A proposed framework emphasizing auditor reliability over auditor independence.

This paper introduces an auditor reliability framework that repositions the role of auditor independence in the accounting profession. The framework is motivated in part by widespread confusion about independence and the auditing profession's continuing problems with managing independence and

inspiring public confidence. We use philosophical, theoretical, and professional arguments to argue that the public interest will be best served by reprioritizing professional and ethical objectives to establish reliability in fact and appearance as the cornerstone of the profession, rather than relationship-based independence in fact and appearance. This revised framework requires three foundation elements to control subjectivity in auditors' judgments and decisions: independence, integrity, and expertise. Each element is a necessary but not sufficient condition for maximizing objectivity. Objectivity, in turn, is a necessary and sufficient condition for achieving and maintaining reliability in fact and appearance.

Keywords: auditor independence; expertise; integrity; objectivity; reliability.

"The significant problems we face cannot be solved at the same level of thinking we were at when we created them."

--Albert Einstein

INTRODUCTION

Recent high-profile business and audit failures, such as WorldCom, Enron, Cendant, Sunbeam, and Waste Management, created an unprecedented crisis in the accounting profession. The crisis in part stems from the concerns about auditor independence that existed for many years. Despite recent research, education initiatives, and regulatory efforts to reduce independence risk, (1) the auditing profession continues to suffer severe public criticism. This paper develops a new perspective on auditor independence that refocuses current and future research, practice, and policy making on what stakeholders' truly seek: auditor reliability.

The new auditor reliability framework proposed here repositions independence as one of three necessary but subordinate conditions, along with integrity and expertise, for maximizing auditor objectivity and, ultimately, auditor reliability. In this context, reliability refers to a condition where stakeholders consistently find the auditor's work and opinion credible and dependable. Our view is that auditor reliability rather than auditor independence is, or should be, the profession's "cornerstone" for protecting the public interest. Recent regulatory changes, high-profile business and audit failures, ongoing financial statement restatements, and the inherent limitations of independence as a professional cornerstone create an audit environment that compromises auditors' ability to serve the public interest and maintain public confidence.

We justify our emphasis on reliability as the new professional cornerstone because the fundamental goal of the audit is to provide assurance about the reliability of an entity's financial statements as specified, for example, in the Securities and Exchange Commission's final rule on auditor independence requirements (SEC 2001) and the Independence Standards Board's Exposure Draft on independence concepts (ISB 2000). Stakeholders expect financial statements to provide a reliable representation of the financial position, results of operations, and cash flows of the entity audited. Moreover, stakeholders will judge an audit effective if they consider the auditor's opinion about the fairness of the financial statements to be reliable. Our proposed conceptual framework therefore elevates the importance of reliability and relegates independence to a more realistic subordinate role.

Our framework is further motivated by our belief that extensive ongoing public criticism of the audit profession reveals the inherent problems caused by excessive focus on auditor independence as the profession's cornerstone. The American Institute of Certified Public Accountant's Code of Professional Conduct Rule 101 (AICPA 2002a) is the basis for the profession's independence rules. A number of recent regulatory initiatives went beyond Rule 101, including the SEC's (2001) independence rules noted above and the U.S. General Accounting Office's (2002) amendment to its independence auditing standards. Educational efforts, such as the Independence Education Project's Faculty Tool Kit (2000) were also undertaken. All of these efforts that were designed to reduce independence risk continue the profession's long-standing tradition of attempting to achieve auditor independence and preserve public confidence by proscribing certain auditor-client relationships. For example, the SEC's (2002) independence rule essentially modernizes a list of unacceptable relationships. The troublesome assumption underlying this continuing proscriptive strategy is that auditors can remain free of conflicts of interest principally by avoiding or limiting certain relationships.

Our framework is based on work in several disciplines, including Mautz and Sharaf (1961) and Kinney (1999) in accounting and auditing, Benn (1998) in ethics, Nagel (1970, 1986) in philosophy, and Bazerman et al. (1997, 2002) in psychology. Exhibit 1 is a visual overview of our auditor reliability framework. It suggests that maximizing auditor reliability and financial statement reliability ultimately hinges on the auditor's ability to manage judgment and decision bias. In turn, this ability is a function of three underlying components:

* independence (relationship-based),

* expertise (technical, client, and industry), and

* integrity (honesty and forthrightness).

