1

Why Good Accoontunts o Bud Aodits

Bv Mux H. Buzermun; George oewensLeIn und Don A. Moore
8o Hurvurd BusIness RevIew ; (November, zooz)

ON JUY o, uL u ceremonv In LIe EusL Room oI LIe WIILe House uLLended bv
congressIonuI Ieuders oI boLI purLIes, PresIdenL George W. BusI sIgned InLo Iuw
LIe Surbunes-OxIev AcL oI zooz uddressIng corporuLe uccounLubIIILv. A response
Lo recenL IInuncIuI scunduIs LIuL Iud begun Lo undermIne cILIzens' conIIdence In
U.S. busIness, LIe wIde-rungIng ucL IIew LIrougI LIe House oI RepresenLuLIves
und SenuLe In record LIme und pussed In boLI cIumbers bv overwIeImIng
mujorILIes. TIe ucL pIuces new IeguI consLruInLs on execuLIves und gIves expunded
proLecLIons Lo wIIsLIe-bIowers. PerIups mosL ImporLunL, LIougI, IL puLs LIe
uccounLIng IndusLrv under LIgILened IederuI oversIgIL. L creuLes u reguIuLorv
bourd-wILI broud powers Lo punIsI corrupLIon-Lo monILor uccounLIng IIrms, und
IL esLubIIsIes sLIII crImInuI penuILIes, IncIudIng Iong juII Lerms, Ior uccounLIng
Iruud. "TIe eru oI Iow sLundurds und IuIse proIILs Is over," BusI procIuImed.
I onIv IL were LIuL eusv.
GIven LIe vusL scuIe oI recenL uccounLIng scunduIs und LIeIr devusLuLIng eIIecLs on
workers und InvesLors, IL's noL surprIsIng LIuL LIe governmenL und LIe pubIIc
ussume LIuL LIe underIvIng probIems ure corrupLIon und crImInuIILv-uneLIIcuI
uccounLunLs IuIsIIvIng numbers Lo proLecL equuIIv uneLIIcuI cIIenLs. BuL LIuL's
onIv u smuII purL oI LIe sLorv. SerIous uccounLIng probIems Iuve Iong pIugued
corporuLe uudILs, rouLIneIv IeudIng Lo subsLunLIuI IInes Ior uccounLIng IIrms. Some
oI LIe errors, no doubL, ure LIe resuIL oI Iruud. BuL Lo uLLrIbuLe mosL errors Lo
deIIberuLe corrupLIon wouId be Lo beIIeve LIuL LIe uccounLIng proIessIon Is rIIe
wILI crooks-u concIusIon LIuL unvone wIo Ius worked wILI uccounLunLs knows Is
unLrue. TIe deeper, more pernIcIous probIem wILI corporuLe uudILIng, us IL's
currenLIv prucLIced, Is ILs vuInerubIIILv Lo unconscIous bIus. Becuuse oI LIe oILen
subjecLIve nuLure oI uccounLIng und LIe LIgIL reIuLIonsIIps beLween uccounLIng
IIrms und LIeIr cIIenLs, even LIe mosL IonesL und meLIcuIous oI uudILors cun
unInLenLIonuIIv dIsLorL LIe numbers In wuvs LIuL musk u compunv's Lrue IInuncIuI
sLuLus, LIerebv mIsIeudIng InvesLors, reguIuLors, und someLImes munugemenL.
ndeed, even seemIngIv egregIous uccounLIng scunduIs, sucI us Andersen's uudILs
oI Enron, muv Iuve uL LIeIr core u serIes oI unconscIousIv bIused judgmenLs
ruLIer LIun u deIIberuLe progrum oI crImInuIILv.
UnIIke conscIous corrupLIon, unconscIous bIus cunnoL be deLerred bv LIreuLs oI
juII LIme. RooLIng ouL bIus, or uL IeusL LemperIng ILs eIIecLs, wIII requIre more
IundumenLuI cIunges Lo LIe wuv uccounLIng IIrms und LIeIr cIIenLs operuLe. I we
ure reuIIv goIng Lo resLore LrusL In LIe U.S. svsLem oI uudILIng, we wIII need Lo go
weII bevond LIe provIsIons oI LIe Surbunes-OxIev AcL. We wIII need Lo embruce
z
prucLIces und reguIuLIons LIuL recognIze LIe exIsLence oI bIus und moderuLe ILs III
eIIecLs. OnIv LIen cun we be ussured oI LIe reIIubIIILv oI LIe IInuncIuI reporLs
Issued bv pubIIc compunIes und ruLIIIed bv proIessIonuI uccounLunLs.
TIe RooLs oI BIus
PsvcIoIogIcuI reseurcI sIows LIuL our desIres powerIuIIv InIIuence LIe wuv we
InLerpreL InIormuLIon, even wIen we're LrvIng Lo be objecLIve und ImpurLIuI.
WIen we ure moLIvuLed Lo reucI u purLIcuIur concIusIon, we usuuIIv do. TIuL's
wIv mosL oI us LIInk we ure beLLer LIun uveruge drIvers, Iuve smurLer LIun
uveruge cIIIdren, und cIoose sLocks or Iunds LIuL wIII ouLperIorm LIe murkeL-
even II LIere's cIeur evIdence Lo LIe conLrurv. WILIouL knowIng IL, we Lend Lo
crILIcuIIv scruLInIze und LIen dIscounL IucLs LIuL conLrudIcL LIe concIusIons we
wunL Lo reucI, und we uncrILIcuIIv embruce evIdence LIuL supporLs our posILIons.
