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
in this paper are: (1) Is the auditor likely
to complywiththe firm'sdemands because
of an asymmetricalpower structurefavor-
ing thefirms?;(2) If an asymmetricalstruc-
ture does exist, what are the factorscaus-
ing the imbalance? and; (3) What changes
in thestructureoftheauditor-firm relation-
ship would reduce the probability of the
firm'sattemptingto influencethe auditor
and also decrease the likelihoodof auditor
compliancewhen such attemptsare made?
In one of the few articles on the topic,
Goldman and Barlev [1974, pp. 707-718]
recentlydeveloped a model incorporating
a number of factors which affect the
auditor-firm conflictsituation. It is our in-
tention to expand on their analysis and,
among other things,indicate some appar-
ent weaknesses in their conclusions. A
briefreviewof some of the essentialfactors
of theirmodel will provide a basis for de-
parture.
Goldman and Barlev (G&B) argue that
attempts to influencethe auditor to take
an action that is not in conformitywith
professionalstandards may be successful
because of an asymmetricalpower rela-
tionship in favor of the firmin a conflict
situation [1974, p. 712]. Accordingto the
G&B model, the power of a professional
vis-a-visa client may be described by the
matrix in Table 1, and the auditing pro-
fession is characterized by cell 4. The
auditor is so classifiedbecause the auditor
is providing a service not for the paying
client,the firm,but primarilyforthe bene-
fitof a thirdparty, such as the stockhold-
ers or creditors.In addition, the auditor's
serviceis consideredto be basically routine
since many standardized procedures are
utilized and discretionaryjudgments of
the professionalsare minimal. Situations
characterizedby the performanceofhighly
routine services for the primary benefit
of nonpaying third parties are identified
as low power relationships in the G&B
model. As described in the matrix, the
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The AccountingReview,April 1976
higherthe proportionof nonroutineactivi-
ties performedby the professional, the
more power the professional wields vis-
a-vis the client.In addition, the higherthe
proportion of services the professional
renders directlyto the paying client, the
more importantare these services to the
client and the greater the professional's
power. The implication of this model is
that movement of the auditor's position
from cell 4 to cell 1 would increase the
auditor's power to withstandinfluenceat-
temptsby the clientto pressurehim or her
into a violation of professionalstandards.
We shall examine these assumptions and
conclusionsin the followingsections using
behavioral science concepts.
TABLE 1
THE AMOUNT OF POWER WIELDED BY PROFES-
SIONALS Vis-a-Vis PAYING CLIENTS
ProblemSolved
Beneficiary Nonroutine Routine
Paying Clients (1) Highest (2) Medium
Others (3) Low (4) Lowest
THE AUDITOR-FIRM CONFLICT SITUA-
TION AND INTERPERSONAL
EXCHANGE THEORY
Cartwrightand Zander [1968, p. 216]
defined power as the capability of one
partyto influencethe attitudesor behavior
of anotherparty. Thus, in the auditor-firm
conflictsituation, the power of the firm
can be representedby its ability to influ-
ence the audit or finalreportof the auditor.
The independence of the auditor can be
represented by the auditor's ability to
withstandsuch influenceattempts.Under-
standing the exercise of power between
two parties and the success of such at-
tempts to influencebehavior requires ex-
amination of the relationship between
both parties and theirrelationshipto third
parties. These relationships can be ana-
Nichols and Price: Auditor-FirmConflict
lyzed by using exchange theory terms
[Tibaut and Kelly, 19571 and by using the
concepts of dependency as related to
power formalizedby Emerson [1962].
Emerson [1962, p. 32], describinga two-
party relationship,stated that power of A
over B rests implicitlyin B's dependency
on A. The greater the dependency of one
individual on the rewards and/or punish-
ments that the other party can mediate,
the greaterwill be the power of the party
to gain compliance with his or her wishes.
Since power in any dyadic relationshipis a
functionof the dependency of each party
on the other, the alleged asymmetrical
power relationship between the auditor
and the firmcan be analyzed by examining
the pattern of dependency between both
parties. Following Emerson, the following
pair of equations can be used to describe
the auditor-firmrelationship.
