Audit failures: why they occur and some suggestions for reducing them

Despite the strong regulatory response to the series of high-profile audit failures that marked the turn of the last century, high-profile audit failures continue to occur. We conjecture that audit failures are difficult to curb primarily because auditors are charged with serving the public interest, but are hired and fired by the management they are tasked with monitoring. Serving two masters can be problematic for auditors because conflicts arise if client management demands lower quality audits than the shareholders. Critically, audit quality is also difficult for the public to assess in the absence of a financial failure, which makes external monitoring challenging. Together, the agency problems unique to auditing and the credence-good nature of audit services make it difficult for market and regulatory forces to incentivise auditors to deliver the audit quality that shareholders and the public demands. The purpose of this paper is to discuss the forces that lead to low quality audits in the hope of better understanding why audits fail. We also propose some changes that might reduce the high incidence of audit failures, including an increase in audit process transparency, enhancements to audit firm governance, and structural changes to the allocation of audit resources in the economy.