The Auditor-Firm Conflict: An Analysis Using Concepts of Exchange Theory

Author(s): Donald R. Nichols and Kenneth H. Price

Source: The Accounting Review, Vol. 51, No. 2 (Apr., 1976), pp. 335-346
Published by: American Accounting Association
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 The Auditor-FirmConflict:An Analysis
Using Concepts of Exchange Theory

Donald R. Nicholsand KennethH. Price

T HE auditor'srealand perceivedinde- of the attest function.However, it will be

pendenceand autonomyin the per- necessary to consider at a later point the
formanceof the attest function effect of special engagements, including
seemsuniversallyacceptedas a desirable management services, on the attest func-
attribute [ASOBAC, 1972, pp. 24-34; tion conflictsituation.
Mautz and Sharaf, 1961, pp. 204-231]. The specific conflict situation occurs
Nevertheless,whether theauditoractually when the auditor and firmdo not agree on
possessessufficientpowerto maintainin- some aspect of the performanceof the at-
dependencein auditor-firm conflictsitua- test function.Under these circumstances,
tionshas been questioned[Sterling,1973, the firm may attempt to influence the
pp. 61-67; Briloff,1972]. In spite of the mannerin whichthe attestfunctionis con-
apparentimportanceof auditorindepen- ducted. The firm,in attemptingto influ-
dence,littleattentionhas been given in ence the performanceof the attest func-
the literatureto the variableswhichmay tion, may pressurethe auditor to take an
affectthe auditors'abilityto withstand action that violates acceptable auditing
pressurefroma client.This studyutilizes standards, including the renderingof an
interpersonalexchangetheoryto consider inappropriateopinion. Since we generally
in detail some of the factorswhichmay assume that the auditor is motivated to
affectthe relativepowerof theauditorto comply with professionalethics and gen-
maintainindependence in an auditor-firm erally acceptable auditing standards, the
conflictsituation. auditor would be in a conflictsituation.
Compliance with the firm'sdemands may
BACKGROUND OF THE AUDITOR- lead to violations ofprofessionalstandards
FIRM CONFLICT which the auditor wishes to avoid. Failure
In thisarticle,theterm"auditor"refers to comply with the firm'sdemands may
to a professionalaccountantwho is hired result in sanctions by the firm,including
by a companyto performan audit and the possibility of terminationof the en-
renderan opinionon statementsto be pro- gagement.The questions of major interest
vided fora thirdparty.The term"firm"
refersto the partythat hiresthe auditor Donald R. Nichols is Associate Professor
to perform the attestfunction;oftenthis ofAccountingat The Universityof Kansas;
is the ownerand/ormanagementof the KennethH. Price is Assistant Professorof
firm.Our analysis concentrateson con- Business Administrationat The University
flictswhichmay arisein the performance of Texas at Arlington.
335

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336 The AccountingReview,April 1976

in this paper are: (1) Is the auditor likely higherthe proportionof nonroutineactivi-
to complywiththe firm'sdemands because ties performedby the professional, the
of an asymmetricalpower structurefavor- more power the professional wields vis-
ing thefirms?;(2) If an asymmetricalstruc- a-vis the client.In addition, the higherthe
ture does exist, what are the factorscaus- proportion of services the professional
ing the imbalance? and; (3) What changes renders directlyto the paying client, the
in thestructureoftheauditor-firm relation- more importantare these services to the
ship would reduce the probability of the client and the greater the professional's
firm'sattemptingto influencethe auditor power. The implication of this model is
and also decrease the likelihoodof auditor that movement of the auditor's position
compliancewhen such attemptsare made? from cell 4 to cell 1 would increase the
In one of the few articles on the topic, auditor's power to withstandinfluenceat-
Goldman and Barlev [1974, pp. 707-718] temptsby the clientto pressurehim or her
recentlydeveloped a model incorporating into a violation of professionalstandards.
a number of factors which affect the We shall examine these assumptions and
auditor-firm conflictsituation. It is our in- conclusionsin the followingsections using
tention to expand on their analysis and, behavioral science concepts.
among other things,indicate some appar-
ent weaknesses in their conclusions. A TABLE 1
briefreviewof some of the essentialfactors THE AMOUNT OF POWER WIELDED BY PROFES-
of theirmodel will provide a basis for de- SIONALS Vis-a-Vis PAYING CLIENTS