Pab = Dba
Pba = Dab
In equation (1), the power (P) of the
firm(a) over the auditor (b) is equivalent
to the dependency (D) of the auditor (b)
on the firm(a). In equation (2), the power
(P) of the auditor (b) over the firm(a) is
equivalent to the dependency (D) of the
firm (a) on the auditor (b). The G&B
model suggests that the power of the firm
is greaterthan the power of the auditor in
a conflictsituation. However, we would
argue that the cause of this imbalance is
not, as the G&B model indicated, a result
of the audit functionbeing routine com-
pared to nonroutineor that a thirdparty
is the primarybeneficiaryof the auditor's
services. Instead, we hope to demonstrate
that this imbalance is a result of the dif-
feringpattern of dependencies that exists
between the auditor and the firm.
More specifically,the dependenceof one
party on the other [Emerson, 1962] is
directlyproportional to the motivational
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337
investmentsthat one partyhas in the goals
mediated by the otherparty,and inversely
proportional to the availability of these
goals throughparties outside the current
relationship. Therefore, dependency is a
function of the valuation placed on the
rewardsthat one party can offerthe other
and the availability of these rewards in
otherrelationships.It may be argued that
in the conflictsituation,the dependence of
the auditor on the firmis greaterthan the
dependence of the firm on the auditor.
This would resultfromthe auditor placing
greater significanceon the rewards medi-
ated by the firmthan the firmplaces on
the rewardsmediated by the auditor, and
because the alternatives available to the
firm are greater than the alternatives
available to the auditor.
In the conflictsituation, the firmdoes
not highlyvalue the rewardsthat a specific
auditor can mediate. The rewards an in-
(1) dividual auditor offersare special skills in
(2) accurately assessing the financial opera-
tions of the firm.The firmmay not be
interestedin the most competentaudit or
most accurate statement of its financial
positionand resultsof operations.Instead,
the firmmay desire to secure statements
that have a particularexpected impact on
third parties. Since anyone with the ap-
propriate credentials is able to perform
this type of attest function,the individ-
ual auditor's expertise or special skills in
accounting or auditing may have little
significanceto the firm.On the otherhand,
the auditor is likely to place a high valua-
tion on the rewards that the firm can
mediate, such as present and potential
fees from the audit and, perhaps, other
services. The auditor places a high valua-
tion on these rewards because they are
consistentwith the auditor's needs. Thus,
the rewards offeredby the firmare con-
sistentwith the goals that the auditor has
in exchanging services; however, the re-
wards offeredby the specificauditor, the
338
accountingand auditingexpertise,may be
inconsistentwith the goals that the firm
seeks to obtain.
The resultof the auditor placing greater
valuation on the rewards the firm can
mediate than the firmplaces on the re-
wards the auditor can mediate does not,
by itself, produce an asymmetrical pat-
tern of dependency. However, this differ-
ence in valuation of rewards, combined
with greater alternatives available to the
firmcompared to the auditor,produces an
asymmetrical pattern of dependency. It
is likely that the alternativesavailable to
the firmto obtain the rewards mediated
by the auditor are greater than the alter-
natives available to the auditor to obtain
the rewards mediated by the firm. An
auditor operates in a competitivemarket
attemptingto sell his or her services to a
specificcompany. It is probably easier and
less costly for the firmto replace its cur-
rent auditors than it is for an auditor to
obtain additional or alternativesources of
fees. In the conflictsituation,the alterna-
tives available to the firmare probably
numerous, since any individual with the
appropriate credentials can performthe
attest function.Thus, the large potential
supply of auditors that the firm might
utilize to achieve its objectives decreases
the firm'sdependencyon a specificauditor.
This would not be true if the rewardsof
the specific auditor were desired by the
firmbecause of the auditor's special skills
or high levels of competence.In this case,
the services offeredby the auditor have
high significancefor the firm, and the
numberof alternativeauditors who might
provide equivalent services might be re-
duced. However, this is not the case in
attest functionconflictsituationssince the
competence and credentials of a specific
auditor to performthe attest functionare
apparently not considered to be greater
than any other memberof the profession.
In addition, the firmin a conflictsituation
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The AccountingReview,April 1976
is apparentlyinterestedin the outcome of
the attest functionrather than the com-
petence with which it is performed.Thus,
the firm'slack of interestin the rewards
the auditor can mediate seriously erodes
the only base of power (expert power) the
auditor possesses vis-a-visthe firm.There-
fore,the net effectis to produce a different
pattern of dependencywhich resultsin an
asymmetricalpower relationshipfavoring
the firm.