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JUSTIFYING A REFOCUS ON RELIABILITY

We highlight three reasons that a model of auditor reliability is superior to a traditional model of auditor independence. First, when auditor reliability in fact and appearance becomes the auditor's ultimate objective, focus shifts from managing client relationships to protecting the public interest, which is what the auditor ultimately is supposed to do. (2) When auditors emphasize concern for the public interest, and not on holding certain relationships in check, they should be more resistant to inappropriate client pressures to "pass" on aggressive (creative) accounting. A renewed focus on reliability and the public interest should point toward favoring transaction "substance" over transaction form."

Second, auditors can never be completely independent because clients pay auditors directly for audit and nonaudit services (Bazerman et al. 1997; Mautz and Sharaf 1961). Consequently, a dominating focus on independence is dysfunctional and, perhaps, dangerous to the extent that auditors and stakeholders believe they achieve independence by complying with authoritative rules that emanate from, for example, the AICPA and SEC. We believe that open acknowledgment of potentially compromising dependencies and concurrent emphasis on compensating quality controls, including ethical awareness training, decision aids, and outside peer review, provides auditors with a realistic alternative for pursuing and maintaining credibility in the marketplace.

Finally, recognizing that objectivity is contingent not only on independence, but also on integrity and expertise, highlights the notion that auditors must nurture and develop their own integrity and expertise. Myopic focus on independence may induce auditors to neglect or underemphasize other key antecedents to auditor objectivity and reliability. We assert that there is no real basis for elevating independence over expertise and/or integrity as key antecedents in the pursuit of auditor reliability. Research by Palmrose (2000) finds that independence problems emerge in only about 5 percent of alleged audit failures resulting in litigious or regulatory action. Ultimately, recasting relationship-based independence in a balanced role with integrity and expertise provides a more realistic foundation for managing stakeholders' expectations and assessing auditors' performance.

Analysis of news reports on prominent alleged audit failures reveals a disproportionately intense focus on auditor independence in the popular press. Criticism of Andersen in the Enron debacle focused in large part on the fact that Enron was a dominant client in the firm's Houston office. Anecdotal evidence almost immediately converged on an explanation for the audit failure that was in large part based on a lack of auditor independence--Andersen's total engagement fees of $52 million/year included $27 million characterized as "nonaudit." Such immediate and pervasive concern about auditor independence in the Enron case overwhelms the other important factors related to auditor integrity and expertise. Enron was an enormously complex audit client requiring considerable auditor expertise. Further, the highly publicized paper-shredding incident was much more a matter of individual integrity than of independence.

THE INDEPENDENCE PROBLEM

The fundamental goal of the external independent audit is to provide users with reasonable assurance that financial statements are reliable by being (1) free of material misstatement and (2) presented fairly in conformity with GAAP. Traditional approaches to ensuring independence, such as rulemaking and standard setting, suggest that such assurance can exist only to the extent that stakeholders believe the auditor is independent, or free from conflicts of interest, in both fact and appearance. As a result, regulators, practitioners, and researchers tend to focus on independence as the means of providing assurance to stakeholders.

But history clearly indicates that auditors continually experience difficulty in maintaining independence as the cornerstone of the profession. (3) As noted, extensive efforts have been made to educate stakeholders and conduct research, such as the Independence Education Project's (2000) Faculty Tool Kit and the Public Oversight Board's Panel on Audit Effectiveness (2000). Further, recent attempts made to modernize existing standards include the aforementioned SEC (2001) independence rules and the International Federation of Accountants (2001) pronouncement on ethics. Despite these efforts, problems persist. For example, the Independence Standards Board, a regulatory entity established in 1997 dedicated solely to managing the independence problem, was abruptly closed when it became more aggressive. As Johnstone et al. (2001) were raising a number of important issues for auditors and other stakeholders to consider when managing client relationships, the ISB (2000) proposed a principles-based conceptual framework for independence. Although such efforts provide useful guidance for managing independence risk, they do not focus on managing the accompanying "integrity risk" and "expertise risk" that can undermine objective (reliable) judgment and decision making (JDM). (4)

Kinney (1999) highlights the challenge of defining independence as either a core value or a necessary constraint for the profession, marking the clear difficulty in managing, or even in agreeing on how to manage, independence. When alleged audit failures emerge, however, independence often is scrutinized with an intensity that detracts from analyzing other potentially culpable areas, such as planning, supervision, integrity, expertise, sampling risk, and judgment errors. While all areas of the audit are likely to be scrutinized in legal proceedings and regulatory enforcements, press coverage and public commentary focus primarily on the scope and nature of audit and nonaudit services provided. The fact that accounting firms pushed the limits of independence to expand the scope of services offered reinforces the "independence bias" problem.