parture.
ProblemSolved
Goldman and Barlev (G&B) argue that
attempts to influencethe auditor to take Beneficiary Nonroutine Routine
an action that is not in conformitywith Paying Clients (1) Highest (2) Medium
professionalstandards may be successful Others (3) Low (4) Lowest
because of an asymmetricalpower rela-
tionship in favor of the firmin a conflict
THE AUDITOR-FIRM CONFLICT SITUA-
situation [1974, p. 712]. Accordingto the
TION AND INTERPERSONAL
G&B model, the power of a professional
EXCHANGE THEORY
vis-a-visa client may be described by the
matrix in Table 1, and the auditing pro- Cartwrightand Zander [1968, p. 216]
fession is characterized by cell 4. The defined power as the capability of one
auditor is so classifiedbecause the auditor partyto influencethe attitudesor behavior
is providing a service not for the paying of anotherparty. Thus, in the auditor-firm
client,the firm,but primarilyforthe bene- conflictsituation, the power of the firm
fitof a thirdparty, such as the stockhold- can be representedby its ability to influ-
ers or creditors.In addition, the auditor's ence the audit or finalreportof the auditor.
serviceis consideredto be basically routine The independence of the auditor can be
since many standardized procedures are represented by the auditor's ability to
utilized and discretionaryjudgments of withstandsuch influenceattempts.Under-
the professionalsare minimal. Situations standing the exercise of power between
characterizedby the performanceofhighly two parties and the success of such at-
routine services for the primary benefit tempts to influencebehavior requires ex-
of nonpaying third parties are identified amination of the relationship between
as low power relationships in the G&B both parties and theirrelationshipto third
model. As described in the matrix, the parties. These relationships can be ana-

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Nichols and Price: Auditor-FirmConflict 337

lyzed by using exchange theory terms investmentsthat one partyhas in the goals
[Tibaut and Kelly, 19571 and by using the mediated by the otherparty,and inversely
concepts of dependency as related to proportional to the availability of these
power formalizedby Emerson [1962]. goals throughparties outside the current
Emerson [1962, p. 32], describinga two- relationship. Therefore, dependency is a
party relationship,stated that power of A function of the valuation placed on the
over B rests implicitlyin B's dependency rewardsthat one party can offerthe other
on A. The greater the dependency of one and the availability of these rewards in
individual on the rewards and/or punish- otherrelationships.It may be argued that
ments that the other party can mediate, in the conflictsituation,the dependence of
the greaterwill be the power of the party the auditor on the firmis greaterthan the
to gain compliance with his or her wishes. dependence of the firm on the auditor.
Since power in any dyadic relationshipis a This would resultfromthe auditor placing
functionof the dependency of each party greater significanceon the rewards medi-
on the other, the alleged asymmetrical ated by the firmthan the firmplaces on
power relationship between the auditor the rewardsmediated by the auditor, and
and the firmcan be analyzed by examining because the alternatives available to the
the pattern of dependency between both firm are greater than the alternatives
parties. Following Emerson, the following available to the auditor.
pair of equations can be used to describe In the conflictsituation, the firmdoes
the auditor-firmrelationship. not highlyvalue the rewardsthat a specific
auditor can mediate. The rewards an in-
Pab = Dba (1) dividual auditor offersare special skills in
Pba = Dab (2) accurately assessing the financial opera-
tions of the firm.The firmmay not be
In equation (1), the power (P) of the interestedin the most competentaudit or
firm(a) over the auditor (b) is equivalent most accurate statement of its financial
to the dependency (D) of the auditor (b) positionand resultsof operations.Instead,
on the firm(a). In equation (2), the power the firmmay desire to secure statements
(P) of the auditor (b) over the firm(a) is that have a particularexpected impact on
equivalent to the dependency (D) of the third parties. Since anyone with the ap-
firm (a) on the auditor (b). The G&B propriate credentials is able to perform
model suggests that the power of the firm this type of attest function,the individ-
is greaterthan the power of the auditor in ual auditor's expertise or special skills in
a conflictsituation. However, we would accounting or auditing may have little
argue that the cause of this imbalance is significanceto the firm.On the otherhand,
not, as the G&B model indicated, a result the auditor is likely to place a high valua-
of the audit functionbeing routine com- tion on the rewards that the firm can
pared to nonroutineor that a thirdparty mediate, such as present and potential
is the primarybeneficiaryof the auditor's fees from the audit and, perhaps, other
services. Instead, we hope to demonstrate services. The auditor places a high valua-
that this imbalance is a result of the dif- tion on these rewards because they are
feringpattern of dependencies that exists consistentwith the auditor's needs. Thus,
between the auditor and the firm. the rewards offeredby the firmare con-
More specifically,the dependenceof one sistentwith the goals that the auditor has
party on the other [Emerson, 1962] is in exchanging services; however, the re-
directlyproportional to the motivational wards offeredby the specificauditor, the