In the G&B model the auditor is in a
low position of power partly because the
auditing functionis routine; they suggest
that "the higher the proportion of non-
routineproblemsdealt with by the profes-
sional, the more power he wields vis-a-vis
the client" [1974, p. 711]. This relation-
ship may be describedby Figure 1 (linear-
ity need not be assumed).
High
Power to
WithstandThreats
of Replacement
Low I
Low High
Routinismof Auditor'sService
FIGURE 1
THE RELATION BETWEEN POWER AND DEGREE
OF ROUTINISM OF AUDITOR'S SERVICES
The assumption underlying the G&B
model is that the more nonroutine the
auditor's services, the greater the impor-
tance the firm attaches to the specific
auditor's expertise.The resultwould be an
increase in the power of the auditor vis-a-
vis the firm,because the firmnow would
place greater significanceon the services
the specificauditor could mediate.
The conclusion of the G&B model re-
garding the relationship between power
and routinismis not justified.In order to
be valid, the analysis would require a dif-
Nichols and Price: Auditor-FirmConflict
ferentiationbetween attest function ser-
vices and management services. As we
hope to demonstrateregardingthe attest
function, the model is incorrect and, in
fact, the relationship is reversed. With
respect to managementservices,there are
a number of significantvariables omitted
fromthe model and the net effectof such
services is difficultto determine. These
issues are examined in the followingsec-
tions.
ROUTINISM IN THE ATTEST FUNCTION
AND ITS IMPACT ON POWER
The basic reason that increasing the
nonroutinismof the attest function does
not increase the auditor's power to with-
stand threats of replacement is that the
firm'svaluation of the auditor's services
is not affectedby the degree of nonroutin-
ism in the attest function. As we have
argued in the previous section, in conflict
situations, the auditor's relative skills in
accounting or auditing activities are not
highlyvalued by the firm.The low valua-
tion of the auditor's services is related to
two considerations.
First, the firmconsents to an audit be-
cause of the requirementsof a thirdparty.
Generally, the firm does not expect to
gain new informationfrom the audit or
the report; i.e., the firmdoes not depend
on the audit to detector preventirregulari-
ties, or to determinefinancialposition or
results of operations. It is important to
recognize that informationbeneficial to
the firm,such as reportson internal con-
trol that may result from the audit, are
being considered as part of the manage-
ment service activity to be discussed later
since it is not a requiredpart of the audit.
Thus, the actual informationfrom the
audit or contained in the audit reportis of
littleor no significanceto the firm.
Second, the firmplaces a low valuation
on the auditor's services because of the
nature of the firm'srelationshipto third
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339
parties. Essentially,the firmmust have an
audit because of a requirementof the Se-
curities and Exchange Commission or
other reasons. The firm cannot perform
the audit; only a professionalwith the ap-
propriate credentials can. Changing the
audit functionfromroutineto nonroutine
would not alter this basic relationshipbe-
tween the auditor, the firmand the third
party. Since this basic relationship be-
tween the three parties remains un-
changed, it seems unlikely the goals of
each partywould change. In this situation,
the firmwould not place any greater sig-
nificanceon the services the auditor can
offer regardless of how nonroutine the
auditingfunctionmightbe. The firmmay
be only interestedin obtaining a particu-
lar reporton statementsto be provided to
third parties. Thus, in this conflictsitua-
tion the nonroutinenessof the auditor's
services does not increase the significance
of the auditor's services vis-a-visthe firm
because it does not alter the goals of the
firmand because the audit providesno new
information.
Finally, it should be noted that chang-
ing the auditing functionfromroutine to
nonroutine,since it does not alter the de-
pendency of the firmon the auditor, does
not change the firm'sbasis of social power
or willingnessto utilize this power. Re-
gardless of how nonroutine the auditing
function might be, the firmstill retains
the ability to hire and firethe auditor. In
addition, the firmwould not be less likely
to employrewardand coercivepowerifthe
final report were not consistent with its
desires,regardlessof the nonroutinenature
of the auditingfunction.
We have suggested that changing the
attest functionfromroutineto nonroutine
does not necessarily alter the motivation
of the firmor its valuation of a specific
auditor's expertise.In this section,we will
argue that the power of the auditor to
withstandattempts to influencethe audit-
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
firmsof equal prestigeand statusthatjust might
see the resultsof a transactiondifferentlyis a
specterdifficultto shake fromthe mindsof any
who make audit decisions" [1972, p. 911 .
concerningthe authority of the auditor)...