Unuwure oI our skewed InIormuLIon processIng, we erroneousIv concIude LIuL
our judgmenLs ure Iree oI bIus.
Munv experImenLs Iuve demonsLruLed LIe power oI seII-servIng bIus und sIown,
Ior exumpIe, Iow bIus cun dIsLorL IeguI negoLIuLIons.| 1| n one serIes oI
experImenLs, wIIcI we descrIbe In u 1; SIoun MunugemenL RevIew urLIcIe,
puIrs oI purLIcIpunLs were gIven poIIce und medIcuI reporLs, deposILIons, und
oLIer muLerIuIs Irom u IuwsuIL InvoIvIng u coIIIsIon beLween u moLorcvcIe und u
cur und were ussIgned Lo LIe roIe oI eILIer LIe moLorcvcIIsL pIuInLIII or LIe cur-
drIvIng deIendunL. TIev were gIven LIe Lusk oI negoLIuLIng u seLLIemenL und were
LoId LIuL II LIev couIdn'L reucI one, u judge wouId decIde LIe uwurd umounL, und
boLI purLIes wouId puv subsLunLIuI penuILIes. InuIIv, beIore sLurLIng LIe
negoLIuLIon, eucI purLIcIpunL wus usked Lo predIcL LIe umounL LIe judge wouId
uwurd LIe pIuInLIII II negoLIuLIons sLuIIed. To IurLIer eIImInuLe bIus, eucI member
oI LIe puIr wus ussured LIuL LIe oLIer purLv wouIdn'L see IIs or Ier esLImuLe und
LIuL LIe esLImuLes wouId noL InIIuence LIe judge's decIsIon.
TIe resuILs were sLrIkIng. PurLIcIpunLs pIuvIng LIe moLorcvcIIsL pIuInLIII Lended Lo
predIcL LIuL LIev'd receIve drumuLIcuIIv Iurger uwurds LIun LIe deIendunLs
predIcLed. TIIs Is un exumpIe oI seII-servIng bIus: Armed wILI LIe sume
InIormuLIon, dIIIerenL peopIe reucI dIIIerenL concIusIons-ones LIuL Iuvor LIeIr
own InLeresLs. n uddILIon, LIe degree Lo wIIcI LIe Lwo IvpoLIeLIcuI uwurds
dIIIered wus un exceIIenL predIcLor oI LIe IIkeIIIood LIuL LIe puIr wouId negoLIuLe
u seLLIemenL. TIe greuLer LIe dIIIerence In LIe negoLIuLors' beIIeIs, LIe Iurder IL
wus Ior LIem Lo come Lo ugreemenL.
How cun sucI un ImpuIse Lowurd seII-servIng bIus be moderuLed? n IoIIow-up
experImenLs, LIe sume reseurcIers LrIed Lo reduce purLIcIpunLs' bIus bv puvIng
LIem Lo uccuruLeIv predIcL LIe umounL oI LIe judge's uwurd und IuvIng LIem
wrILe essuvs urguIng LIe oLIer sIde's poInL oI vIew. NeILIer sLruLegv reduced bIus;
purLIcIpunLs consIsLenLIv LIougIL LIuL LIe judge wouId uwurd dumuges LIuL
Iuvored LIeIr sIde. And wIuL ubouL educuLIng LIe subjecLs, uIerLIng LIem LIuL LIev
were IIkeIv Lo reucI bIused concIusIons? TIuL dIdn'L work, eILIer. AILer LeucIIng

purLIcIpunLs ubouL bIus und LesLIng LIem Lo muke sure LIev undersLood LIe
concepL, LIe reseurcIers Iound LIuL LIe purLIcIpunLs concIuded LIuL LIeIr
negoLIuLIng opponenLs wouId be IIgIIv bIused buL reIused Lo beIIeve LIuL LIev
LIemseIves wouId be.
n veL unoLIer oI LIese experImenLs, purLIcIpunLs were presenLed wILI 16
urgumenLs-eIgIL IuvorIng LIe sIde LIev Iud been ussIgned (pIuInLIII or deIendunL)
und eIgIL IuvorIng LIe oLIer-und were usked Lo predIcL Iow u neuLruI LIIrd purLv
wouId ruLe LIe quuIILv oI LIe urgumenLs. n generuI, sLudv purLIcIpunLs Iound
urgumenLs LIuL Iuvored LIeIr own posILIons more convIncIng LIun LIose LIuL
supporLed LIe oLIer sIde. BuL wIen purLIcIpunLs were ussIgned Lo LIe roIe oI
pIuInLIII or deIendunL onIv uILer LIev'd seen LIe cuse muLerIuIs-und so were
unbIused In LIeIr evuIuuLIon oI LIe duLu-LIeIr degree oI bIus wus sIgnIIIcunLIv Iess.
Tuken LogeLIer, LIese IIndIngs suggesL LIuL unconscIous bIus works bv dIsLorLIng
Iow peopIe InLerpreL InIormuLIon.
AccounLIng Ior Bud AccounLIng
ProIessIonuI uccounLunLs mIgIL seem Immune Lo sucI bIuses (uILer uII, LIev work
wILI Iurd numbers und ure guIded bv cIeur-cuL sLundurds). BuL LIe corporuLe
uudILIng urenu Is u purLIcuIurIv IerLIIe ground Ior seII-servIng bIuses. TIree
sLrucLuruI uspecLs oI uccounLIng creuLe subsLunLIuI opporLunILIes Ior bIus Lo
InIIuence judgmenL.
