features of any such process – it involves the contest for power”. A power struggle between a regulator and a regulatee can be detrimental for their relationship and might have unintended consequences (Kirchler et al., 2008).
Audit oversight regulators monitor, enforce, penalize and report non-compliance with
professional standards by auditors, with the objective of improving audit quality (Dowling et al., 2015). The primary instrument in achieving this objective are audit firm inspections (Dowling et al., 2015). Inspection reports issued by regulators identify audit deficiencies, and audit
deficiencies have implications for audit quality (Church and Shefchik, 2012). Since 2006 the AFM has conducted inspections at audit firms to supervise the quality of the statutory audits conducted. In 2010 the AFM issued a report regarding the results of their inspection of statutory audits performed by Big 4 audit firms (PWC, EY, KPMG, Deloitte). In 52% of the reviewed
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audits the AFM found that insufficient audit evidence was obtained. Four years later, in 2014, the AFM issued another report on the audit quality of Big 4 audit firms, this time the AFM
concluded that in 45% of the statutory audits inspected insufficient audit evidence was obtained (AFM, 2014). The AFM expressed their dissatisfaction and warned the audit firms: “Since the AFM considers that the number of statutory audits qualifying as ‘inadequate’ is still too high, it does not rule out the application of formal enforcement measures.” (AFM, 2014, p.7.). In 2016 the AFM imposed fines in total of 6.1 million euro to the Big 4 audit firms (AFM, 2016).
Based on the AFM reports one might get the impression that audit quality did not improve much and not much has changed. However, audit clients in the Netherlands have certainly noticed a change in auditor behavior as a result of AFM oversight. Jos Nijhuis, CEO of Schiphol and former auditor: “What I worry about is that it seems as if the rules and the files have become more important than the client. I see a narrowed focus on the pure audit. So much narrowed that auditors have lost the big picture and lost value as business partner” (Financieel Dagblad, 2016). Ton van Veen, cfo of Jumbo supermarkets: “the power of the collaboration with the CFO is disappearing. It has become almost impossible to have a useful conversation with your
auditor, they are trapped in rules.”. (Financieel Dagblad, 2016) Martin Noordzij, secretary of employer’s organization VNO-NCW: “Under pressure from the AFM everything has to be documented to three figures behind the decimal point. It’s unpleasant”. (Financieel Dagblad, 2016).
For auditors, it is important to have a ‘clean’ audit inspection report (Daugherty and Tervo, 2010), and as a consequence auditors shift their focus to managing inspection risk in addition to managing audit risk (Dowling et al., 2015). Glover and Prawitt, (2013) found that auditor’s effort, attention and procedures are directed to a larger degree by the perceived risk of inspection by the regulator than by audit risk. Regulators are thus influencing audit practice. Dowling et al. (2015) raise the question if regulatory oversight can have the unintended consequence of audit firms adapting the audit process in ways that satisfy inspector but do not necessarily improve audit quality. One way audit firms may manage inspection risk is employing checklist and procedures to visualize compliance even if this does not attribute to a higher quality audit (Houghton et al., 2013; Johnson et al., 2014).
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The AFM as a regulator is of opinion that their regulation of the audit profession has not resulted in sufficient changes yet (AFM, 2016). Audit clients do see changes in the audit profession but not for the better. The perception auditors have of the actions and intentions of a regulator are important because it influences their responses to the regulatory oversight (Dowling et al., 2015). This study investigates how has the regulator’s enforcement style influenced the compliance response of the Dutch audit firms?
Research shows the response of the audit profession to imposed external regulation can differ from country to country (Malsch & Gendron, 2011; Canning & O’Dwyer, 2013; Hazgui & Gendron, 2015; Dowling et al., 2015). However, none of the research has been done in the Netherlands. This research is also answering a call for research on how audit inspections are influencing audit practice (Humphrey et al., 2011; Dowling et al., 2015; Lamoreaux, 2016; Glover et al., 2017). An exploration of the response of auditors in The Netherlands adds valuable insight on how the Dutch audit profession reacts compared to audit professions in other
countries. This insight is not only valuable for the AFM in drafting their regulative approach in the future, it also may help audit firms to understand the effects of regulatory oversight and serve as a basis for improvement of the regulatory process. As both the AFM and the audit firms ultimately benefit from increased audit quality a better insight into the mechanisms behind audit inspection performance can be mutually beneficial. Of course, this not only applies to the Dutch national context, but also goes for regulators and audit firms in other countries, who will find similarities and differences with their own regulatory oversight on the audit profession. And as the audit profession is far from the only profession that faces a change from self-regulation to governmental regulation, insight from this research can potentially also be useful for other professions.
The remainder of this thesis will be structured as follows. In chapter 2 the theoretical framework will be explained. In chapter 3 the research method is described. Chapter 4 shows the results of the interviews. In the chapter 5 a discussion of the results follows. Chapter 6 concludes this thesis.
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2. LITERATURE
Role of Enforcement style
Regulators make choices about the focus of their enforcement, the resources they allocate and the enforcement tools they employ, this is directed by their enforcement strategy (May and Winter, 2011). Regulators interact with regulated parties as they act out their enforcement strategy. The way the regulator interacts with regulatees is described by their enforcement style (McAllister, 2010). Enforcement style can be analysed on both agency level as on individual inspector level (McAllister, 2010). A regulator can carry out the same enforcement strategy in different styles of enforcement, this enforcement style is reflected by the way the regulator interacts with the regulatees (McAllister, 2010). Different enforcement styles are likely to gain different results, as the enforcement style will have an influence on the regulatee’s compliance response (McAllister, 2010). Dowling et al. (2015) distinguish between two extremes of
enforcement styles, formal and facilitative. Formal styles include rigid interpretation of rule and inquisitional evaluations of specific behaviors (Dowling et al., 2015). If a regulator with a formal enforcement style perceives a lack of compliance, his actions are likely perceived as coercive by the regulatee. A regulator using a facilitative enforcement style is likely to be more flexible and open to discussion (May and Wood, 2003). Facilitative regulators are more likely to focus on education, advice and persuasion (Dowling et al., 2015). Facilitative styles tend to foster
cooperation and collaboration, formal styles negatively influence cooperation (May and Winter, 2011; May and Wood, 2003).