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338 The AccountingReview,April 1976

accountingand auditingexpertise,may be is apparentlyinterestedin the outcome of

inconsistentwith the goals that the firm the attest functionrather than the com-
seeks to obtain. petence with which it is performed.Thus,
The resultof the auditor placing greater the firm'slack of interestin the rewards
valuation on the rewards the firm can the auditor can mediate seriously erodes
mediate than the firmplaces on the re- the only base of power (expert power) the
wards the auditor can mediate does not, auditor possesses vis-a-visthe firm.There-
by itself, produce an asymmetrical pat- fore,the net effectis to produce a different
tern of dependency. However, this differ- pattern of dependencywhich resultsin an
ence in valuation of rewards, combined asymmetricalpower relationshipfavoring
with greater alternatives available to the the firm.
firmcompared to the auditor,produces an In the G&B model the auditor is in a
asymmetrical pattern of dependency. It low position of power partly because the
is likely that the alternativesavailable to auditing functionis routine; they suggest
the firmto obtain the rewards mediated that "the higher the proportion of non-
by the auditor are greater than the alter- routineproblemsdealt with by the profes-
natives available to the auditor to obtain sional, the more power he wields vis-a-vis
the rewards mediated by the firm. An the client" [1974, p. 711]. This relation-
auditor operates in a competitivemarket ship may be describedby Figure 1 (linear-
attemptingto sell his or her services to a ity need not be assumed).
specificcompany. It is probably easier and
less costly for the firmto replace its cur-
rent auditors than it is for an auditor to High
obtain additional or alternativesources of Power to
fees. In the conflictsituation,the alterna- WithstandThreats
of Replacement
tives available to the firmare probably
numerous, since any individual with the Low I
appropriate credentials can performthe Low High
attest function.Thus, the large potential Routinismof Auditor'sService
supply of auditors that the firm might
FIGURE 1
utilize to achieve its objectives decreases
THE RELATION BETWEEN POWER AND DEGREE
the firm'sdependencyon a specificauditor.
OF ROUTINISM OF AUDITOR'S SERVICES
This would not be true if the rewardsof
the specific auditor were desired by the
firmbecause of the auditor's special skills The assumption underlying the G&B
or high levels of competence.In this case, model is that the more nonroutine the
the services offeredby the auditor have auditor's services, the greater the impor-
high significancefor the firm, and the tance the firm attaches to the specific
numberof alternativeauditors who might auditor's expertise.The resultwould be an
provide equivalent services might be re- increase in the power of the auditor vis-a-
duced. However, this is not the case in vis the firm,because the firmnow would
attest functionconflictsituationssince the place greater significanceon the services
competence and credentials of a specific the specificauditor could mediate.
auditor to performthe attest functionare The conclusion of the G&B model re-
apparently not considered to be greater garding the relationship between power
than any other memberof the profession. and routinismis not justified.In order to
In addition, the firmin a conflictsituation be valid, the analysis would require a dif-

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Nichols and Price: Auditor-FirmConflict 339

ferentiationbetween attest function ser- parties. Essentially,the firmmust have an