SOURCES OF CONFUSION AND CONTROVERSY SURROUNDING INDEPENDENCE

We suggest that the confusion and controversy surrounding independence stem from at least three primary sources, including:

* definitional inconsistency--the use of varied and inconsistent definitions and conceptualizations of independence;

* operational inconsistency the promulgation and enforcement of narrow and inconsistent interpretations of independence in authoritative pronouncements; and

* implementational inconsistency--the practical impossibility of achieving absolute independence in fact and appearance.

A pressing need exists to clarify these inconsistencies because of the varied and often conflicting meanings the profession assigns to independence. For example, some definitions focus on the need to control independence to ensure objectivity. Arens et al. (2003) state that "independence in auditing means taking an unbiased viewpoint in the performance of audit tests, the evaluation of results, and the issuance of the audit report" (emphasis added). The Independence Standards Board (2000, para. 4) notes similarly that "auditor independence is freedom from those pressures and other factors that compromise, or can reasonably be expected to compromise, an auditor's ability to make unbiased audit decisions." In contrast, the International Federation of Accountants (IFAC 2000, 53) offers a seemingly circular definition of independence, stating that to achieve independence, auditors "should be and appear to be free of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity, objectivity and independence."

Our view is that confusion about the meaning of independence is exacerbated to the extent that the AICPA and the SEC define and operationalize independence in terms of the numerous conflicts of interest that can arise from financial and family relationships involving the client. (5) Missing are specific references to, and measures of, the biases highlighted in alternative definitions. In addition, the AICPA Code of Professional Conduct (2002a) further confuses the meaning of independence by considering "Objectivity and Independence" together, and "Integrity" separately, in the Principles of Professional Conduct while considering "Independence" separately and "Integrity and Objectivity" together in the Rules of Conduct. (6) The AICPA (2001, 5) apparently recognized this construct validity problem when it noted that "independence is essentially an abstract concept that requires judgment and generally implies one's ability to be impartial, intellectually honest, and free of conflicts of interest."

We also argue that the problems caused by this confusion are compounded by the practical consideration that independence is impossible to achieve given the nature of the audit function and the auditor-client relationship. Mautz and Sharaf (1961, 210) recognized long ago that the auditing profession suffers from a number of "built-in anti-independence factors" and that "inherent in the nature of public accounting work ... are a number of features which, to the layman, are almost certain to cast the shadow of suspicion on the auditor's protests of complete independence." The apparent financial dependence of the auditor on the auditee, the emphasis on service to management, and the mixing of audit and nonaudit services all create an environment that jeopardizes independence in fact and makes achieving independence in appearance highly unlikely. Indeed, Kinney (1999) argues that the push for growth in nonaudit services, and the ambiguity of independence in appearance as an achievable objective, have led to suggestions that this objective be de-emphasized or abandoned altogether because of a lack of solid empirical evidence of its importance.

Bazerman et al. (1997) use the psychology literature to argue that achieving independence is impossible and that current approaches to independence in accounting are naive and unrealistic. The current audit framework implies that the goal of independence is to eliminate auditor bias, that is, to achieve objectivity. As stated above, the Independence Standards Board (2000) defines auditor independence as "freedom from those pressures and other factors that compromise, or can reasonably be expected to compromise, an auditor's ability to make unbiased audit decisions." (7) The paradox is that this definition suggests that independence is a "catch-all" construct that includes integrity, expertise, and objectivity. Then the definition implies that independence can be achieved and managed only by focusing on and controlling those client relationships that can motivate auditors to compromise objectivity and professional skepticism. Our framework relieves independence of this cumbersome and confusing role by rejecting the notion that independence should be continued as a multidimensional "state of mind" construct of de facto objectivity. In our opinion, confusion about the meaning of independence, coupled with costly business and audit failures, points to the need for an alternative framework that clarifies the role of independence in the assurance function. (8)