AmbIguILv. BIus LIrIves wIerever LIere Is LIe possIbIIILv oI InLerpreLIng
InIormuLIon In dIIIerenL wuvs. As we suw In LIe sLudv InvoIvIng LIe coIIIsIon,
peopIe Lend Lo reucI seII-servIng concIusIons wIenever umbIguILv surrounds u
pIece oI evIdence. WIIIe IL's Lrue LIuL munv uccounLIng decIsIons ure cuL-und-
drIed-esLubIIsIIng u proper conversIon ruLe Ior BrILIsI pounds, Ior InsLunce,
enLuIIs mereIv consuILIng duIIv IoreIgn excIunge ruLes-munv oLIers requIre
InLerpreLuLIons oI umbIguous InIormuLIon. AudILors und LIeIr cIIenLs Iuve
consIderubIe Ieewuv, Ior exumpIe, In unswerIng some oI LIe mosL busIc IInuncIuI
quesLIons: WIuL's un InvesLmenL? WIuL's un expense? WIen sIouId revenue be
recognIzed? TIe InLerpreLuLIon und weIgILIng oI vurIous Lvpes oI InIormuLIon ure
rureIv sLruIgILIorwurd. As JosepI BerurdIno, ArLIur Andersen's Iormer cIIeI
execuLIve, suId In IIs congressIonuI LesLImonv on LIe Enron coIIupse, "Munv
peopIe LIInk uccounLIng Is u scIence, wIere one number, numeIv eurnIngs per
sIure, Is LIe number, und IL's sucI u precIse number LIuL IL couIdn'L be Lwo
pennIes IIgIer or Lwo pennIes Iower. come Irom u scIooI LIuL suvs IL reuIIv Is
mucI more oI un urL." (See "AmbIguILv In AccounLIng und AudILIng.")
ALLucImenL. AudILors Iuve sLrong busIness reusons Lo remuIn In cIIenLs' good
gruces und ure LIus IIgIIv moLIvuLed Lo upprove LIeIr cIIenLs' uccounLs. Under LIe
currenL svsLem, uudILors ure IIred und IIred bv LIe compunIes LIev uudIL, und IL Is
weII known LIuL cIIenL compunIes IIre uccounLIng IIrms LIuL deIIver unIuvorubIe
uudILs. Even II un uccounLIng IIrm Is Iurge enougI Lo ubsorb LIe Ioss oI one cIIenL,
IndIvIduuI uudILors' jobs und cureers muv depend on success wILI specIIIc cIIenLs.
q
Moreover, In recenL decudes, uccounLIng IIrms Iuve IncreusIngIv LreuLed uudILs us
wuvs Lo buIId reIuLIonsIIps LIuL uIIow LIem Lo seII LIeIr more IucruLIve consuILIng
servIces. TIus, Irom LIe execuLIve Leum down Lo IndIvIduuI uccounLunLs, un
uudILIng IIrm's moLIvuLIon Lo provIde IuvorubIe uudILs runs deep. As LIe coIIIsIon
cuse uIso sIowed, once peopIe equuLe LIeIr own InLeresLs wILI unoLIer purLv's,
LIev InLerpreL duLu Lo Iuvor LIuL purLv. ALLucImenL breeds bIus.
ApprovuI. An uudIL uILImuLeIv endorses or rejecLs LIe cIIenL's uccounLIng-In oLIer
words, IL ussesses LIe judgmenLs LIuL someone In LIe cIIenL IIrm Ius uIreudv
mude. ReseurcI sIows LIuL seII-servIng bIuses become even sLronger wIen peopIe
ure endorsIng oLIers' bIused judgmenLs-provIded LIose judgmenLs uIIgn wILI
LIeIr own bIuses-LIun wIen LIev ure mukIng orIgInuI judgmenLs LIemseIves? n
one serIes oI sLudIes, reseurcIers Iound LIuL peopIe were more wIIIIng Lo endorse
un overIv generous ouLcome LIuL Iuvored LIem LIun LIev were Lo muke LIuL
judgmenL LIemseIves. or exumpIe, II someone suvs LIuL vou deserve u IIgIer
ruIse LIun IucLs mIgIL suggesL, vou ure more IIkeIv Lo come Lo ugree wILI LIIs vIew
LIun vou ure Lo decIde on vour own LIuL vou deserve u IIgIer ruIse. TIIs kInd oI
LIInkIng ImpIIes LIuL un uudILor Is IIkeIv Lo uccepL more uggressIve uccounLIng
Irom Ier cIIenL LIun wIuL sIe mIgIL suggesL IndependenLIv.
n uddILIon Lo LIese sLrucLuruI eIemenLs LIuL promoLe bIus, LIree uspecLs oI
Iumun nuLure cun umpIIIv unconscIous bIuses.
umIIIurILv. PeopIe ure more wIIIIng Lo Iurm sLrungers LIun IndIvIduuIs LIev
know, especIuIIv wIen LIose IndIvIduuIs ure puvIng cIIenLs wILI wIom LIev Iuve
ongoIng reIuLIonsIIps. An uudILor wIo suspecLs quesLIonubIe uccounLIng musL
LIus cIoose, unconscIousIv perIups, beLween poLenLIuIIv IurmIng IIs cIIenL (und
IImseII) bv cIuIIengIng u compunv's uccounLs or IurmIng IuceIess InvesLors bv
IuIIIng Lo objecL Lo LIe possIbIv skewed numbers. GIven LIIs LensIon, uudILors muv
unconscIousIv Ieun Lowurd upprovIng LIe dubIous uccounLIng. And LIeIr bIuses
wIII grow sLronger us LIeIr personuI LIes deepen. TIe Ionger un uccounLIng
purLner serves u purLIcuIur cIIenL, LIe more bIused IIs judgmenLs wIII Lend Lo be.
