Last Friday the US Treasury’s Advisory Committee on the Audit Profession served up its report – helpfully mapped on Edith Orenstein’s FEI blog for September 26. As I had predicted – here and here – the group failed to agree on the existence of catastrophic risk, or on anything like a set of achievable solutions.
With that opportunity now closed out, although the issues persist unsolved, it’s an open question where leadership may now migrate. Meantime, the public desire and expectation for high-quality assurance remain challenged – not least because that quality is so hard to identify. Here’s an idea:
There’s an odd but well-observed phenomenon -- highway drivers, asked about their skills behind the wheel, consistently rate themselves more highly than they deserve.
I am obliged to Tom Vanderbilt’s new book, “Traffic,” because it bears on a survival issue for the large accounting firms – their inability to persuade a hostile audience that they can meet the public’s expectations for quality work.
Despite the ruthless mathematical impossibility that most vehicle operators actually perform above average, the exaggerated self-evaluations rest on two doubtful supports:
• First, both standards and expertise are weak and ambiguous. Herd behavior on the daily roadways is not a fair context by which to measure real skill, and in any event, a poor driver is not qualified to assess the extent of his own mediocrity.
• Second, only a tiny fraction of “driver errors” have bad outcomes. The typical commuter commits routine violations without incident – speeding, lane cut-offs, distracted concentration while texting, even drinking. He usually gets home safely, despite bad habits and performance, with a subtle but erroneous endorsement of his adequacy. With a history that is unsafe, unrecognized and only unharmful due to good fortune, an at-risk driver suffers an “accident” only when his accumulated risk factors converge with, say, an icy patch or a darting child or another drunk crossing the mid-lane.
Having spent a career studying corporate malfeasance and failure, I’ve found it both puzzling and depressing that the large audit firms persistently fall victim to the same behaviors, decade after decade.
Vanderbilt’s approach to driver quality illuminates the similar disconnect in the audit context: The Big Four issue virtually identical proclamations of a commitment to do quality work. Yet their pleas for liability relief and their admitted exposure to more than $100 billion in litigation claims reveal the reality of grave performance concerns.
So the auditors’ credibility gap may rest on their three-order resemblance to the cluelessly optimistic drivers:
• First, the large firms – along with their critics and the surrounding community of regulators and financial statement users – have no real way to differentiate good work from bad. Auditors’ reports all look exactly alike, so as long as nothing catastrophic has happened to a corporate issuer, the reasons may lie as much with luck or circumstance as with a job well or poorly done.
• Second, there’s nobody even trying to do contemporaneous audit quality assessment – a process not within the remit or the resources of the SEC, the PCAOB, or their counterparts. And the prospect of a robust and independent research body is one of the many ideas failing to emerge out of the Treasury Committee.
• And at the third order: An audit engagement may have been rife with potential for break-down – of the types all too familiar to both the investor plaintiffs’ lawyers and the profession’s own defensive advocates. But only in the rarest cases do the conditions for failure actually ripen into disaster. As a result, the skewed bias of hindsight provides a steady but misleading stream of reinforced messages, that everything is cruising along without problems or concerns.
Vanderbilt describes the fundamental re-training needed to relieve the typical under-estimation of driver fallibility and culpability – namely, large-scale collection, scrutiny and discipline of the “near misses” – a program that would perhaps be familiar in the airline industry’s highly pro-active inquiries into incidents threatening air traffic safety.
But neither the accounting profession nor its regulators today possess the insight or the resources to search for, investigate and extract wisdom from the “crashes that didn’t happen.”
A one-day symposium of either audit critics or supporters alike could flesh out the catalog of factors that have contributed to the notorious audit failures – ranging from inadequate industry expertise at the partner level to pliant accommodation of aggressive accounting policies to the most basic break-downs in routine audit procedure execution.
Conceivably, these would form a template against which audit performance could be assessed – if only there were the will, the availability of competent evaluators, and the readiness actually to learn from the results.
But considering that the Treasury Committee could not even agree that there is a threat to large-firm survivability, such re-oriented leadership vision is unlikely to emerge any time soon.
So it is probable that audit crashes will continue to claim reckless and over-optimistic victims, as well as innocent by-standers, for the same unexamined reasons that have recurred over and over for years, while the currently depressed level of insight and progress to quality remains unmoved.
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