vices and management services. As we audit because of a requirementof the Se-
hope to demonstrateregardingthe attest curities and Exchange Commission or
function, the model is incorrect and, in other reasons. The firm cannot perform
fact, the relationship is reversed. With the audit; only a professionalwith the ap-
respect to managementservices,there are propriate credentials can. Changing the
a number of significantvariables omitted audit functionfromroutineto nonroutine
fromthe model and the net effectof such would not alter this basic relationshipbe-
services is difficultto determine. These tween the auditor, the firmand the third
issues are examined in the followingsec- party. Since this basic relationship be-
tions. tween the three parties remains un-
changed, it seems unlikely the goals of
ROUTINISM IN THE ATTEST FUNCTION each partywould change. In this situation,
AND ITS IMPACT ON POWER the firmwould not place any greater sig-
The basic reason that increasing the nificanceon the services the auditor can
nonroutinismof the attest function does offer regardless of how nonroutine the
not increase the auditor's power to with- auditingfunctionmightbe. The firmmay
stand threats of replacement is that the be only interestedin obtaining a particu-
firm'svaluation of the auditor's services lar reporton statementsto be provided to
is not affectedby the degree of nonroutin- third parties. Thus, in this conflictsitua-
ism in the attest function. As we have tion the nonroutinenessof the auditor's
argued in the previous section, in conflict services does not increase the significance
situations, the auditor's relative skills in of the auditor's services vis-a-visthe firm
accounting or auditing activities are not because it does not alter the goals of the
highlyvalued by the firm.The low valua- firmand because the audit providesno new
tion of the auditor's services is related to information.
two considerations. Finally, it should be noted that chang-
First, the firmconsents to an audit be- ing the auditing functionfromroutine to
cause of the requirementsof a thirdparty. nonroutine,since it does not alter the de-
Generally, the firm does not expect to pendency of the firmon the auditor, does
gain new informationfrom the audit or not change the firm'sbasis of social power
the report; i.e., the firmdoes not depend or willingnessto utilize this power. Re-
on the audit to detector preventirregulari- gardless of how nonroutine the auditing
ties, or to determinefinancialposition or function might be, the firmstill retains
results of operations. It is important to the ability to hire and firethe auditor. In
recognize that informationbeneficial to addition, the firmwould not be less likely
the firm,such as reportson internal con- to employrewardand coercivepowerifthe
trol that may result from the audit, are final report were not consistent with its
being considered as part of the manage- desires,regardlessof the nonroutinenature
ment service activity to be discussed later of the auditingfunction.
since it is not a requiredpart of the audit. We have suggested that changing the
Thus, the actual informationfrom the attest functionfromroutineto nonroutine
audit or contained in the audit reportis of does not necessarily alter the motivation
littleor no significanceto the firm. of the firmor its valuation of a specific
Second, the firmplaces a low valuation auditor's expertise.In this section,we will
on the auditor's services because of the argue that the power of the auditor to
nature of the firm'srelationshipto third withstandattempts to influencethe audit-

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340 The AccountingReview,April 1976

or reportis positivelyrelatedto the de- the extreme, all auditors would perform
greeofroutinism of theauditfunction,as the same audit procedures and reach the
describedin Figure2. Thus, we are sug- same conclusionabout the financialstate-
gestingan inverserelationshipbetween ments conformingto GAAP in a specific
routinismof the attestfunctionand the circumstance. As a simple example, as-
ability of the auditor to withstandin- sume that the only point of possible con-
fluence. troversyis the question of capitalization
or noncapitalizationof a material amount
of R&D expenses. Capitalization results
High in an income statementreportinga profit
Power to
whichthe firmdesires,whilenoncapitaliza-
WithstandThreats tion results in reportinga loss which the
of Replacement firmdoes not desire. Since currentFASB
opinion clearly requires noncapitalization
Low
of these items,the determinationof which
Low High
treatmentis in conformitywith GAAP is
Routinismof Auditor'sService
clear, and the process may be described
FIGURE 2 as routineor highlystructured.Given the
THE RELATION BETWEEN POWER AND DEGREE above situation, with highly routine or
OF ROUTINISM OF ATTEST FUNCTION structured auditing procedures and ac-
counting principles we would argue that
The basis forour argumentis whilethe the firmwould be less likely to pressure
firmmaypossessconsiderable rewardand the auditor, and the auditor would be less
coercivepowerovertheauditor(abilityto likely to comply with the firm'swishes to
hireand firethe auditor),the exerciseof capitalize the R&D expenses in determin-
suchpowerin obtainingcompliancefrom ing income. The reason is simply that the
the auditordependson the rewardsand costs to each party associated with such
coststhat the firmperceivesthat willac- action, both internalin termsof guilt and
cruefromsuchactions.Similarly, whether external because of possible sanction ad-
the auditoris responsiveto the firm'sin- ministeredby third parties, are likely to
fluenceattemptsmay dependon whether be greaterthan the rewards.
the auditor perceivesthat the rewards
fromcomplaintbehaviorwilloutweighthe AuditorPerspective
costs.In effect,the exerciseof powerim- From the perspective of the auditor,
pliesan exchangerelationship [Tibautand routinenesswithfewerdiscretionaryjudg-
Kelly,1957,p. 124]. ments implies a greaterpossibilityof con-
Considerthefollowing examplebasedon sensual validation among professionalsin
thedegreeofstructure in GAAP,although the field concerningthe appropriate ac-
the implications to any aspectsof the at- tions and conclusions.When thereis little
testfunction seemanalogous.Assumethat agreementconcerningthe appropriatepro-
theauditingprofession consistsof a num- ceduresand/orinterpretations, the auditor
ber of professionalswho are qualified may be morelikelyto use thoseprocedures
equally to performthe attest function. which result in a reportthat is desired by
Further, assumethattheauditprocessand the firm.There are two main considera-
determination of conformity to generally tions.First,the costs to the auditorofcom-
accepted accountingprinciples(GAAP) pliance are not as great because feelings
are routineand completely structured.At of guilt associated with violations of ac-