DIscounLIng. PeopIe Lend Lo be Iur more responsIve Lo ImmedIuLe consequences
LIun deIuved ones, especIuIIv wIen LIe deIuved ouLcomes ure uncerLuIn. Munv
Iumun vIces sprIng Irom LIIs reIIex. We posLpone rouLIne denLuI cIeckups
becuuse oI LIe cosL und InconvenIence und LIe IurgeIv InvIsIbIe Iong-Lerm guIn. n
LIe sume wuv, uudILors muv IesILuLe Lo Issue crILIcuI uudIL reporLs becuuse oI LIe
udverse ImmedIuLe consequences-dumuge Lo LIe reIuLIonsIIp, poLenLIuI Ioss oI
LIe conLrucL, und possIbIe unempIovmenL. BuL LIe cosLs oI u posILIve reporL wIen
u neguLIve reporL Is cuIIed Ior-proLecLIng LIe uccounLIng IIrm's repuLuLIon or
uvoIdIng u IuwsuIL, Ior exumpIe-ure IIkeIv Lo be dIsLunL und uncerLuIn.
EscuIuLIon. L's nuLuruI Ior peopIe Lo conceuI or expIuIn uwuv mInor IndIscreLIons
or oversIgILs, someLImes wILIouL even reuIIzIng LIuL LIev're doIng IL. TIInk oI LIe
munuger wIo mIsses u IumIIv dInner und bIumes LIe LruIIIc, LIougI Ie sImpIv IosL
Lruck oI LIme. IkewIse, un uudILor's bIuses muv Ieud Ier Lo unknowIngIv udupL
=
over LIme Lo smuII ImperIecLIons In u cIIenL's IInuncIuI prucLIces. EvenLuuIIv,
LIougI, LIe sum oI LIese smuII judgmenLs muv become Iurge und sIe muv
recognIze LIe Iong-sLundIng bIus. BuL uL LIuL poInL, correcLIng LIe bIus muv
requIre udmILLIng prIor errors. RuLIer LIun expose LIe unwILLIng mIsLukes, sIe
muv decIde Lo conceuI LIe probIem. TIus, unconscIous bIus muv evoIve InLo
conscIous corrupLIon-corrupLIon represenLIng LIe mosL vIsIbIe end oI u sILuuLIon
LIuL muv Iuve been deLerIoruLIng Ior some LIme. L's our beIIeI LIuL some oI LIe
recenL IInuncIuI dIsusLers we've wILnessed begun us mInor errors oI judgmenL und
escuIuLed InLo corrupLIon. As CIurIes NIemeIer, cIIeI uccounLunL Ior LIe $EC's
enIorcemenL dIvIsIon, puL IL: "PeopIe wIo never InLend Lo do someLIIng wrong
end up IIndIng LIemseIves In sILuuLIons wIere LIev ure uImosL Iorced Lo conLInue
Lo commIL Iruud once LIev Iuve sLurLed doIng LIIs. OLIerwIse, IL wIII be reveuIed
LIuL LIev Iud used Improper uccounLIng In LIe eurIIer perIods."
PuLLIng TIeorv Lo LIe TesL
BIus, bv ILs verv nuLure, Is LvpIcuIIv InvIsIbIe: You cun'L revIew u corporuLe uudIL
und pIck ouL errors uLLrIbuLubIe Lo bIus. OILen, we cun'L LeII wIeLIer un error In
uudILIng Is due Lo bIus or corrupLIon. BuL vou cun desIgn experImenLs LIuL reveuI
Iow bIus cun dIsLorL uccounLIng decIsIons. We recenLIv dId jusL LIuL, wILI LeIIIng
resuILs.
We guve undergruduuLe und busIness sLudenLs u compIex seL oI InIormuLIon
ubouL LIe poLenLIuI suIe oI u IIcLIonuI compunv und usked LIem Lo esLImuLe LIe
compunv's vuIue. PurLIcIpunLs were ussIgned dIIIerenL roIes: buver, seIIer, buver's
uudILor, or seIIer's uudILor. AII subjecLs reud LIe sume InIormuLIon ubouL LIe
compunv. As we expecLed, LIose wIo Ioped Lo seII LIe IIrm LIougIL LIe compunv
wus worLI more LIun LIe prospecLIve buvers dId. More InLeresLIng were LIe
opInIons oIIered bv LIe uudILors: TIeIr judgmenLs were sLrongIv bIused Lowurd
LIe InLeresLs oI LIeIr cIIenLs.
TIese uudILors dIspIuved roIe-conIerred bIuses In Lwo wuvs. IrsL, LIeIr vuIuuLIons
(judgmenLs) were bIused In LIe cIIenLs' Iuvor: TIe seIIers' uudILors pubIIcIv
concIuded LIuL LIe IIrm wus worLI more LIun LIe buvers' uudILors suId IL wus.