THE PUSH FOR OBJECTIVITY

Exhibit 1 indicates that sustained reliability in fact and in appearance can be achieved only by the relentless pursuit of objectivity. Here we define objectivity as a bias-free state of mind that all auditors should pursue to provide reliable opinions. Objectivity is a cognitive processing variable that encompasses three foundation principles: independence, integrity, and expertise. Our framework recasts independence as a solely relationship-based construct that can affect auditor objectivity and the resulting reliability because the client can exert influence on auditor judgment.

Moreover, our framework also promotes integrity and expertise as equally important antecedents to objectivity. (9) Integrity can enhance objectivity because by maintaining their relatively clear focus on "truthful" reporting, consistently honest auditors should be relatively sensitive to dishonest manipulated reporting behavior. Expertise can enhance objectivity because technical knowledge, ability, and experience allow auditors to exercise due diligence and properly fulfill their responsibilities in a competent and proficient manner, (10) As used here, expertise includes the support professionals and staff that help assure the quality of work done by the audit engagement team.

It is important to note that, in our framework, objectivity supersedes relationship-based independence. This hierarchy is important because objectivity directly affects the quality of auditor judgment and decision making (JDM) while independence only indirectly affects auditor JDM. Stakeholders have a direct interest in the role objectivity plays in the audit function, whereas stakeholder interest in relationship-based independence is indirect because concern about relationships only exists to the extent that relationships impair objectivity. Hence, the effort to maximize objectivity by managing subjectivity is both a necessary and sufficient intermediate step in our reliability framework, but independence is not. Because stakeholders have a direct interest in the auditor's objectivity, our discussion below focuses on overcoming the biases that may erode objectivity.

The Importance of Objectivity

To understand the role of objectivity, we assert that it is critical to acknowledge that absolute objectivity is not possible in a judgment-based profession. All individuals making judgments face inherent subjectivity. In philosophy, Nagel (1979, 1986) recognized subjectivity as an inescapable part of all JDM. Further, the psychology literature is replete with examples of judgment biases, including attributional, hindsight, recency, and self-serving biases, that affect individuals' JDM (Arkes and Hammond 1986). Biases exist because individuals are imperfect information processors making judgments subject to both positive and negative influences. (11) Although the accounting literature acknowledges such biases, it focuses almost exclusively on the dysfunctional effects of bias, such as impaired performance, job dissatisfaction, and unethical conduct. We believe that the profession needs to acknowledge these judgmental biases and explore the wide variety of potential controls extending beyond client relationship management that can help manage subjectivity. Our framework suggests that the pursuit of objectivity by honest and competent auditors who are free of significant client relationship conflicts is sufficient for achieving reliability in fact and appearance.

Nagel (1970, 1986) discusses the difficulties of achieving objectivity from the perspective of moral and political theory. Specifically, Nagel argues for judgment unanimity, also called "agent neutrality," where individuals are capable of applying reason to judgment in ways that should hold for all agents in similar circumstances. This perspective implies that auditors should justify their judgments in ways that eliminate forms of subjectivity that are unacceptable to stakeholders. Nagel's (1970) approach requires individuals who are committed to and capable of justifying judgments and/or decisions on "agent-neutral" grounds. Although auditors possess personal interests, they purposefully subjugate these interests in the justification process. For example, when auditors justify materiality judgments to the audit committee and other stakeholders, there must be incentives to control the subjectivity produced by dependent relationships. Nagel's (1070) argument suggests that auditors can achieve sufficient objectivity to be reliable without being completely independent.

In addition, to the extent that Bazerman et al.'s (1997) argument that independence is impossible is valid, the requirement that an auditor have no interest in a client is unreasonable. Moreover, agent neutrality suggests that auditors can justify their judgments and decisions on appropriately neutral grounds that fully informed stakeholders find appropriate. Building auditors' objectivity therefore goes beyond eliminating interests or relationships that tend to produce bias. There is also a strong need for developing an honest and informed commitment to agent-neutral justification as a method of managing bias in the JDM process.