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Nichols and Price: Auditor-FirmConflict 341

ceptableauditingor accountingstandards courts.Given a greaterpossibilityof de-

are less likelyto occur.In thissituation,
tectionand successful sanctionorprosecu-
theauditormay rationalizecompliantbe- tion,thepotentialcostto thefirmofsuch
haviorbecause of the ambiguityconcern- inappropriatebehaviormay exceed the
ing acceptableprocedures.Given a more potentialrewardsof issuinga morefavor-
routinetask and the increasedpossibilityable, but inappropriate, report.If this is
offormalizing acceptableauditingand ac-the case, one wouldexpectthat pressure
countingstandards, ofguiltresult-
feelings by the firmon the auditorto violateac-
ingfromtransgressions of thesestandardsceptablepracticeswoulddecrease.
cannotbe rationalizedeasilyby individual Finally,an additionaleffectof increas-
auditors.These feelingsof guilt,resulting
ing the degreeof structurein the attest
in part fromthe individualauditor'smo- functionby more clearlyspecifyingac-
tivationto conform to generallyacceptedceptable auditing and accountingstan-
auditingand accountingstandards,repre- dardsmaybe to reducetheprobability of
senta costofcompliantbehavior.In fact, findinganotherauditorwho would com-
theymay preventthe auditorfromcom- ply withthe firm'sdesiresif the current
plyingwiththewishesofthefirm.Second, auditorwere terminated.In the routine
the possibilityof other costs resulting situation,whereacceptableauditingand
fromsanctionsthat may be administered accountingpracticesare clear and unam-
by thirdpartieswould also be increased. biguous,the firmmay perceiveit to be
Given that agreementconcerning accept-highlyunlikelythat it might find an
able standardsis morelikelyto occurun- auditorwho would arriveat a different
der routineconditions,detectionof inap- conclusionor wouldagreeto an inappro-
propriatebehavioris more probable. If priatereport,or both.The neteffect is to
sanctions are administeredwhen inap- reducethe potentialrewardsthat might
propriatebehavioris detected,then the accrueto thefirmthroughfiring thepres-
expectedcostofcompliantbehavior,which entauditorand hiringa different auditor.
violatesacceptablestandards,is increased.
The consequenceof thismaybe to render
The increased costs resultingfrom a ineffective the coercivepower possessed
greaterpossibilityof detectionand sanc- by the firmin attempting to obtaincom-
tion of inappropriatebehaviormay out- pliant behavior by individualauditors.
weightherewardsthatmayaccrueto the Mautz [1972,pp. 81-95] wouldseemto be
auditor as a consequenceof complying in agreement withtheseconclusions when
withthefirm'swishes. he commented on the effectof the degree
of structurein GAAP and its impacton
FirmPerspective
the auditor.He concludedthatdeliberate
In a similarmanner,a rewards-costs misstatement (givingan inappropriate re-
analysis may be used in examiningthe port) is unforgivable. Whilehe does per-
possibilityofthefirmdemandingthatthe ceive thisas an infrequent occurrence, he
auditorissue an appropriatereport.In a does note the possible pressuresin the
more routineenvironment, violationsor situation:
improprieties on the part of the firmin
pressuringthe auditorto issue an inap- To the extent that it (yielding on principles)
propriatereportmay be detectedmore does occur, it probably is not intentional but
easily. In addition,such cases may be rather is an unintended and often unrecognized
result of tryingto meet the needs of clients in the
sanctionedmoreeasilyor prosecutedsuc- face of competition from other (auditing) firms.
cessfullyby a bodysuchas theSEC or the The ever present knowledge that there are other

