Does Being the Auditor Impair Independence?

By Jeffry R. Haber

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Coverage and discussion of the Enron scandal tends to focus on the length of the relationship between Andersen and Enron and the additional services rendered by Andersen to Enron, and whether those revenues impaired Andersen’s independence (and presumably its objectivity and judgment). If the additional services did not impair actual independence, they certainly impaired the perception of independence. An auditing environment where the public has faith in the product (financial statements) requires both actual and perceived independence.

But even if no additional services were rendered by Andersen to Enron, Enron likely would still have failed. Even without the additional revenue from nonaudit services as a reason for Andersen to relax its professional judgment, as some have alleged, the audit fees paid to Andersen by Enron represented a substantial portion of the revenue of the servicing office. In the public process of unraveling this scandal and leveling blame, it would not be a far stretch to infer that Andersen’s independence would be questioned simply because of the size of the audit fee. That is, the impairment would arise simply because the client paid a fee to the auditor.

Audit firms are businesses. Partners and staff work long and hard to achieve success, which manifests itself in their financial compensation. The money for all this comes from clients paying for audit, tax, consulting, and other services. If each audit client purchased no other services, the audit fee would represent the only element of revenue. The maintaining and satisfying of clients is important, and such criteria are used in manager and partner evaluations.

This is not to say that firms would risk a lawsuit or purposely renege on their professional duties; neither should they backseat their professional duty when receiving consulting revenue. The underlying question becomes: When so much revenue is being realized, can any business firm properly exercise the standard of professional care? This question exists even when a firm receives only audit fees.

The auditor-client relationship is unique in professional services. Auditors are hired and paid by the client, but their product is really for use by the public, to whom they owe a standard of care. Auditor rotation has been proposed as a solution, and although it is a step in the right direction, it does not go far enough. Having the stock exchanges (or the SEC or another oversight body) be responsible for hiring and paying the auditors would remove the potential for independence impairment.

If the goal is to increase the public’s perception of auditor independence, then the company being audited can no longer be the client. Another party must contract for the audit, pay the auditor, and become the client. Then there would be no perceived or actual impairment of auditor independence. All other solutions being discussed still leave open the potential for questioning independence, and therefore for undermining the usefulness of the audit process.