The economics of auditing standards

• Main Author: Ye, Minlei
• Language: English
• Published: University of British Columbia 2009
• Online Access: http://hdl.handle.net/2429/10176

Auditing standards provide the objectives to be achieved in an audit and methods to be used by auditors. Standards differ across countries and vary over time. This thesis explores variations in auditing standards, focusing on the questions of how players with different economic incentives influence (or set) auditing standards and how those choices vary with different legal liability regimes. The thesis analyzes the process of setting auditing standards by considering two of the standards' properties: toughness (stringency) and vagueness (imprecision). I present a contracting model between an auditor and prospective investors. The properties of auditing standards are incorporated into the model because they affect the auditor's expected liability to investors and thereby affect the level of effort the auditor chooses to exert. The model predicts that auditors and investors each weakly prefer precise auditing standards if they can choose both the toughness and precision of the standards. Given precise auditing standards, investors are likely to choose tougher standards than the auditors' professional organization. If the toughness is fixed at a non-optimal level, however, the auditors and investors will prefer vaguer auditing standards whether the toughness is too high or too low. These predictions are supported by empirical evidence. When the legal regime becomes stronger, the standard setters (auditors or investors) initially prefer tougher auditing standards, but when the regime is stronger than a negligence-based liability regime with auditing standards defining due care, they prefer less tough auditing standards. Furthermore, if the toughness is fixed at an optimal level, the players have stronger incentives to choose precise standards as the legal regime becomes stronger. This thesis adds to the literature by investigating the standard setters' economic incentives in influencing (in this thesis, choosing) the properties of auditing standards. By understanding the economic impact of different standards, regulators, investors, and auditors are more able to anticipate the implications of a change in standards. This research is timely given the recent transfer of authority over auditing standards for public companies from the AICPA to the PCAOB in the U.S., and the world-wide trend of improving the clarity of auditing standards.