Second, und more LeIIIngIv, LIeIr prIvuLe judgmenLs ubouL LIe compunv's vuIue
were uIso bIused In LIeIr cIIenLs' Iuvor: AL LIe end oI LIe experImenL, LIe uudILors
were usked Lo esLImuLe LIe compunv's Lrue vuIue und were LoId LIuL LIev wouId be
rewurded uccordIng Lo Iow cIose LIeIr prIvuLe judgmenLs were Lo LIose oI
ImpurLIuI experLs. DespILe LIIs IncenLIve Ior uccurucv, LIe esLImuLes oI LIe seIIers'
uudILors uveruged o% IIgIer LIun LIose oI LIe buvers' uudILors. TIIs exempIIIIes
LIe persIsLenL InIIuence oI serI-servIng bIuses: Once purLIcIpunLs InLerpreLed
InIormuLIon ubouL LIe LurgeL compunv In u bIused wuv, LIev were unubIe Lo undo
LIe bIus IuLer.
EurIIer LIIs veur, we run u sLudv wILI Iovd TunIu LIuL Iocused on proIessIonuI
uudILors LIemseIves. TIe sLudv, oI 1 uudILors empIoved IuII LIme bv one oI LIe
bIg U.S. uccounLIng IIrms, IIIumInuLed LIe proIessIonuIs' vuInerubIIILv Lo bIus und
6
LIeIr Lendencv Lo be InIIuenced bv cIIenLs' bIuses. EucI purLIcIpunL wus gIven IIve
umbIguous uudILIng vIgneLLes und usked Lo judge LIe uccounLIng Ior eucI. HuIL
LIe purLIcIpunLs were usked Lo suppose LIuL LIev Iud been IIred bv LIe compunv
LIev were uudILIng; LIe resL were usked Lo suppose LIev Iud been IIred bv u
dIIIerenL compunv, one LIuL wus conducLIng busIness wILI LIe compunv LIuL Iud
creuLed LIe IInuncIuI sLuLemenLs. n uddILIon, IuII LIe purLIcIpunLs In eucI oI
LIose Lwo groups generuLed LIeIr own uudILIng numbers IIrsL, LIen sLuLed
wIeLIer LIev beIIeved LIuL LIe IIrm's IInuncIuI reporLs compIIed wILI generuIIv
uccepLed uccounLIng prIncIpIes (GAAP), wIIIe LIe oLIer IuII dId LIe Lwo Lusks In
LIe reverse order.
or uII IIve vIgneLLes, LIe uudILors were on uveruge o% more IIkeIv Lo IInd LIuL
LIe uccounLIng beIInd u compunv's IInuncIuI reporLs compIIed wILI GAAP II LIev
were pIuvIng LIe roIe oI uudILor Ior LIuL IIrm. urLIermore, LIe purLIcIpunLs wIo
generuLed LIeIr own uudILIng numbers uILer IIrsL pussIng judgmenL on LIe
compunv's IInuncIuI reporLs Lended Lo come up wILI numbers LIuL were cIoser
LIun LIe oLIer purLIcIpunLs' Lo LIe cIIenL's numbers. TIe sLudv sIowed boLI LIuL
experIenced uudILors ure noL Immune Irom bIus und LIuL LIev ure more IIkeIv Lo
uccede Lo u cIIenL's bIused uccounLIng numbers LIun Lo generuLe sucI numbers
LIemseIves.
TIese experImenLs sIow LIuL even LIe suggesLIon oI u IvpoLIeLIcuI reIuLIonsIIp
wILI u cIIenL dIsLorLs un uudILor's judgmenLs. mugIne LIe degree oI dIsLorLIon
LIuL musL exIsL In u Iong-sLundIng reIuLIonsIIp InvoIvIng mIIIIons oI doIIurs In
ongoIng revenues.
ProbIems wILI Proposed ReIorms
Becuuse LIe reIorms In LIe Surbunes-OxIev AcL und LIose proposed bv oLIers do
noL uddress LIe IundumenLuI probIem oI bIus, LIev wIII noL soIve LIe crIsIs In
uccounLIng In LIe UnILed SLuLes. Some oI LIe reIorms, In IucL, muv weII muke IL
worse.
ConsIder LIe provIsIons deuIIng wILI dIscIosure. TIev requIre IndIvIduuI uudILors
or LIeIr IIrms Lo reveuI conIIIcLs oI InLeresL Lo InvesLors. BuL Lo counLerucL bIus,
sucI dIscIosure musL eILIer InIIbIL bIus ouLrIgIL or uIIow InvesLors Lo udjusL Ior IL.
NeILIer Is IIkeIv. WILI regurd Lo InIIbILIng bIus, we suw eurIIer LIuL u person's
conscIous eIIorLs Lo reduce bIus Iuve IImILed eIIecL. And LIe IuLLer Ideu, LIuL
dIscIosure wouId IeIp InvesLors InLerpreL uudILors' reporLs, wouId be oI IILLIe
beneIIL unIess InvesLors knew Iow u dIscIosed conIIIcL oI InLeresL bIused un
uudILor's judgmenL. mugIne un InvesLor wIo reuds u posILIve uudIL reporL
conLuInIng LIe cuveuL LIuL LIe uudILor receIves $6o mIIIIon In unnuuI Iees Irom
LIe uudILed compunv. Bv Iow mucI sIouId LIe InvesLor udjusL LIe compunv's
seII-reporLed eurnIngs per sIure? WILIouL specIIIc guIdunce, peopIe cunnoL
uccuruLeIv IucLor conIIIcL oI InLeresL InLo LIeIr InvesLmenL decIsIons.