Can you imaginewhat wouldhappen to a major
company if an accountingtreatmentwhich its
managementinsisted upon was consideredun-
satisfactoryby all CPA's? There seems little
doubt but that the companywould have to give
(agree to acceptable treatment)[p. 94].
MANAGEMENT SERVICES AND THEIR
IMPACT ON POWER
Considered in the G&B model is the
question of whetherperformanceof man-
agement services will increase or decrease
the independenceof the auditor (resistance
to influence)in auditor-firm conflictsitua-
tions.While most of the previousliterature
on the subject has questioned seriouslythe
compatibility of management services
and audit independence,the G&B model
leads to the conclusion that such services
tend to increase the independence of the
auditor. This conclusion is based on the
fact that "most consulting activities are
nonroutineand because these servicesben-
efitthe clientfirmdirectly" [1974,p. 715].
We would submit that thereis not suffi-
cientevidence to supportor reject thiscon-
clusion unequivocably because of a va-
riety of factors that may or may not be
present in each situation. Furthermore,if
in certain situations the addition of man-
agement services did increase the power
of the auditor, this would be a result of
changing the dependency of the firmon
the auditor.
The addition of management services
would only increase the power of the
auditor ifthe firmperceivedthat the addi-
tional management services had some
unique value which could not be fulfilled
easily by replacingthe auditor or by other
consultants.In this circumstance,the per-
formance of management services in-
creases the significanceof the auditor's
total services and, thus, increases the de-
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The AccountingReview,April1976
pendency of the firmon the auditor. The
costs associated with replacement of the
. . (and auditor (loss of the expertise) when few
alternatives are available would be in-
creased. Given these assumptions, Figure
3 indicates the possible relation between
the performanceof management services
and the auditor's independence.
High
Abilityof
Auditorto
Withstand
Conflict
Situations /
Low /
Negative Low High
Negative
PerceivedUnique Value of Management
ServiceActivity
FIGURE 3
RELATIONSHIP OF MANAGEMENTSERVICE
ACTIVITY TO AUDIT INDEPENDENCE
As portrayed by Figure 3, if the firm's
perceptionof the unique value of manage-
ment service activity were high, then the
ability of auditors to withstand conflict
situations would tend to be high. That is,
greaterconflictin the audit area would be
requiredbeforethe firmwould replace the
auditor over an audit dispute. It is im-
portant to note that the horizontal axis
in Figure 3 is not the amount of manage-
ment service activity, but the perceived
unique value of those services. The G&B
model fails to distinguishbetween these
two; however, differentiationis critical.
For example, at one point (the origin)
the perceivedunique value of the manage-
ment services is zero. This may be be-
cause the auditor performs(or is expected
to perform)no management services, or
it may be because the firmbelieves that
these services can be performedequally
well by another auditor or other consult-
Nichols and Price: Auditor-FirmConflict
ant. In this case, the management service
factor has no impact on the independence
of the auditor. Further, the graph indi-
cates the possibilityof dissatisfactionwith
the management service activity on the
part of the firm,perhaps resultingfrom
apparent poor recommendations in the
past, or fromthe auditorchargingwhat the
client considered to be an exorbitantfee
forthe service.In those cases, the auditor's
independence would be decreased by per-
formance of additional management ser-
vice activities. Finally, the ability of the
auditor to withstand threats of replace-
ment may not be increased through the
addition of management services if the
value of such additional services are not
perceived by the firmto exceed the costs
associated with an undesirable report.
Here, the firm might perceive that the
costs associated with undesirable actions
by third parties may outweigh any addi-
tional rewards the auditor might provide
throughhis or her special services.
Thus, there does not appear to be suffi-
cient informationabout the firm's per-
ceptions of the unique value of the audi-
tor's management service activities in
relation to both rewardsand costs to sup-
port or reject a conclusionabout its effect
on the auditor-firmconflictsituation. Any
finalresolutionof the managementservice
controversy would require consideration
of all of the above factors. Since these
factors may be quite variable, depending
on the specific situation, any general a
priori conclusion specifyingeffectsacross
all situationsmay be impossibleto obtain.