Audit regulators are instituted with the goal of improving audit quality (AFM; 2016). Audit quality is not directly observable (DeAngelo, 1981; Knechel et al., 2009). Audit regulators rely on inspections to observe policies, processes and audit files to form an opinion on audit quality (Dowling et al., 2015; AFM, 2016). If cooperation and cooperation are at a low level, audit regulators can only rely on the visible evidence of compliance that audit firms display. Audit firms then have an incentive to focus on measures that increase the visibility of compliance (Power, 2009), whilst these measures might not substantially increase audit quality.
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Slippery-slope framework
Dowling et al. (2015) used the slippery-slope framework (Kirchler et al., 2008) to analyse how regulator enforcement style influences the way audit firms show compliance to standards. Dowling et al. (2015) specifically analysed audit partners’ perceptions of regulator actions and the way their firms responded to the regulator’s oversight. Kirchler et al. (2008) designed the slippery-slope framework as a conceptual and operational tool to explain how the actions of a regulator influence a regulatee’s compliance behavior so (more) responsive regulation can be developed. The slippery-slope framework is a suitable way of viewing the influence of a regulators enforcement style on audit firms’ compliance behavior, because a regulators
enforcement style is reflected by it is actions (McAllister, 2010). As Dowling et al. (2015) show the slippery-slope framework is not only been validated in tax compliance context (Hofmann et al., 2013; Kastlunger et al., 2013; Lisi 2012; Muehlbacher et al., 2011; Prinz et al., 2014; Wahl et al., 2010)., it’s generic focus on the explanation of the influence of regulator and regulatee interaction on the nature of compliance can also be applied to the public oversight of audit firms. Figure 1 depicts a graphical representation of the nature of the slippery-slope framework. Central to the framework is the proposition that the level of compliance is influenced by two dimensions: power of the regulator and trust in the regulator (Kirchler et al., 2008).
Starting in the front corner of Fig.1 the characteristics of the framework will be discussed. When a regulator is perceived to have little power and trust in the regulator is low, compliance is expected to be low, regulatees are expected to avoid cost associated with compliance (Kirchler et al., 2008). In such conditions audit firms are expected to disregard the regulator mostly as
complying with the regulator has a cost and non-compliance is perceived as having little consequences. As the perceived power of authorities to audit, detect non-compliance, and to issue and impose fines increases, we move to the left on the power axis, to a situation of high power and low trust. In a situation of high power and low trust enforced compliance is expected to be high, increasing with the level of power (Kirchler et al., 2008). Regulatees have less to gain
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from non-compliance, because both the likelihood and the impact of detection are deemed higher as the perceived power of the regulator increases (Kirchler et al., 2008). There is however an assumption of diminishing returns, to gain a similar increase in compliance an increasingly high investment in power needs to be made (Kirchler et al., 2008). An audit regulator that is not trusted by audit firms, but has the power to conduct frequent inspections and to impose hefty fines and even revoke licenses, on deficiencies found is an example of such a situation. In this setting auditors are expected to display compliance with the regulator, because the cost of non-compliance and the possibility of detection are high. Regardless of whether the audit firms intrinsically belief it is the right thing to do, they will show a degree of compliance because the potential cost of non-compliance are high. To further increase its power the regulator would need to increase the likelihood of detection or the severity of the punishment, this comes at a cost to the regulator. If the regulator would increase its staff and the number of inspections by thirty percent, the number of deficiencies found is not expected to be reduced by a similar percentage. Starting in the front corner again, as trust increases we move to the right on the trust axis, to a situation of low power and high trust. In a situation of high trust and low power voluntary compliance is expected to be high, increasing with the level of trust. Here there is an assumption of diminishing returns as well. An audit regulator that is perceived by auditors as being a
legitimate authority in the field, acting in a fair manner and working towards the common good is expected to find audit firms collaborating and being compliant voluntarily.
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Figure 1 The slippery-slope framework: The relationship between power and trust and the nature and extent of compliance
Adapted from Krichler et al. (2008, p212)
High compliance can be achieved both under high power and under high trust conditions, but the reasons and the nature enforced and voluntary compliance differ (Kirchler et al., 2008). `A regulatee that is voluntarily compliant bases their compliance activities on their own
interpretation of the regulation independent from the regulators actions (Dowling et al., 2015). A regulatee in a situation of enforced compliance bases his compliance activities on their
perceptions of the regulators interpretation of the regulation (Dowling et al., 2015). Power and trust have a moderating influence on each other need to be viewed from a dynamic perspective (Kirchler et al., 2008).
Power is exercised to have a target behave as one wills (Turner, 2005). According to Kirchler et al. (2008), Turner (2005) distinguishes two different forms of power that a regulator can display, legitimate power and coercive power. This paper begs to differ as Turner (2005) also
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context of the slippery-slope framework as it differs from authority (legitimate power) in the effect is has on the regulatee. Legitimate power is based on acceptance of the right a regulator has to prescribe beliefs or attitudes to others, on voluntary deference and private acceptance of authority, it is not experienced as an oppression or loss of power by those who submit to it (Turner, 2005). Authorities are viewed as more legitimate if their authority is exercised through procedure that are experienced as being fair (Tyler, 2001). Coercive power is “deploying human and material resources to constrain, block, compel and manipulate a target’s behavior without any effort at persuasion or appeals to legitimate authority” (Turner, 2005, p.8). In the slippery-slope framework coercive use of power is low in the trust dimension and legitimate power is high in the trust dimension (Kirchler et al., 2008).