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342 The AccountingReview,April1976

firmsof equal prestigeand statusthatjust might pendency of the firmon the auditor. The
see the resultsof a transactiondifferentlyis a costs associated with replacement of the
specterdifficultto shake fromthe mindsof any
who make audit decisions" [1972, p. 911 . . . (and auditor (loss of the expertise) when few
concerningthe authority of the auditor)... alternatives are available would be in-
Can you imaginewhat wouldhappen to a major creased. Given these assumptions, Figure
company if an accountingtreatmentwhich its 3 indicates the possible relation between
managementinsisted upon was consideredun- the performanceof management services
satisfactoryby all CPA's? There seems little
doubt but that the companywould have to give
and the auditor's independence.
(agree to acceptable treatment)[p. 94].
High
MANAGEMENT SERVICES AND THEIR
Abilityof
IMPACT ON POWER Auditorto
Withstand
Considered in the G&B model is the Conflict
question of whetherperformanceof man- Situations /
agement services will increase or decrease Low /
the independenceof the auditor (resistance Negative Low High
to influence)in auditor-firm conflictsitua-
tions.While most of the previousliterature Negative
on the subject has questioned seriouslythe
compatibility of management services PerceivedUnique Value of Management
ServiceActivity
and audit independence,the G&B model
leads to the conclusion that such services FIGURE 3
tend to increase the independence of the RELATIONSHIP OF MANAGEMENTSERVICE
auditor. This conclusion is based on the ACTIVITY TO AUDIT INDEPENDENCE
fact that "most consulting activities are
nonroutineand because these servicesben- As portrayed by Figure 3, if the firm's
efitthe clientfirmdirectly" [1974,p. 715]. perceptionof the unique value of manage-
We would submit that thereis not suffi- ment service activity were high, then the
cientevidence to supportor reject thiscon- ability of auditors to withstand conflict
clusion unequivocably because of a va- situations would tend to be high. That is,
riety of factors that may or may not be greaterconflictin the audit area would be
present in each situation. Furthermore,if requiredbeforethe firmwould replace the
in certain situations the addition of man- auditor over an audit dispute. It is im-
agement services did increase the power portant to note that the horizontal axis
of the auditor, this would be a result of in Figure 3 is not the amount of manage-
changing the dependency of the firmon ment service activity, but the perceived
the auditor. unique value of those services. The G&B
The addition of management services model fails to distinguishbetween these
would only increase the power of the two; however, differentiationis critical.
auditor ifthe firmperceivedthat the addi- For example, at one point (the origin)
tional management services had some the perceivedunique value of the manage-
unique value which could not be fulfilled ment services is zero. This may be be-
easily by replacingthe auditor or by other cause the auditor performs(or is expected
consultants.In this circumstance,the per- to perform)no management services, or
formance of management services in- it may be because the firmbelieves that
creases the significanceof the auditor's these services can be performedequally
total services and, thus, increases the de- well by another auditor or other consult-

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Nichols and Price: Auditor-FirmConflict 343