Benefitsand Its RelationshiptoPower
The G&B model leads to the conclusion
that the auditor is in a low position of
power vis-a-visthe firmpartly because the
firmmust pay for the audit while other
parties derive the primary benefit from
the audit. It must firstbe clear that there
is a direct benefit to the client from an
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343
audit. The benefitto the paying client is
usually fulfillmentof a requirement,im-
posed or required,by a person outside the
firm(bank, SEC, prospectivebuyer). Ap-
parently, the benefitof fulfillingthis re-
quirementis greater than the cost, or the
audit never would be requested by the
paying client.This is not to suggestthat a
firmunilaterally would request an audit;
however, the fact that the firmis willing
to submit to and pay foran audit is suffi-
cient evidence that it perceives the bene-
fits to be equal or in excess of the costs.
Consequently, the primarybeneficiaryof
the audit may not be determinedclearly.
However, if the third party were the
primary beneficiaryof the auditor's ser-
vices, this would not be the cause of the
auditor's low power vis-a-visthe firm.As
previouslyargued, the auditor is in a low
position of power because the paying
client may not be interestedin the exper-
tise he or she can provide.The cause of this
conflictbetweenthe firmand the auditor is
the coercivemannerin whichthe firmper-
ceives some thirdparty mightuse an un-
favorable report. For example, the third
party might use the auditor's report to
deny the firma loan or, in the case of
stockholders,sanction management poli-
cies. Removal of the third party and its
potential coercive use of the auditor's re-
port would alleviate the cause of auditor-
firm conflict; however, this also would
eliminate the purpose of the attest func-
tion. Therefore, we do not perceive the
cause of the auditor's low position of
power to be a result of thirdparties being
the primarybeneficiariesof the auditor's
services. In addition, we would argue the
possible coerciveuse of the informationby
a thirdparty is a cause of the auditor-firm
conflict.
METHODS OF RESOLUTION
It would be an oversimplification
to sug-
gest that simply increasing the power of
344
the auditor vis-a-visthe firmnecessarily
will implythat the firmwould not attempt
to influencethe performanceof the attest
functionand the auditor would refuseto
comply if such an attempt were made.
That is, power possessed will not be util-
ized necessarilyin a manner to insure ap-
propriate behavior. Instead, the equaliza-
tion of power between the auditor and the
firm,resultingin a symmetricalpowerrela-
tionship,could lead to mutual accommo-
dation. In a situationwithmorepower,the
auditor might comply with the firm'sde-
mands but only under conditions which
the auditor feels to be more acceptable.
Thus, a symmetricalpower relationship
mightonly serve to enhance the auditor's
position and enable the auditor to make
greater counter demands upon the firm.
Whetheror not, given a more symmetrical
power relationship between the auditor
and firm,the firmwould request a viola-
tion of professional standards and the
auditor would agree to the request would
depend on other factors. The critical
factors are the perceived benefits and
costs that accrue to both partiesas a result
of a violation. These potential costs can be
internalor external.They may be internal
in the form of feelings of guilt resulting
from taking an inappropriate action, or
externalin the formof sanctions adminis-
tered by thirdparties (courts, SEC, ethics
committees,etc.). In those cases wherethe
potential costs exceed the rewards, to
either party, it would seem unlikely that
the specific behavior would be enacted.
For this reason, we would suggest that
procedures designed to increase the pos-
sible detection and costs of inappropriate
actions are more likely to decrease the in-
cidence of violations of acceptable prac-
tices than techniques designed to equalize
the power between the auditor and the
firm.
There are at least three reasonably dis-
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The AccountingReview,April 1976
tinct set of proceduresthat mightbe used
to increase the ability of the auditor to
withstand pressure to comply with the
firm'sdemands. The firstset involves the
activities designed to increase the discre-
tionaryoptions available to the auditor to
cause sanctionsto be imposed on the firm.
The second set of procedures represents
attempts to reduce the auditor's and/or
of action by increasing
the firm'sflexibility
the cost of inappropriate behavior. The
thirdset involvesa change in the structure
of auditor-firmcontractual relationships
as a means of decreasingthe discretionary
options available to the firm. We shall
examineexamplesofeach set ofprocedures
in turn with the objective of reducingthe
possibility of the firmdemanding an in-
appropriate action and the auditor com-
plyingwhen such a request is made.