Figure 2 The nature of power through people
From Turner (2005, p.7)
Trust in de slippery-slope framework is defined as the perception of the regulatees that
“authorities are benevolent and work beneficially for the common good.” (Kirchler et al., 2008, p.212). Rousseau et al.’s (1998) came to an interdisciplinary definition of trust in an attempt to align different concepts of trust used in various disciplines: “Trust is a psychological state
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comprising the intention to accept vulnerability based upon positive expectations of the
intentions or behavior of another.” (p.395). Both definitions contain a positive expectation about the behavior of the trustee and imply a relationship between trustor and trustee, however
Rousseau et al.’s (1998) definition includes the acceptance of vulnerability by the trustee. Being vulnerable to the actions of another means one is facing risk. Risk is regarded as the core of trust, to trust implies taking a risk and being vulnerable to the actions of trusted others (Das & Teng, 1998). Trust can only be built in a gradual and conscious manner (Bhide & Stevenson, 1992) and hence a trustor needs to take some initial risk for a trustee to be able to demonstrate its
trustworthiness (Das & Teng, 1998). Open and prompt communication is an essential part of a trusting relationship (Kanter, 1994; Larson, 1992). A sustained information flow allow parties to collect evidence about the others credibility and trustworthiness starts the reciprocal process that leads to a trusting environment (Das & Teng, 1998). Additionally, communication helps building trust as it provides a basis for continued interaction through which common values and norms are developed (Leifer & Mills, 1996). Trust is reciprocal in nature, one trusts another because they trust you (McAllister, 1995). Trust functions as an affective lens through which a trustor interprets the actions of the trustee. (Jones, 1996). The existence of trust enables cooperative behavior (Gambetta, 1988), and the absence of trust inhibits productive cooperative behavior (Das & Teng, 1998).
The exercise of power and the development of trust are interrelated (Kirchler et al., 2008). Coercive use of power by a regulator undermines the regulatee’s trust towards the regulator (Turner, 2005). An increase in trust of the regulatee in the regulator can increase a regulator’s power as the regulatees are more likely to cooperate, in the same way a decrease in trust can reduce a regulator’s power (Kirchler et al., 2008). An increased auditing effort by regulators can be seen as a sign of distrust towards regulatees (Cialdini, 1996), which in turn reduces trust in the regulator by regulatees, especially if audits are inquisitorial in style (Kirchler et al., 2008). The increase in power leads to a decrease in trust. However, if the regulator is able to convey the message that they are efficient in detecting compliance and their punishment of non-compliance is perceived as fair, trust of well-intending regulatees is likely to increase (Kirchler et al., 2008). Credible sanctions and legitimate power are found to lead to higher compliance
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rates (Bergman, 2003). In that case increased power leads to increased trust. It is the perspective of the regulatee on the actions of the regulator that is important here.
The reciprocal influences of power and trust influences the compliance climate (Dowling et al., 2015). Kirchler et al. (2008) centralize the idea that the compliance climate can vary on a continuum from antagonistic to synergistic. A regulator and regulatee having a trusting and respectful relationship will lead to a synergistic climate (Kirchler et al., 2008). A synergistic climate is characterized by regulate and regulator working together (Kirchler et al., 2008). In an antagonistic climate regulatees feel persecuted by the regulator, feel it justified to hide, social distant is large and there is little respect and little positive feelings towards the regulators exists with the regulatees (Kirchler et al., 2008). Voluntary compliance is likely to be negligible in an antagonistic compliance climate, regulatees rationally weigh cost and benefit of non-compliance (Kirchler et al., 2008). A synergistic climate is the opposite of an antagonistic climate. In a synergistic climate voluntary compliance is likely to be the prevalent form of compliance, social distance is likely low, regulator and regulatee relations are friendly and respectful and regulatees are compliant out of a sense of obligation (Kirchler et al., 2008).
The mutually reinforcing nature of a synergistic climate and trust can create a positive feedback loop (Dowling et al., 2015), increasing both voluntary compliance by the regulatee and the use of a more facilitative enforcement style by the regulator. A lack of trust will create an antagonistic climate, where voluntary compliance slips to enforced compliance, and a more formal
enforcement style by the regulator starting a downward spiral (Kirchler et al., 2008).
It was mentioned before that Kirchler et al. (2008) took only two out of three forms of power distinguished by Turner (2005), authority and coercion, into consideration. The omission of persuasion as a power is a shortfall of the model, all be it perhaps only a hypothetical shortfall. If a regulator manages to persuade a regulatee to adjust their behavior this means several things. A) An exchange of ideas has taken place. A form communication which has led to a common value or norm (Leifer & Mills, 1996). B) The regulator has accepted vulnerability and showed a positive expectation, characteristics of trust (Rousseau et al., 1998), about the behavior of the regulate by engaging in persuasion rather than control. As trust is reciprocal (McAllister, 1995) this will contribute to the development of trust by the regulate. C) The regulator being able to
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persuade the regulatee based on the sake of their arguments, rather than control the regulatee, will add to the regulator’s legitimacy and authority (Tyler, 2005). Increased legitimacy and authority will increase voluntary compliance and reduce the ‘need’ for coercive use power. D) A regulator willing to attempt persuasion rather than control signals the intention to move towards a more synergetic climate. Persuasion can be seen as a risky strategy by a regulator, as it might not achieve the goal intended, the regulator might fail to persuade the regulatee. But as Das & Teng (1998, p. 503) put it: “Only if some initial risk is taken is it possible for the trustee to demonstrate his or her trustworthiness”.
Procedural Justice or Slippery-Slope?
Van Buren and Wong (2016) propose the concept of procedural justice as a basis for analysis of Dowling et al.’s (2015 results rather than the slippery slope framework. The first reason Van Buren and Wong (2016) to use to propose a different framework is that in their opinion some of the assumptions underlying the slippery-slope framework are problematic. Van Buren and Wong argue that “a high level of compliance can only be reached if there are clear, unequivocally interpreted compliance rules” (p.360). Only if the rules are clear can a regulator enforce compliance effectively, and such clarity of rules is missing sometimes in the public auditing context according to Van Buren and Wong (2016). Whilst clear unequivocally interpreted compliance rules would be helpful, their absence is not an argument against the use of the slippery-slope framework. A powerful regulator becomes a de facto standard setter (Knechel, 2013) by their interpretation of the rules. In fact, this is an effect auditors describe in the
interviews. It can be seen as a reflection of the regulator’s enforcement style if they refrain from engaging in communication about their interpretation of the standards with standard setters and regulatees. A regulator with a facilitative enforcement style would embrace the opportunity to create clarity.