ant. In this case, the management service audit. The benefitto the paying client is
factor has no impact on the independence usually fulfillmentof a requirement,im-
of the auditor. Further, the graph indi- posed or required,by a person outside the
cates the possibilityof dissatisfactionwith firm(bank, SEC, prospectivebuyer). Ap-
the management service activity on the parently, the benefitof fulfillingthis re-
part of the firm,perhaps resultingfrom quirementis greater than the cost, or the
apparent poor recommendations in the audit never would be requested by the
past, or fromthe auditorchargingwhat the paying client.This is not to suggestthat a
client considered to be an exorbitantfee firmunilaterally would request an audit;
forthe service.In those cases, the auditor's however, the fact that the firmis willing
independence would be decreased by per- to submit to and pay foran audit is suffi-
formance of additional management ser- cient evidence that it perceives the bene-
vice activities. Finally, the ability of the fits to be equal or in excess of the costs.
auditor to withstand threats of replace- Consequently, the primarybeneficiaryof
ment may not be increased through the the audit may not be determinedclearly.
addition of management services if the However, if the third party were the
value of such additional services are not primary beneficiaryof the auditor's ser-
perceived by the firmto exceed the costs vices, this would not be the cause of the
associated with an undesirable report. auditor's low power vis-a-visthe firm.As
Here, the firm might perceive that the previouslyargued, the auditor is in a low
costs associated with undesirable actions position of power because the paying
by third parties may outweigh any addi- client may not be interestedin the exper-
tional rewards the auditor might provide tise he or she can provide.The cause of this
throughhis or her special services. conflictbetweenthe firmand the auditor is
Thus, there does not appear to be suffi- the coercivemannerin whichthe firmper-
cient informationabout the firm's per- ceives some thirdparty mightuse an un-
ceptions of the unique value of the audi- favorable report. For example, the third
tor's management service activities in party might use the auditor's report to
relation to both rewardsand costs to sup- deny the firma loan or, in the case of
port or reject a conclusionabout its effect stockholders,sanction management poli-
on the auditor-firmconflictsituation. Any cies. Removal of the third party and its
finalresolutionof the managementservice potential coercive use of the auditor's re-
controversy would require consideration port would alleviate the cause of auditor-
of all of the above factors. Since these firm conflict; however, this also would
factors may be quite variable, depending eliminate the purpose of the attest func-
on the specific situation, any general a tion. Therefore, we do not perceive the
priori conclusion specifyingeffectsacross cause of the auditor's low position of
all situationsmay be impossibleto obtain. power to be a result of thirdparties being
the primarybeneficiariesof the auditor's
Benefitsand Its RelationshiptoPower
services. In addition, we would argue the
The G&B model leads to the conclusion possible coerciveuse of the informationby
that the auditor is in a low position of a thirdparty is a cause of the auditor-firm
power vis-a-visthe firmpartly because the conflict.
firmmust pay for the audit while other
parties derive the primary benefit from METHODS OF RESOLUTION
the audit. It must firstbe clear that there It would be an oversimplification
to sug-
is a direct benefit to the client from an gest that simply increasing the power of

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344 The AccountingReview,April 1976

the auditor vis-a-visthe firmnecessarily tinct set of proceduresthat mightbe used

will implythat the firmwould not attempt to increase the ability of the auditor to
to influencethe performanceof the attest withstand pressure to comply with the
functionand the auditor would refuseto firm'sdemands. The firstset involves the
comply if such an attempt were made. activities designed to increase the discre-
That is, power possessed will not be util- tionaryoptions available to the auditor to
ized necessarilyin a manner to insure ap- cause sanctionsto be imposed on the firm.
propriate behavior. Instead, the equaliza- The second set of procedures represents
tion of power between the auditor and the attempts to reduce the auditor's and/or
firm,resultingin a symmetricalpowerrela- of action by increasing
the firm'sflexibility
tionship,could lead to mutual accommo- the cost of inappropriate behavior. The
dation. In a situationwithmorepower,the thirdset involvesa change in the structure
auditor might comply with the firm'sde- of auditor-firmcontractual relationships
mands but only under conditions which as a means of decreasingthe discretionary
the auditor feels to be more acceptable. options available to the firm. We shall
Thus, a symmetricalpower relationship examineexamplesofeach set ofprocedures
mightonly serve to enhance the auditor's in turn with the objective of reducingthe
position and enable the auditor to make possibility of the firmdemanding an in-
greater counter demands upon the firm. appropriate action and the auditor com-
Whetheror not, given a more symmetrical plyingwhen such a request is made.
power relationship between the auditor The firstapproach centerson increasing
and firm,the firmwould request a viola- the power of the auditor, primarilyby in-
tion of professional standards and the creasing the ability of a replaced auditor
auditor would agree to the request would to cause sanctions to be imposed on the
depend on other factors. The critical firm resulting from unjustified replace-
factors are the perceived benefits and ment.Examples currentlyin use are, a new
costs that accrue to both partiesas a result auditor being required to consult with the
of a violation. These potential costs can be previous auditor to obtain all relevant
internalor external.They may be internal information;or,in cases consideredby the
in the form of feelings of guilt resulting SEC, the former accountant having to
from taking an inappropriate action, or submita reportto the SEC concerninghis
externalin the formof sanctions adminis- or her displacement. Procedures of this
tered by thirdparties (courts, SEC, ethics natureare quite likelyto alter the auditor's
committees,etc.). In those cases wherethe power vis-a-vis the firm.In effect,these
potential costs exceed the rewards, to proceduresprovide or create a new base of
either party, it would seem unlikely that power for the auditor vis-a-vis the firm.
the specific behavior would be enacted. This new base of power is clearly coercive
For this reason, we would suggest that in nature since a replaced auditor can
procedures designed to increase the pos- make other parties aware of alleged inap-
sible detection and costs of inappropriate propriate demands made or unjustified
actions are more likely to decrease the in- actions taken by a firm.These procedures
cidence of violations of acceptable prac- increase the potential costs to the firmin
tices than techniques designed to equalize attempting to influence the auditor to
the power between the auditor and the violate professionalstandards by making
firm. it more likely that others will learn of
There are at least three reasonably dis- the attempts. These procedures may