;
More worrIsome Is evIdence LIuL dIscIosure couId ucLuuIIv Increuse bIus. I
uudILors suspecL LIuL dIscIosure wIII Ieud InvesLors Lo dIscounL or muke
udjusLmenLs Ior LIe uudILors' pubIIc sLuLemenLs, LIev muv IeeI Iess duLv bound Lo
be ImpurLIuI und muv muke judgmenLs more cIoseIv uIIgned wILI LIeIr personuI
InLeresLs. ReseurcI bv DuvIIun CuIn, Don Moore, und George oewensLeIn puIred
purLIcIpunLs und ussIgned one member oI eucI puIr Lo LIe roIe oI esLImuLor und
LIe oLIer Lo LIuL oI udvIser. TIe esLImuLor vIewed severuI jurs oI coIns Irom u
dIsLunce, esLImuLed LIe vuIue oI LIe monev In LIem, und wus puId uccordIng Lo
Iow cIose LIe esLImuLes were Lo LIe jurs' Lrue vuIues. TIe udvIser, wIo couId
sLudv LIe jurs up cIose, guve LIe esLImuLor udvIce. TIe udvIser, Iowever, wus noL
puId uccordIng Lo LIe esLImuLor's uccurucv buL uccordIng Lo Iow IIgI LIe
esLImuLor's guesses were. n oLIer words, udvIsers Iud un IncenLIve Lo mIsIeud LIe
esLImuLors so LIuL LIev wouId guess IIgI.
n uddILIon, we LoId IuII oI LIe esLImuLors ubouL LIe udvIsers' puv urrungemenL;
we suId noLIIng ubouL IL Lo LIe resL. DIscIosure Iud Lwo eIIecLs. IrsL, udvIsers
wIose moLIves were dIscIosed provIded mucI more bIused guesses (I.e., IIgI
esLImuLes oI coIn jur vuIues) LIun dId udvIsers wIose moLIves were noL dIscIosed;
second, dIscIosure dId noL cuuse esLImuLors Lo subsLunLIuIIv dIscounL LIeIr
udvIsers' udvIce. As u resuIL, dIscIosure Ied udvIsers Lo muke mucI more monev
und esLImuLors Lo muke mucI Iess. AppIIed Lo uudILIng, LIIs IIndIng suggesLs LIuL
uudILors wIo ure Iorced Lo dIscIose conIIIcLs mIgIL exIIbIL greuLer seII-servIng
bIus.
One oLIer proposed poIIcv wurrunLs menLIon: LIe move Lo Impose sLrIcLer
uccounLIng sLundurds. TIIs remedv, Loo, Is unIIkeIv Lo Improve LIe sILuuLIon.
ReseurcI sIows LIuL IL Lukes verv IILLIe umbIguILv Lo produce bIused judgmenLs?
n one sLudv, some purLIcIpunLs were usked Lo ImugIne LIuL LIev Iud worked
seven Iours on u Lusk und LIuL unoLIer person Iud worked Len Iours on LIe sume
Lusk. OLIer purLIcIpunLs were usked Lo ImugIne LIe opposILe scenurIo: TIev'd
worked Len Iours on LIe projecL wIIIe LIe oLIer person worked seven. n eucI
cuse, IL wus specIIIed LIuL LIe person wIo Iud worked seven Iours wouId be puId
$z=; LIe quesLIon wus Iow mucI LIe person wIo Iud worked Len Iours sIouId be
puId. Ten-Iour purLIcIpunLs, on uveruge, LIougIL LIuL LIev sIouId be puId ubouL
$= Ior LIeIr Len Iours oI work, wIIIe LIose wIo Iud worked seven Iours LIougIL
LIuL LIe 1o-Iour person sIouId receIve Iess-ubouL $o. Here, uII IL Look wus u LInv
bIL oI umbIguILv-wIeLIer LIe IuIr soIuLIon wus equuI IourIv puv (us LIe Len-Iour
peopIe LIougIL) or equuI LoLuI puv (us LIe seven-Iour peopIe LIougIL)-Lo produce
dIIIerenL seII-servIng ussessmenLs oI IuIrness. NoLe, Loo, LIuL LIe IncenLIves Ior
beIng bIused In LIIs sLudv were uwIuIIv weuk becuuse LIe quesLIon wus
IvpoLIeLIcuI; In LIe reuI worId, IncenLIves Ior bIus ure Iur sLronger. L seems
ImpIuusIbIe LIuL sLrIcLer uccounLIng ruIes couId eIImInuLe umbIguILv-und LIus
LIev ure unIIkeIv Lo reduce seII-servIng bIus.


8
RudIcuI RemedIes
TIe kev Lo ImprovIng uudILs, cIeurIv, Is noL Lo LIreuLen or cujoIe. L musL be Lo
eIImInuLe IncenLIves LIuL creuLe seII-servIng bIuses. TIIs meuns LIuL new poIIcIes
musL reduce un uudILor's InLeresL In wIeLIer u cIIenL Is pIeused bv LIe resuILs oI
un uudIL.
One provIsIon oI LIe Surbunes-OxIev AcL proIIbILs uccounLIng IIrms Irom
provIdIng cerLuIn consuILIng servIces Lo compunIes LIev uudIL. TIIs Is u sLep In LIe
rIgIL dIrecLIon, buL IL doesn'L go Iur enougI. CIeurIv, uccounLIng IIrms LIuL udvIse
LIeIr cIIenLs on Iow Lo boosL proIILs, wIIIe uL LIe sume LIme LrvIng Lo ImpurLIuIIv
judge LIeIr books, Iuce un ImpossIbIe conIIIcL oI InLeresL. TIIs reIorm boLI
reduces LIIs conIIIcL und euses LIe pressure on uudILors Lo ucL us suIespeopIe Ior
LIeIr IIrm's oLIer servIces. UnIorLunuLeIv, wIIIe LIe new Iuw IImILs LIe consuILIng
servIces uudILIng IIrms cun provIde, IL doesn'L proIIbIL LIem enLIreIv, und IL gIves
LIe new oversIgIL bourd creuLed bv LIe Surbunes-OxIev AcL LIe opLIon oI
overrIdIng LIIs provIsIon.