Ultimately, this line of reasoning suggests that a framework for serving the public trust should begin with the goal of achieving auditor reliability to improve financial reporting reliability by aggressively pursuing objectivity. Independence helps achieve this goal by eliminating or limiting the most basic and common conflicting interests between the auditor and client. Although limiting these interests increases the likelihood of maximizing objectivity, it cannot succeed without expertise and integrity among professionals.

CONCLUDING THOUGHTS

Despite considerable attention paid to issues of independence by both regulators and the profession at large, current business and audit failures clearly indicate that managing independence remains a serious problem for the auditing profession. A problem of this magnitude requires a new level of thinking about "independence" itself and about the related dimensions of expertise, integrity, objectivity, credibility, diligence, and reliability. This paper describes a framework that refocuses attention on the fundamental goal of auditor reliability as a means for achieving reliability in financial reporting.

Implications for Research

Although we recognize this change in perspective is not a panacea in a litigious and hindsight-biased environment, we believe our framework has a number of important implications for research, practice, pedagogy, regulation, and public policy. From a research perspective, the framework suggests the need to develop and implement objectivity training and decision aids designed to manage auditors' innate biases and improve professional JDM. Such aids should make auditors aware of the biases, the institutional variables that exacerbate the biases, and the tools and institutional modifications to manage, alleviate, and minimize such biases (Bazerman et al. 2002).

Further, the development of tools and aids should be empirically investigated to assess the extent that they improve auditor's JDM and lead to reliability in fact. Research is need to empirically measure whether stakeholders believe such training and aids that complement existing independence regulations enhance auditor reliability in appearance. The profession must understand the extent to which the public will "buy into" such aids as inducements to auditor reliability.

We also suggest the need for research that investigates whether relationship-based independence is even a necessary condition for maintaining sufficient objectivity and reliability in fact and appearance. This suggestion highlights the possibility that high levels of expertise and integrity are sufficient to maximize judgment objectivity, even in the presence of currently proscribed relationships.

Implications for Teaching

From a pedagogical perspective, our framework provides auditing instructors with a realistic alternative for explaining the role of independence and the other framework components in the auditing profession. Reasoned focus on auditor reliability could help students put the confusing independence construct in perspective and maintain focus on the need for financial information reliability. Although we have anecdotal evidence that this auditor reliability framework facilitates student understanding of independence, objectivity, and reliability, only empirical research can clarify the framework's relative pedagogical value.

Public Policy Implications

From a policy perspective, this new framework shifts the accounting profession away from what has become an obsessive focus on the single characteristic of independence in fact and appearance. As cast in our framework, independence is one of three important auditor characteristics that collectively allow professionals to make judgments and decisions that are relatively free from bias. Our reliability framework provides a basis for refocusing regulatory resources on the true objectives of the audit process: auditor reliability in fact and appearance. Indeed, the crisis in the profession is a watershed opportunity to reexamine the fundamentals of the profession (Largay 2002). Our framework can be seen as a basis for discussion regarding elements associated with independence, integrity, and expertise.

For example, our framework suggests the need to consider a fundamental revision of Generally Accepted Auditing Standards (GAAS). Specifically, we recommend reconsidering the second general standard, which currently states, "In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors" (AICPA 2002b). While certainly worthy of careful consideration, we suggest the following revision as a starting point to help stakeholders understand the various related factors needed to achieve reliability:

   In all matters relating to the assignment, auditors should use
   integrity, expertise, and independence
   to maximize their reliability.

We also believe that our framework has the potential to clarify responsibilities and guide other critical financial reporting and corporate governance groups, such as internal auditors and audit committee members. For example, within the internal audit profession, Standards for the Professional Practice of Internal Auditing, defines independence as an individual state of mind and a functional position/status within an organization (IIA 2001). Standard 1100, Independence and Objectivity, and its authoritative interpretation, reveal causal ambiguity, with differing statements like "independence is achieved through organizational status and objectivity" and "internal auditors are independent when they can carry out their work freely and objectively" (IIA 2001). As with external auditors, we believe that internal auditors need relationship-based independence, integrity, and expertise to pursue objectivity and, ultimately, a level of reliability that makes their value within their organization clear.