Second, Van Buren and Wong (2016) argue that the assumption of the possibility of a 100% compliance, regardless which enforcement strategy is selected is a too strong assumption in the slippery-slope framework. It is indeed a strong assumption unlikely to be valid in real life.
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However, the essence of the framework lies in the interrelationship between power and trust, the effect on the regulator’s action on the regulatees’ compliance response. The basic premises that one can increase compliance by coercive use of power or the development of trust still holds, even if one might not achieve a 100% compliance.
The third validity argument against the slippery slope framework being applied to audit regulation Van Buren and Wong (2016) use is that of its external validity. It is argued that tax compliance is different from audit compliance because tax compliance is better observable and audit quality is not well defined, and thus not easily observable (Van Buren and Wong, 2016). Audit quality being less observable than tax compliance makes it hard to study the effect an enforcement style has on audit quality. This is a central issue in auditing research and in auditing oversight. However, whilst this may make it harder to measure the exact degree to which audit quality is effected by the regulators enforcement style, this would apply to any framework and not just the slippery-slope framework. More importantly the slippery-slope framework still provides a direction to the expected compliance response and to the level of compliance.
The arguments against the use of the slippery-slope framework are not convincing, but are used as a means to introduce an alternative way of looking at Dowling et al.’s (2015) results. Van Buren and Wong (2016) propose to interpret the result based on the concept of procedural justice. Brooks and Dunn (2012) say procedural justice “[…]concerns how justice is administered. Key aspects of a just legal system are that the procedures are fair and transparent” (p.146). Blader and Tyler (2003) show that procedural source is an essential element in perceived procedural fairness and distinguish two main elements of procedural fairness: perception of the quality of decision-making processes and perception of the quality of treatment.
Good quality of decision-making process is perceived as having: - Fair and unbiased rules
- Consistently (across people and situations) applied procedures and rules - Rules based on facts, not personal biases and opinions
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- Decisions consistent across people and situation - Decisions made based on facts
- Decisions equally fair to everyone Good Quality of treatment is perceived as:
- Rules lead to fair treatment when decisions are made or implemented - Rules require an honest explanation for how decisions are made - A subject’s views are considered when decisions are made - Trust that the deciding party has good intentions
- Rights are respected - Being treated with dignity
Van Buren and Wong (2016) recommend the concept of procedural justice as a framework as opposed to the slippery-slope framework, stating the procedural justice concept would explain many of the frustrations voiced by auditors. And they are right, procedural justice can be used to explain many of these frustrations, but not because it is necessarily a better framework of
analysis. Procedural fairness is the main element of legitimate power (power through authority) (Tyler, 2001). If a regulator would have legitimate power it could refrain from the use of coercive power and trust would be more likely to develop. To increase the perception of
procedural justice amongst auditors a regulator could apply a more facilitative enforcement style, using education, advice and persuasion. By explaining their expectations, listening to the
auditor’s views, setting clear audit inspections protocol’s and explaining them and collaborating in the creation of an appeal possibility a regulator would increase the perception of procedural justice amongst auditors. From the slippery-slope perspective this would be a less coercive use of power, and increase the development of trust and gain legitimacy, which would increase their level of power through authority. The added value of the slippery-slope framework’s added value lies in its ability to predict auditor behavior,whilst the procedural fairness concept can explain many of the auditors’ frustrations, it does not explain their compliance response.
Using the slippery-slope framework as a lens the regulator’s enforcement style’s influence on the audit firms and more specifically their demonstration of compliance to auditing standards is
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investigated. The regulator’s enforcement style is observed through the audit partner’s perception of the use of power by the regulator. The auditors’ perception on the development of trust and the interacting effects between the use of power and development of trust perceived by the auditors are interpreted with use of the slippery-slope framework to describe the current compliance climate in The Netherlands.
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3. RESEARCH DESIGN
Method and Data collection
Interviews were conducted with audit partners and directors of audit firms in The Netherlands between in April and early June 2017. Interviews provide an opportunity to shed light on complex issues, due to the richness of the data they provide (Malsh and Salterio, 2016). All auditors participated on a voluntary basis and were approached via contacts in the audit firms. The interviewed auditors had to meet three conditions: they had to be working in audit practice currently, they had to be the responsible auditor on a number of clients (signing off), and they had to be involved in the quality control process in their firms. Six out of the eight interviewees had been involved in inspections carried out by the AFM on their files. The experiences of the other two auditors are relevant because of their involvement in shaping the compliance responses of the firms. These selection criteria were employed to ensure that the interviewees were able to reflect both on the actual current audit practice and were able to comment on the influence of the external oversight. As the AFM did not respond to interview requests, formal published
communications where used to corroborate the answers of the interviewed auditors. The interviews were conducted in a semi-structured way, using an interview script containing questions around the themes in the slippery-slope framework. The slippery-slope framework was selected based on upon a review of recent relevant research and exploratory causal
conversations with professionals in the audit industry. As this is an explorative kind of research the interview script functioned as a prompt rather than a verbal survey. Interviews lasted between 46 - 75 minutes, as this allowed sufficient time for in-depth answers by the interviewees, whilst not being overly intrusive on the interviewees' schedules. A table containing the date and duration of the interviews is included below, interviewees are referred to as ‘A’ & ‘interviewee number’. During most interviews two researchers were present. To ensure a balanced view audit partners and directors of three large audit firms are interviewed. A total of eight interviews were conducted. In exploratory interviews, one continues to conduct interviews until there are no new insights coming from the interviews (Malsch and Salterio, 2016).
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Table 1 Date and duration of interviews
Date Interviewee Duration of the recording
(minutes) April 18 2017 A1 50 April 19 2017 A2 54 April 24 2017 A3 52 April 24 2017 A4 51 May 15 2017 A5 46 May 15 2017 A6 75 May 17 2017 A7 56 June 8 2017 A8 48 Analysis
The interviews were recorded and transcribed by the interviewers. Transcriptions and
interpretation of the responses were checked separately by each researcher and then discussed with the other researcher. Both researchers coded the responses and compared their coding to validate it. The interviews were manually coded in several rounds. In the first round the interviews were carefully read for themes and several themes were identified. A second researcher independently identified themes. These themes were checked for extensively
discussed through several rounds and iteratively adjusted. Next, the interview data was recoded based on themes from the slippery-slope framework. The data from the second coding was interpreted.