True uudILor Independence requIres, us u sLurL, IuII dIvesLILure oI consuILIng und
Lux servIces. And even LIen, u IundumenLuI probIem wIII remuIn: Becuuse
uudILors ure IIred und IIred bv LIe compunIes LIev uudIL, LIev ure In LIe posILIon
oI possIbIv cusLIng neguLIve judgmenLs on LIose wIo IIred LIem-und wIo cun cuL
LIem Ioose. TIereIore, even wILI LIe eIImInuLIon oI consuILIng, LIe IundumenLuI
sLrucLure oI LIe uudILIng svsLem vIrLuuIIv ensures bIused uudILIng. To eIImInuLe
LIIs source oI bIus, we musL remove LIe LIreuL oI beIng IIred Ior deIIverIng un
unIuvorubIe uudIL. AudILors musL Iuve IIxed, IImILed conLrucL perIods durIng
wIIcI LIev cunnoL be LermInuLed. AII Iees und oLIer conLrucLuuI deLuIIs sIouId be
specIIIed uL LIe begInnIng oI LIe conLrucL und musL be uncIungeubIe. n uddILIon,
LIe cIIenL musL be proIIbILed Irom reIIrIng LIe uudILIng IIrm uL LIe end oI LIe
conLrucL; InsLeud, LIe mujor uccounLIng IIrms wouId be requIred Lo roLuLe cIIenLs.
CurrenL IegIsIuLIon requIres uudILor roLuLIon; Iowever, LIIs Is deIIned us u cIunge
In LIe Ieud purLner wILIIn un uudILIng IIrm. TIere Is no provIsIon Lo roLuLe LIe
IIrms conducLIng LIe uudIL, und LIere Is no provIsIon Lo prevenL u cIIenL Irom
IIrIng un uudILor. TIus, uudILors wIII conLInue Lo Iuve powerIuI IncenLIves Lo keep
LIeIr cIIenLs Iuppv.
AudIL cIIenLs musL uIso be proIIbILed Irom IIrIng IndIvIduuI uccounLunLs uwuv
Irom LIeIr uudIL IIrms. As LIe Enron scunduI unIoIded, LIe common prucLIce oI
ArLIur Andersen empIovees LukIng posILIons wILI Enron, und vIce versu, cume Lo
IIgIL. CIeurIv, un uudILor cun'L be ImpurLIuI wIen Ie or sIe Iopes Lo pIeuse u cIIenL
In order Lo deveIop job opLIons. We beIIeve LIuL uudILors sIouId be burred Irom
LukIng posILIons wILI LIe IIrms LIev uudIL Ior uL IeusL IIve veurs.
ess LungIbIv, uudILors musL come Lo upprecIuLe LIe proIound ImpucL oI seII-
servIng bIuses on judgmenL. ProIessIonuI scIooIs Iuve begun Lo Luke eLIIcs
serIousIv In recenL veurs, buL LeucIIng uudILors ubouL eLIIcs wIII noL Iuve un
ImpucL on bIus. WIuL's needed Is educuLIon LIuL IeIps uudILors undersLund LIe

unconscIous errors LIev muke und LIe reusons LIev muke LIem. TIuL knowIedge
uIone won'L soIve LIe probIem, buL once members oI LIe uudILIng proIessIon
undersLund LIe roIe oI bIus In LIeIr work, IonesL und vIsIonurv Ieuders In LIe
proIessIon cun IeIp cIunge LIe conducL oI uccounLIng Lo prevenL LIe conIIIcLs oI
InLeresL LIuL promoLe bIus. And uudIL Ieuders wIo suv LIuL so-cuIIed
proIessIonuIIsm Is u suIIIcIenL suIeguurd uguInsL uudIL error-u cIuIm LIuL's
InconsIsLenL wILI LIe weIgIL oI empIrIcuI evIdence on Iumun judgmenL-mIgIL
ubundon LIuL cIuIm II LIev LruIv undersLood LIe roIe oI bIus In uudILIng.
Our proposuIs ure noL perIecL. ndeed, IL's Iurd Lo ImugIne unv prucLIcuI svsLem
LIuL couId eIImInuLe uII bIus. Even wILI our remedIes, Ior InsLunce, IL's sLIII
possIbIe LIuL uudILors' socIuI conLucL wILI cIIenLs couId InLroduce subLIe bIuses.
BuL we envIsIon u svsLem In wIIcI cIIenLs regurd uudILors us more IIke Lux
coIIecLors LIun purLners or udvIsers-u svsLem LIuL couId be expecLed Lo uL IeusL
umeIIoruLe bIus. DevIsIng u more robusL sepuruLIon oI uudILor und cIIenL, one LIuL
mIgIL go IurLIer Lo reduce bIus, wouId requIre upproucIes-sucI us LurnIng over
LIe uudILIng IuncLIon Lo governmenL-LIuL couId creuLe probIems us serIous us
LIose LIev soIve. We see our proposuIs us boLI reuIIsLIc und eIIecLIve. n LIe
ubsence oI rudIcuI und InnovuLIve reIorm, we beIIeve, IurLIer uccounLIng dIsusLers
ure InevILubIe.