The firstapproach centerson increasing
the power of the auditor, primarilyby in-
creasing the ability of a replaced auditor
to cause sanctions to be imposed on the
firm resulting from unjustified replace-
ment.Examples currentlyin use are, a new
auditor being required to consult with the
previous auditor to obtain all relevant
information;or,in cases consideredby the
SEC, the former accountant having to
submita reportto the SEC concerninghis
or her displacement. Procedures of this
natureare quite likelyto alter the auditor's
power vis-a-vis the firm.In effect,these
proceduresprovide or create a new base of
power for the auditor vis-a-vis the firm.
This new base of power is clearly coercive
in nature since a replaced auditor can
make other parties aware of alleged inap-
propriate demands made or unjustified
actions taken by a firm.These procedures
increase the potential costs to the firmin
attempting to influence the auditor to
violate professionalstandards by making
it more likely that others will learn of
the attempts. These procedures may
Nichols and Price: Auditor-FirmConflict
reduce such influence attempts by the
firm,given that the auditor utilizes the
proceduresand that appropriatesanctions
are administeredby the thirdpartiesin the
case of inappropriatebehavior. Thus, the
firmmay be in a more difficultposition to
assess whether the potential rewards of
such influenceattempts will outweigh the
costs.
However, theseproceduresdo not insure
that ifan influenceattemptis made by the
company, the auditor will utilize the
power to preserveindependenceand to re-
fuse to comply. Consequently,the auditor
may comply if the perceived rewards of
complianceare high.The auditor's actions
are likelyto be based on internalstandards
concerningprofessionalbehavior and the
perceived costs associated with unprofes-
sional behavior in relationto the perceived
rewards of compliance. As a result, the
potential costs and rewards may be vari-
able, and success of these types of pro-
cedures in preventing inappropriate be-
havior seem to be unpredictable.
The second set of procedures are de-
signed to increase the expected cost to the
auditor and/or the firmfrom taking in-
appropriateactions. We are of the opinion
that these types of changes would be the
most effectivein decreasingtheprobability
of influence attempts by the firm and
auditor compliance with such demands.
An example would include greaterspecifi-
cation of auditing and accounting stan-
dards. These changes should be successful
because they provide the auditor and the
firmwith a clearerset of standards (reduc-
ing ambiguity about proper actions) and
because they can increase the possibility
of detection of inappropriate actions. In
effect,the specificationof auditing and re-
porting standards changes a more non-
routine task to a more routine task and
increases the possibility of costs being
associated with auditor practices that vio-
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345
late acceptable standards.In addition,
tightening standardsmayreduceattempts
by thefirmto influence thefinalreportof
an auditorbecausethefirmmay (1) have
a clearerunderstanding of the reporting
rules,(2) perceivemoredifficulty in find-
inganotherauditorwhowouldviolatesuch
clearstandardsand (3) be inhibited by the
greaterpossibility ofdetectionby a moni-
toringbody.Implicithereis the assump-
tion that appropriatemonitoring bodies
(professionalcommittees,SEC and the
courts)would be available to determine
violationsand would sanctionthe party
fora violation.Thisappearsto be a reason-
able assumption.Increased monitoring
activityis manifestedby the drasticin-
creasein the numberof lawsuitsagainst
firmsand auditors,the increasein SEC
activityin firmand auditorimproprieties
and professional movements, suchas peer
quality reviews.All of these types of
activities,which increase the potential
cost to the auditorand/orthe firmfrom
takinginappropriateactions,reduce the
flexibilityof each and shouldtend to in-
hibit and reducethe possibilityof inap-
propriateactionsoccurring.
The thirdset ofprocedures forreducing
possible complianceon the part of the
auditorreflectschangingthe structureof
the auditor-firm contractualrelationship
as a meansof reducingthe firm'sdiscre-
tionaryoptions.Proceduresof this type
are likelyto increaseindependence on the
partoftheauditor.The coercivepowerof
the firmis eliminatedas the firmis no
longerresponsible forthe firingor hiring
of the auditor.The movementto audit
committees composedof outsidedirectors
is a positivestepofthistype.However,we
would agree with previouswritersthat
further modifications,e.g.,developinglong-
termengagements or makingthe auditor
an employeeof the public,are ratherex-
tremesolutionsto theproblem.These are
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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Goldman,A. and B. Barlev, "The Auditor-FirmConflictof Interests: Its ImplicationsforIndepen-
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Mautz, R. K., "Toward a Philosophyof Auditing,"in AuditingLooks Ahead, Howard Stettler,ed.
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All use subject to JSTOR Terms and Conditions