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Feedback of the interviewees on the analysis of the interviews is sought to reduce the risk of incorrect interpretations. A draft of the paper was send to the interviewees, on which they were requested to comment. Three of the interviewees responded and agreed1 with the results and
conclusions reported.
The interviewees voices are reflected in contextualized quotes, some relatively extensive quotes are incorporated into the results section to enable the answers of the interviewees to be
comprehensively reflected (Trompeter and Wright; 2010). A balance is sought between transmitting the richness of the answers of the interviewees and overwhelming the reader with minutiae (Ahrens and Dent, 1998; Malsch and Salterio 2016).
All interviews are processed anonymously both on firm and personal level, all references that can be tied to specific firms or people have been removed. Examples of the interview questions asked can be found in appendix I.
1 Some minor textual changes were proposed and incorporated, and some specific phrasings that could be traced
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4. RESULTS
The slippery-slope framework describes how the use of power by a regulator towards a
regulatee, influences a regulatees compliance response. The results of this research are analysed based on the constructs in the slippery-slope framework. First the regulatees’ perception of the regulator’s use of power is discussed. Then the results on the regulatees’ perception of the effect of the regulator’s exercise of power on the development of trust is discussed. Third, the resulting compliance climate experienced by the regulatees is discussed. This chapter is concluded with a discussion on the response of the audit firms to regulation in this compliance climate.
Use of Power
Power is exercised with the intention to create a change in behavior (Turner, 2005). A regulator’s exercise of power can lead to coerced or voluntary disclosure (Dowling et al. 2015). There is unanimous agreement amongst the interviewed auditors that the introduction of regulatory oversight was justified, suggesting there is a basis for the AFM to be seen as a legitimate source of power (Tyler, 2006).
“That we as auditors needed to improve the quality of our work goes without saying.” (A7)
All interviewed auditors were of the opinion that since the introduction of external oversight audit quality increased dramatically as a result. A development that is still continuing in their eyes.
“A file from three years ago, and a file now, that is a world of difference. There has already been gigantic quality improvement.” (A1).
That the introduction of external oversight has led to an increase of audit quality in the eyes of the auditors is to be expected. Given the events that led to the introduction of external regulatory oversight there was a feeling amongst auditors that the introduction of an external regulator was a legitimate action. Besides being seen as legitimate, the regulator was also seen as working
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towards a common goal, as concerns about audit quality were shared by auditors, this added to a degree of trust. The auditors acknowledge benefits of inspections and external regulatory
oversight, but made it clear that the use of power by the AFM was perceived as coercive. A regulator’s enforcement style describes their interaction with regulatees (McAllister, 2010). AFM inspectors are perceived as having a ‘legal mindset’, as being focused on compliance to the letter of the standard, rather than the spirit.
“In the early days, you heard they were some kind of lawyers, focusing very much on legal compliance of the audit file.” (A1)
The skills and abilities of the AFM inspectors are not questioned, but their ways of conducting inspections are criticized for their highly-detailed approach. The auditors all found the AFM inspectors to be knowledgeable and thorough, though it was mentioned that inspectors at times were found to lack experience. However, they placed question marks at the level of detail the AFM expected to be documented.
“People with the AFM all understand the COS and ISA's, they are well equipped to conduct reviews. What you do see is that they find that quality means complete adherence to the standards. That sounds sensible. But the major difference is that we audit the complete annual statements and they zoom into specific areas in their reviews. And in those areas, they dive deep, perhaps too deep.” (A2)
The general consensus amongst the auditors is that AFM has a very rigid and detailed view on how an auditor should perform and document an audit. Similar concerns are raised by auditors in other countries (Defond, 2010). The AFM is found to employ a formal enforcement style by the auditors.
“The AFM does not deviate from the "cook book". And we are less of the Anglo-Saxon model and more of the Rhinelandic model. We understand and conclude together that another approach is good too, you don't want an Anglo-Saxon regulator saying otherwise.” (A4)
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This enforcement style is perceived as rigid, with little room for discussion and inquisitional in nature.
“Quality for the AFM simply means, you as a profession have your standards, you must adhere to those, show me where that is documented in the file.” (A2)
Rigid interpretations of rule and inquisitional evaluations are characteristics of a formal enforcement style (Dowling et al., 2015). The interviews show that power by the AFM is
perceived to be used coercively. Constraining, blocking compelling or manipulating a regulatees behavior are all examples of coercive use of power (Turner, 2005). The regulators enforcement style compels auditors to behave in a certain way. This perception of coercively used power is important, regardless of it is intended or not by the AFM, because it determines the auditor’s response. This enforcement style even causes auditors to sometimes even feel as if they are not treated like professionals by the AFM, thereby reducing perceived procedural fairness.
“If you look at the way they (AFM) look at audit evidence […] as an auditor I am of course no idiot. And sometimes I think that the focus on documenting and triple checking, that doesn't do justice to the image of a professional I have created in my years of visiting clients to do risk assessments.” (A3)
The perceived coercive use of power by the AFM is also reflected by the way the small number of audit files reviewed and the way those audit files are selected. The AFM requested the audit firms to provide all statutory audit clients, the level of risk attached to the audit opinion, whether or not an internal and or external quality review was carried out and the name of the external auditor (AFM, 2014). The AFM selected deliberately at least two listed companies, one pension fund, one public or semi-public entity and one large non-PIE per firm. Additionally, the AFM took into account if audits were done by various external auditors, were distributed across organizational elements of the audit firm and selected only those with an average or higher risk profile (AFM, 2014). For the AFM this an efficient risk-based enforcement strategy (Abbot, Gunny & Zhang, 2013). Furthermore, the AFM defines specific risk areas and reviews those in depth. Selecting the more complex, higher risk audit files and diving deep in the higher risk areas all increases the likelihood of finding deficiencies. Auditors are critical of this approach.
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“The AFM reviews ten files in 18 months, that's almost nothing compared to the total population.” (A2).
“So those 10 companies are definitely not a representative sample for the entire population.” (A5).