--------
AmbIguILv In AccounLIng und AudILIng
EucI veur, Monev muguzIne sends LIe IInuncIuI records oI u IvpoLIeLIcuI IumIIv
Lo o Lo =o proIessIonuI Lux prepurers und usks, "How mucI does LIIs IumIIv owe
In Luxes Ior LIe veur?" No Lwo prepurers ever ugree. TIe runge oI unswers Is
sIockIng. n 18, LIe runge vurIed Irom $;,;1= Lo $68,1z, u dIIIerence oI 8%.
However, LIese Lux proIessIonuIs couId be proud LIuL LIev ugreed Iur more LIun
dId LIeIr coIIeugues wIo perIormed u sImIIur exercIse In 1o: TIuL group's
resuILs runged Irom $6,8o; Lo $;,zq;, u ;6% dIIIerence.
How couId experLs dIsugree so vusLIv on someLIIng LIuL seems us objecLIve us
uccounLIng? L Lurns ouL LIuL decIdIng wIuL Is Income, wIuL Is deducLIbIe, und
wIuL Is un upproprIuLe deprecIuLIon scIeduIe Is subjecLIve. JudgmenL cuIIs ure
purL oI u Lux prepurer's work. SImIIurIv, uL u corporuLe IeveI, u mvrIud oI
umbIguous uccounLIng quesLIons, sucI us wIen Lo recognIze revenue und wIIcI
ILems Lo expense, opens LIe door Ior seII-servIng InLerpreLuLIons. An ILem sucI us
IuLe-sLuge R&D LIuL one uudILor mIgIL regurd us un InvesLmenL cun be seen bv
unoLIer us un expense. WILI execuLIves decIdIng Iow Lo sLuLe eurnIngs, LIe Lwo
LreuLmenLs cun sIgnIIIcunLIv uIIecL LIe boLLom IIne reporLed Lo LIe pubIIc.
AnoLIer IndIcuLIon oI umbIguILv In uccounLIng Is LIe common prucLIce oI
negoLIuLIng ubouL uccounLIng ruIes. n one sLudv bv MIcIueI GIbbIns, SLeven
SuILerIo, und AIun Webb oI uudIL purLners workIng Ior InLernuLIonuI
uccounLIng IIrms, 6;% reporLed LIuL LIev commonIv negoLIuLed wILI =o% or
1o
more oI LIeIr cIIenLs. TIese negoLIuLIons, Ior exumpIe, mIgIL InvoIve LIe LImIng oI
revenue und expenses recognILIon. ExecuLIves ure oILen In u Iurrv Lo recognIze
revenue buL preIer Lo deIuv recognIzIng un expense. I LIere were sucI u LIIng us
"correcL" LImIng, LIese negoLIuLIons wouIdn'L Luke pIuce. AnoLIer IndIcuLIon oI
uudILIng umbIguILv Is LIe Lendencv oI cIIenLs Lo opInIon-sIop-LIuL Is, Lo usk
muILIpIe uudILors Lo InLerpreL specIIIc uccounLIng probIems beIore decIdIng
wIom Lo IIre. Becuuse no "rIgIL" concIusIon exIsLs, dIIIerenL uudILIng IIrms cun
Iuve dIIIerenL opInIons.
InuIIv, In LIe currenL poIILIcuI dIscussIon ubouL expensIng opLIons, opponenLs oI
expensIng oILen urgue LIuL un opLIon's vuIue Is Loo umbIguous Lo ussess. TIev
proIIer umbIguILv us u jusLIIIcuLIon Ior IgnorIng LIe vuIue oI opLIons execuLIves
receIve.

1. TIIs und subsequenL sLudIes ubouL LIe coIIIsIon menLIoned In LIIs urLIcIe were
conducLed bv Indu Bubcock, CoIIn Cumerer, Sum ssucIuroII, und George oewensLeIn
und ure summurIzed In . Bubcock und G. oewensLeIn, "ExpIuInIng BurguInIng mpusse:
TIe RoIe oI SeII-ServIng BIuses," JournuI oI EconomIc PerspecLIves, wInLer 1;.
z. K.A. DIekmunn, S.M. SumueIs, . Ross, und M.H. Buzermun, "SeII-nLeresL und
uIrness In ProbIems oI Resource AIIocuLIon: AIIocuLors Versus RecIpIenLs," JournuI oI
PersonuIILv und SocIuI PsvcIoIogv, Muv 1;.
. D.M. MessIck und K.P. SenLIs, "uIrness und PreIerence," JournuI oI ExperImenLuI
SocIuI PsvcIoIogv, JuIv 1;.
Mux H. Buzermun Is LIe Jesse sIdor SLruus ProIessor oI BusIness AdmInIsLruLIon uL
Hurvurd BusIness ScIooI In BosLon. He Is LIe uuLIor oI JudgmenL In MunugerIuI
DecIsIon MukIng (JoIn WIIev & Sons, IIILI edILIon, zoo1). George oewensLeIn Is u
proIessor oI economIcs und psvcIoIogv uL CurnegIe MeIIon UnIversILv In PILLsburgI. Don
A. Moore Is un ussIsLunL proIessor oI orgunIzuLIonuI beIuvIor und LIeorv uL CurnegIe
MeIIon's GruduuLe ScIooI oI ndusLrIuI AdmInIsLruLIon.