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Nichols and Price: Auditor-FirmConflict 345

reduce such influence attempts by the late acceptable standards.In addition,

firm,given that the auditor utilizes the tightening standardsmayreduceattempts
proceduresand that appropriatesanctions by thefirmto influence thefinalreportof
are administeredby the thirdpartiesin the an auditorbecausethefirmmay (1) have
case of inappropriatebehavior. Thus, the a clearerunderstanding of the reporting
firmmay be in a more difficultposition to rules,(2) perceivemoredifficulty in find-
assess whether the potential rewards of inganotherauditorwhowouldviolatesuch
such influenceattempts will outweigh the clearstandardsand (3) be inhibited by the
costs. greaterpossibility ofdetectionby a moni-
However, theseproceduresdo not insure toringbody.Implicithereis the assump-
that ifan influenceattemptis made by the tion that appropriatemonitoring bodies
company, the auditor will utilize the (professionalcommittees,SEC and the
power to preserveindependenceand to re- courts)would be available to determine
fuse to comply. Consequently,the auditor violationsand would sanctionthe party
may comply if the perceived rewards of fora violation.Thisappearsto be a reason-
complianceare high.The auditor's actions able assumption.Increased monitoring
are likelyto be based on internalstandards activityis manifestedby the drasticin-
concerningprofessionalbehavior and the creasein the numberof lawsuitsagainst
perceived costs associated with unprofes- firmsand auditors,the increasein SEC
sional behavior in relationto the perceived activityin firmand auditorimproprieties
rewards of compliance. As a result, the and professional movements, suchas peer
potential costs and rewards may be vari- quality reviews.All of these types of
able, and success of these types of pro- activities,which increase the potential
cedures in preventing inappropriate be- cost to the auditorand/orthe firmfrom
havior seem to be unpredictable. takinginappropriateactions,reduce the
The second set of procedures are de- flexibilityof each and shouldtend to in-
signed to increase the expected cost to the hibit and reducethe possibilityof inap-
auditor and/or the firmfrom taking in- propriateactionsoccurring.
appropriateactions. We are of the opinion The thirdset ofprocedures forreducing
that these types of changes would be the possible complianceon the part of the
most effectivein decreasingtheprobability auditorreflectschangingthe structureof
of influence attempts by the firm and the auditor-firm contractualrelationship
auditor compliance with such demands. as a meansof reducingthe firm'sdiscre-
An example would include greaterspecifi- tionaryoptions.Proceduresof this type
cation of auditing and accounting stan- are likelyto increaseindependence on the
dards. These changes should be successful partoftheauditor.The coercivepowerof
because they provide the auditor and the the firmis eliminatedas the firmis no
firmwith a clearerset of standards (reduc- longerresponsible forthe firingor hiring
ing ambiguity about proper actions) and of the auditor.The movementto audit
because they can increase the possibility committees composedof outsidedirectors
of detection of inappropriate actions. In is a positivestepofthistype.However,we
effect,the specificationof auditing and re- would agree with previouswritersthat
porting standards changes a more non- further modifications,e.g.,developinglong-
routine task to a more routine task and termengagements or makingthe auditor
increases the possibility of costs being an employeeof the public,are ratherex-
associated with auditor practices that vio- tremesolutionsto theproblem.These are

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346 The AccountingReview,April 1976

likely to produce drastic changes in the flictsituationshopefullycharacterizeonly

professionthat are perhaps more serious a relativelysmall percentage of the audi-
than the problem,especiallysince the con- tor-firm interactions.
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Emerson,R. M., "Power-DependenceRelations," AmericanSociologicalReview(February 1962), pp.
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Goldman,A. and B. Barlev, "The Auditor-FirmConflictof Interests: Its ImplicationsforIndepen-
dence," THE ACCOUNTINGREVIEW (October 1974), pp. 707-718.
Mautz, R. K., "Toward a Philosophyof Auditing,"in AuditingLooks Ahead, Howard Stettler,ed.
(Universityof Kansas PrintingService,1972).
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