“You should consider if such a small number of files is enough to say something about audit quality.” (A6)
The number of files reviewed by the AFM is seen as very small on the total number of audit files in a firm, the files selected are not representative for the total population of audit files and no valid conclusions can be drawn on such a small number files according to the interviewed auditors. By most auditors, the selection procedures are perceived as being procedurally unfair. The selection procedures do not meet the criteria of being fair and unbiased and they are not applied and are not applied consistently in the eyes of the auditors. Auditors are suspicious of the motives of the AFM for selecting the small number of specific audit files.
“Probably they selected those items they want to highlight, so they can stretch their authority on the edges of those items.” (A4)
“The AFM has an interest in it, especially in the early days they had a desire to justify their existence […] nothing human is strange to them. They have their own agenda.” (A1).
And as the above quotes show auditors have little trust in the good intentions of the deciding party, all in all the selection procedures are not seen as procedurally fair (Blader and Tyler, 2003). However, there is some support the risk based selection by the AFM, stating it is justified as an effective regulatory strategy.
“I don't agree with my colleagues that say it is an unfair sample. I think that if even the most complex audit files are not up to standard, do you think that the less complex files got the required attention? I don’t think so […]” (A6).
The point of selecting those cases with a higher risk profile is also mentioned by regulators (e.g. ASIC, 2015) as an effective regulatory strategy because they deem those files to be given the
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most attention. In their 2014 report the AFM specifically compares itself to other major regulators and reports that other regulators find a similar percentage of inspected audit files to contain insufficient audit evidence (AFM, 2014). This can be seen as an illustration of the AFM working towards a predefined target, or it can be seen as an attempt to show that these results are a reasonable reflection of audit quality as they are in line with what other regulators find. The fact that auditors explain this is as, the AFM is working towards a predefined target, is telling for the lack of trust.
Development of trust
Not only does the AFM inspections lead to high fines (AFM, 2016), the negative findings are reported publicly by the AFM and are given a lot of attention by the media. Auditors perceive this as coercive, the AFM yields significant power over them. Auditors feel the AFM
communications are not balanced and lead to negative press attention.
“There has been so much negativity in the press for years. It would be good, a positive note in the press for once.” (A1)
“The conclusion was it was not insufficient. There you have it, 'not insufficient'. Look if you think something is positive, write that down. 'Not insufficient' gives it a negative connotation, that's not necessary.” (A6)
Auditors are clearly frustrated by the negative tone in the AFM communications and the way these are covered in the press.
“I notice people becoming frustrated and annoyed because they work very hard to improve quality, but time after time they are portraited as greedy charlatans. It is a very frustrating process. And that's not because of the AFM means of power, but because of their tone and attitude. C'est le ton qui fait la musique2.” (A6)
2 French proverb that is literately translated as “It is the tone that makes the music”. It is not what you say, it is the
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Imposing statutory oversight to the audit profession means there was a certain distrust regarding the audit profession. However, as Rousseau et al. (1998) put it trust is not a static phenomenon and can be build, stabile or dissolved and is based on the willingness to accept vulnerability based on the positive expectations on the behavior of the other party. The results of the
interviews show that the coercive exercise of power by the AFM has inhibited the development of trust between auditors and AFM. The negative tone the AFM is perceived to use and the high fines imposed, combined with a lack of dialogue experienced by the auditors, does not lead to positive expectations that are an essential element of trust (Kirchler et al., 2008). This absence of positive expectations is illustrated by all auditors mentioning fear as a motivator at some point, fear implies that they do not have positive expectations, but negative ones. As mentioned before auditors are suspicious of the motives of the AFM. Coupled with a perceived lack of clarity on the expectations of the AFM on auditor behavior, this lack of positive expectations leads to significant uncertainty amongst the auditors.
“I know that the PCAOB had no issues with some files, whilst the AFM thought these files were insufficient. When is it good enough?” (A8)
As trust is of reciprocal nature (McAllister, 1995), a lack of trust effects in the AFM results in the perception that the AFM has a lack of trust in the auditors.
“The basis for trust is not there, on neither side.” (A6)
The formal enforcement style and coercive use of power by the regulator, has clearly inhibited the development of trust as predicted in the slippery-slope framework. As will be discussed further in this paper the lack of open communication continuous to inhibited trust to develop and cooperative behavior to emerge.
Compliance climate
According to the slippery slope framework a regulator exercising power coersively and the development of trust being inhibited, should cause for an antagonistic compliance climate to
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emerge (Kirchler et al. 2008). In a synergistic climate, regulators and regulatees are more likely to develop a working relationship whereby the regulator supports the regulate to become
compliant. In such an environment, a regulatee and regulator would be expected to have open discussions about audit inspections findings. The interviewed auditors note that the AFM inspectors “do their utmost to appear as peers.” (A3), indicating that they are in fact not peers. One of the interviewees compared the AFM’s approach to that of the Dutch Tax Authorities (DTA).
“[…] look at the Dutch Tax Authorities for instance, they have this program called Horizontal Supervision. They see you as a business partner, they work from the
presumption that you do the right thing. You sit down with them to discuss everything, but there is one condition, you discuss everything, if you don't then the collaboration ends. I think the AFM positions itself more along the lines of this is the standard, this is what should be done. Of course, we talk with the AFM, but the nature of the conversations is different.” (A3)
The difference clearly illustrates the absence of a synergistic compliance climate between the AFM and the audit profession. Whereas the DTA acts as a trusting communicative peer, the relationship with the AFM is of a completely different nature. As in Das & Teng (1998) the open and sustained information flow between the Inspection of Education and the auditors created a trusting environment, allowing cooperative behavior to emerge (Gambetta, 1998). Another interviewee compared the AFM with the Inspection of Education (Inspectie van het Onderwijs), stressing the point that there is no dialogue with the AFM another indicator of the absence of a synergistic climate.