The End Game

Finally, we highlight the potential for this framework to promote consistency and synergy among conceptual frameworks and standards in accounting and auditing. A refocus on auditor reliability as a means for achieving financial reporting reliability could help create a useful link between auditing and accounting standards and conceptual frameworks in a rapidly changing professional environment. To the extent that auditor reliability is recognized as a critical step in achieving accounting information reliability, and perhaps even relevance, the profession can maintain clear and consistent focus while facing challenges created by high-profile business and audit failures, internationalization, and technological change.

(1.) Independence risk is defined as "the risk that threats to auditor independence, to the extent that they are not mitigated by safeguards, compromise, or can reasonably be expected to compromise, an auditor's ability to make unbiased decisions" (ISB 2000, 1).

(2.) Other professions provide similar calls for serving the public interest. For example, the National Society for Professional Engineers' first canon is, "Engineers, in the fulfillment of their professional duties, shall hold paramount the safety, health, and welfare of the public" (Martin and Schinzinger 1996, 408).

(3.) For example, in the late 1990s the newly merged PricewaterhouseCoopers was charged with more than 8,064 independence violations (MacDonald and Schroeder 2000).

(4.) Despite our argument for reprioritizing auditor independence, we agree with the Independence Education Project's (2000) call for more proactive efforts to manage independence risk and for more research to help auditors and audit firms proactively manage independence risk.

(5.) Messier (2003, 674) specifically notes that "because of the difficulty that sometimes arises in defining independence relationships, numerous interpretations of Rule 101 have been issued."

(6.) Interestingly, the second general standard of GAAS defines independence in terms of the "mental attitude" that auditors should maintain (AICPA 2002b).

(7.) Independence Standards Board (2000, para. 4).

(8.) we proceed with the assumption that some level of independence is necessary, possible, and beneficial. However, future research is needed to define the potential scope, limits, and benefits of independence in our proposed framework for serving the public interest.

(9.) Although we acknowledge the likely interactions among independence, integrity, and expertise, we assume here that the three constructs are relatively "independent" antecedents to objectivity and reliability. Future research should assess discriminant validity for the framework's constructs.

(10.) Motivation to pursue reliability is assumed in the model, although future research should be careful to control for differences in auditor incentives and motivation.

(11.) For example, Messick and Sentis (1979) argued that most judgments and decisions are likely to be biased toward self-interest that results from confusing the interest of self with the interest of others (Messick 1995). While the audit environment exacerbates the self-serving bias problem because of its "built-in anti-independence factors" (Mautz and Sharaf 1961), it does little to facilitate managing the problem at the individual level.

REFERENCES

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MacDonald, E., and M. Schroeder. 2000. Report by SEC says Pricewaterhouse violated rules on conflicts of interest. Wall Street Journal (January 7): A3.

Martin, M. W., and R. Schinzinger. 1996. Ethics in Engineering. Third edition. New York, NY: McGraw-Hill.

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Messick, D. M., and K. P. Sentis. 1979. Fairness and preference. Journal of Experimental Social Psychology (15): 418-434.

--. 1995. Equality, fairness, and social conflict. Social Justice Research (8): 153-173.

Messier, W. F. 2003. Auditing and Assurance Services: A Systematic Approach. Third edition. New York, NY: McGraw-Hill/Irwin.

Nagel, T. 1970. The Possibility of Altruism. Oxford, U.K.: Clarendon Press.

--. 1979. Subjective and Objective. Mortal Questions. New York, NY: Cambridge University Press.

--. 1986. The View from Nowhere. New York, NY: Oxford University Press.

Palmrose, Z-V. 2000. Empirical Research in Auditor Litigation: Considerations and Data. Studies in Accounting Research #33. Sarasota, FL: American Accounting Association.

Public Oversight Board (POB). 2000. The Panel on Audit Effectiveness: Report and Recommendations. Stamford, CT: POB.

Securities and Exchange Commission (SEC). 2001. Final Rule: Revision of the Commission's Auditor Independence Requirements. Washington, D.C.: SEC.

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Mark H. Taylor is an Associate Professor at Creighton University, F. Todd DeZoort is an Associate Professor at The University of Alabama, Edward Munn is a Visiting Assistant Professor at the University of South Carolina, and Martha Wetterhall Thomas is Director, Center for Business Communication at the University of South Carolina.

We thank Dana Hermanson, Rich Houston, Jack Krogstad, and Gary Taylor for their helpful comments.