“In the education sector there is the Inspection of Education, and you know what they do so well? They have created an open dialogue with the audit firms. Two, three times a year the regulator, the audit firms and the NBA discuss the issues and the results of the inspections by the regulator. We don't always agree, but there is an open dialogue.” (A6, emphasis added)
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A lack of dialogue makes it less likely for the regulator power to be perceived as legitimate (Wahl et al., 2010) and more likely to be perceived as coercive (Turner, 2005). Perceived
legitimate power has a positive effect on trust (Wahl et al., 2010). Perceived legitimacy of power has not only a positive effect on trust it is also intertwined with procedural fairness (Tyler, 1990). Authorities perceived as being more legitimate, exercising authority in a manner perceived as fair, have their decisions and rules more willingly accepted (Tyler, 2006). Here the importance of open communication shows the reciprocal nature of the power and trust relation in the slippery-slope framework. Not only does open communication allow trust and cooperation to develop, it also makes the exercised power by the regulator seem more legitimate and less coercive. An illustration of trust acting as a lens (Jones, 1996). The present compliance climate can be
described as antagonistic, this climate does not contribute to the perception of procedural justice nor to the development of trust as any further action of the regulator is perceived in this context. Lack of a third party as an arbiter on differences of opinion is also a point of concern for
auditors, especially as the auditors perceive there is no dialogue. The auditors have no one to turn to if there is disagreement with the AFM. Similar to Glover et al. (2009) who found that the PCAOB in the US served as “sheriff, prosecutor, jury, judge, and executioner” (p.232), which contributed to auditors being dissatisfied with the regulatory process.
“There is no institute to settle a disagreement. The AFM is always right.” (A7) Recently the AFM issued large fines to all Big 4 audit firms for the deficiencies found in the inspections that formed the basis of their 2014 report. The fines and the publicity surrounding them has shocked the auditors.
“The fine system creates a fear culture. But the fine system is never intended to be used like that. The AFM can force firms with the means of power they have got.” (A6) The AFM justifies the fines in their published ‘fine decision’(AFM, 2016) on the fine issued to Deloitte amongst other factors on its “generally preventative effect…signaling to the market that offences such as these do not go unpunished” (p.90). This decision is especially interesting as fine was issued after investigations that were partially were conducted jointly with the PCAOB.
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The PCAOB did not decide to issue a fine in those cases, because they give more importance to improvement measures (AFM, 2016). The AFM responds that the fact that another regulator, operating in another jurisdiction, has a different enforcement strategy, is irrelevant to their decision (AFM, 2016). This clearly signals a coercive use of power (Turner, 2005) and the absence of trust in the intentions of the auditors further illustrates the antagonistic climate.
Firms’ response
In the eyes of the auditors the AFM’s coercive use of power and their formalistic enforcement style creates a need to show compliance, consistent with the response predicted by the slippery-slope framework. Auditors indicate they spend a lot of time on documenting their considerations and documenting the exact activities performed in the audit files.
“All we talk about is quality and the file, everything else gets snowed under” (A4). The interviewed auditors stressed that there are a lot of measures being implemented in their firms to improve audit quality and the AFM inspections are mentioned as a cause of the “quality revival” (A3), all say that there is a lot more focus on audit file completeness.
“Documenting, file completeness, that is important. It should be a tool, it is, but on the other hand it is also forced upon us by the standards and the regulator.” (A1)
As a means to ensure the completeness of the audit files and as a response to the regulator’s oversight all auditors report their firms are conducting a lot more internal reviews. These reviews are both conducted during the audit (in real-time) as well as post audit reviews on the complete files.
“We have primarily chosen to do more reviews. To check work before it goes out.” (A3) These measures are a response to findings the AFM reported in 2010 and 2014 (AFM, 2010; AFM, 2014), that stated that the internal quality review systems were performing inadequate. The AFM oversight clearly has its influence on the daily practice in the firms. Fear for the AFM is named by most auditors as a motivation for these changes.
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“Now the fear that the file is not good enough is our first, second and third consideration. We over audit (do too much).” (A4)
Although this might sound strong, fear is found to be a common emotion for auditors in their job, and a mechanistic reliance on rule based approaches is a common strategy employed by auditors to cope with that fear (Guénin-Paracini et al., 2014). Auditors do agree that having a complete file is important, however, the effect of the enforcement style of the AFM is that auditors are occupied with their expectations of what the AFM expects them to do, rather than with their own expectations of what should be done. A clear example of enforced compliance in the slippery-slope framework.
“The focus seems to be very much on the file now, but to me audit quality is first and foremost doing a proper risk assessment and the proper execution of the audit. Secondary is the documenting of the audit in the file in a manner that satisfies the regulator. And even more the issue of added value and impact to the users.” (A4)
Auditors are feeling coerced by the regulator and experience uncertainty of what is expected of them, both factors make it difficult to develop trust in the regulator (Dowling et al., 2015).
“We are in reality forced to follow the lines of the AFM, because we can't be sure otherwise. We have documented a lot more work these last few years, wrote down a lot more for every item we audit.” (A5)
As auditors are feeling coerced to comply, but are uncertain about the exact expectations of the AFM, they are responding to what they belief the regulator expects.
“The thing is, the AFM is learning too, they adjust their norms too, we just can't be sure on what it is exactly they expect from us. They will tell you it is our job to adhere to the standards and interpret them correctly and it is. But it is their interpretation of the audit standard that they test, and history shows their interpretations to be formal and strict, so we have to anticipate on that.” (A8)
Asked directly to what drove changes in the audit process, auditors often stressed that these changes were made out of a genuine belief that they contribute to an increase in audit quality.
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However, their descriptions of the compliance climate and the effect on the prevailing attitudes in their firms suggest however that this may not be the primary motivation for the changes made.
“There is a certain fear in the organisation, we don't want to be hit with those sticks over and over, so we make an enormous effort, which might be more than what's required. That we should do more is clear, but sometimes the balance is lost.” (A7)
The above quote illustrates the extent to which fear of negative consequences for not doing something is a driver, rather than an intrinsic belief the right things are done, a clear sign of enforced compliance. The language in the “fine decision” of the AFM stresses the point that whilst they acknowledge that the audit firms have taken significant steps for quality
improvement, this is no reason not to punish the firms for non-compliance and any single case of non-compliance can be grounds for a fine (AFM, 2016b). The AFM is clearly intent on enforcing compliance. There is a common perception amongst the interviewed auditors that the profession is in trouble and that their response to the regulatory oversight by the AFM is very much a contributing factor in that process.
“It is a complete downwards spiral. The profession formalises, we understand less of what our clients do, people are trained insufficiently, people are no longer attracted to the profession and leave it and the biggest threat of all, we are no longer innovative. All because we are afraid our systems are not AFM proof.” (A6)
The understanding of a client is central to auditors’ vision on audit quality. Auditors perceives this understanding the client to be reduced as more and more attention is spend on the display of compliance. Auditors cannot spend an unlimited amount of time on an audit, so additional time invested in improving the audit file may reduce time spent on actual audit activities performed, it may actually reduce audit quality in the eyes of the auditors.
“The essence is guarding your understanding of the client’s business. That is a challenge, specifically for the younger generations that started with all the forceful attention towards a complete audit file, complete checklists, without really understanding what lies beneath.” (A1)
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The threat to audit quality is seen as form becoming prevalent over substance, a loss of understanding what goes on at a client.
“The 'why?' question is essential. We are asking ourselves that question a lot less these days, because we are very much focused on audit file compliance.” (A5)
Asked what the concrete impact on the activities performed during an audit is, auditors mention a reduced attention to risk assessments and less analytical reviews. Activities that auditors deem to be important to gain an understanding of the client, which in turn is an essential part of audit quality to them.
“Analytical reviews of the figures are no longer done and we rather don't rely on internal controls, all because it is harder to explain to the regulator.” (A6)
The formal enforcement style, coercive use of power and lack of trust have created an
antagonistic compliance climate, where compliance is predominantly enforced. This has resulted in audit firms actively managing inspection risk at the expense of audit risk.
“We are so preoccupied with the audit file at the moment, making the audit file
compliant, that we forget about the meaning of what is in that file…it is threating audit quality.” (A6)
The response of the audit firms to the AFM oversight has become very much focused on showing compliance with what they perceive the AFM expects. Audit practice is adapted on a very cautious expectation of what the AFM wants to see, and not necessarily on what contributes to a higher quality audit.
“The focus seems to be very much on the file now, but to me audit quality is first and foremost doing a proper risk assessment and the proper execution of the audit. Secondary is the documenting of the audit in the file in a manner that satisfies the regulator.” (A4) The focus on the audit files and visualizing compliance had led to an increased use of checklists. At checklist is a rule-based way of making the steps in the audit process visible and provides comfort to inspectors (Power, 2009). However, the binary nature of checklist is not always
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suitable to the complexity of an audit environment. Professionals judgement cannot be ruled out completely.
“On the one hand, if you are rule based and you followed the rules it is easy to show that you are compliant. It prevents discussions with regulators. The whole interpretation issue can be remediated to a certain degree. On the other hand, our profession is not black and white. You don't have an answer to everything. That's why principles are important, you need to consider what to do. We need to think about the AFM's interpretation of our principals, it is a risk in my opinion.” (A5)
The results of the interviews clearly show that in response to the AFM’s formal enforcement style in an antagonistic climate, audit firms display enforced compliance, consistent with the expectations of the slippery-slope framework (Kirchler et al., 2008). The interviews show that the compliance response of the auditors is predominantly focused on showing the image the regulator expects to see.
Call for collaboration
Amongst the interviewees there is agreement on the necessity of the AFM oversight and the positive effects it has brought in the past few years. However, there is also a shared belief that a ‘tipping point’ is near or reached, Dowling et al. (2015) found similar beliefs amongst auditors in Australia.
“It is a logical part of a quality ‘revival’. The purpose is overshot. People no longer find the occupation attractive. There is a lot of nitty gritty that has to be done. You have to get through it. Then you can focus on what really matters.” (A3)
The above quote illustrates again the influence of the regulatory oversight on audit practice, a focus on trivial matters instead of the bigger picture, but also a belief that this is a temporary situation, something that will eventually settle down.
“It depends on which phase you are in as a profession. A couple of years ago the approach of the AFM was fine, it was what we needed. These are the rules and you
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should comply. My personal opinion is that we have now arrived at a point where we understand what needs to be done and what we didn't do enough in the past.” (A7) Auditors see a formal enforcement style and coercive use of power as something that was once necessary, and had a positive effect but is now becoming counter-productive, threatening to reduce audit quality instead of improving it.
“There comes a time when "the shore will turn the ship". The discussion has started. Clients that say that auditors mainly act out of fear of an incomplete file. At a certain point in time you should think about what is relevant for the client.” (A4)
One auditor put forward a rather colorful metaphor for the current relationship between the auditors and the AFM.
“Compare the situation to that of a misbehaving child. You can scream at the child, give it detention or even slap it. The child will make an effort not to get caught anymore, to avoid punishment. But you can't be sure what will happen if you are not there. What you really want is for the kid to be convinced that this behavior is wrong and then reward it's positive behavior.” (A8)
This quote has all the elements, there is coercive use of power, coerced compliance and no trust, but the wish is to convince, use power through persuasion (Turner, 2005), and to communicate and create positive expectations by rewarding positive behavior, thereby increasing trust
(Rousseau et al., 1998). It is a clear call for a more synergetic compliance climate. The wish for a more synergetic compliance climate is broadly shared amongst the auditors.
“..that the AFM would position itself a bit more vulnerable. That the AFM would go to the NBA (Dutch Professional Organization of Auditors) and show that they are willing to discuss openly what is sufficient. That would be a basis for trust. And if the firms on their
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turn would share information with the NBA and not portray the AFM as boys and girls that left the profession frustrated3...then the profession might get somewhere.” (A6)
The auditors want to AFM to be more vulnerable, to trust them (Das & Teng, 1998), open communication and an agreement on norms. Recognizing the reciprocal character of trust (McAllister, 1995 and the importance of communication in a productive collaboration (Das & Teng, 1998) auditors in turn would need to act more trusting by sharing more information.
3 This is the only openly mention of auditors having a negative image of the regulator in the interviewees. It
highlights the serious limitation of this research, the lack of regulator participation. It would be relevant to know if the regulatees’ treatement or attitude towards the regulator influences their enforcement style.
