Conflict of interest

Working Paper # 03-115

Rev. 09/04

Conflicts of Interest and the
Case of Auditor
Independence: Moral
Seduction and Strategic Issue
Cycling
Don A. Moore
Carnegie Mellon University
Philip E. Tetlock
Haas School of Business
Lloyd Tanlu
Harvard Business School
Max H. Bazerman
Harvard Business School

This paper has benefited from the feedback of Art Brief, George Loewenstein, and three anonymous reviewers of an earlier version of the paper. This paper was supported by a grant from the American Accounting Association.

Copyright © 2003 Don A. Moore, Philip E. Tetlock, Lloyd Tanlu, and Max H. Bazerman.
Working papers are in draft form. This working paper is distributed for purposes of comment and discussion only.
It may not be reproduced without permission of the copyright holder. Copies of working papers are available from the author.

Conflict of Interest

Abstract
A series of financial scandals, climaxing in the 2002 bankruptcy of the Enron
Corporation, revealed a key weakness in the American business model: the failure of the U.S. auditing system to deliver true independence. We offer a two-tiered analysis of what went wrong. At the more micro tier, we advance moral-seduction theory which explains why professionals are often unaware of how morally compromised they have become by conflicts of interest. At the more macro tier, we offer issue-cycle theory which explains why conflicts of interest of the sort that compromised major accounting firms are so pervasive. The latter theory depicts organizations as norm creators (not just followers) that: (a) relentlessly seek out rentseeking opportunities under rhetorical smokescreens designed to create attributional ambiguity about their intentions; (b) retreat only under intense pressure, such as that created when conflicts of interest lead to significant losses among important political constituencies; and (c) as soon as outrage wanes, reconcentrate their lobbying efforts to gain the

References: Antle, R. 1984. Auditor independence. Journal of Accounting Research, 22(1): 1-20. Antle, R., Gordon, E. A., Narayanamoorthy, G., & Zhou, L. 2002. The joint determination of audit fees, non-audit fees, and abnormal accruals Arens, A. A., Elder, R. J., & Beasley, M. S. 2003. Auditing and Assurance Services, 9th ed. Ashbaugh, H., LaFond, R., & Mayhew, B. 2003. Do non-audit services compromise auditor independence? Further evidence Babcock, L., Loewenstein, G., Issacharoff, S., & Camerer, C. F. 1995. Biased judgments of fairness in bargaining Babcock, L., & Loewenstein, G. 1997. Explaining bargaining impasse: The role of self-serving biases Baker, C. R. 1993. Self-regulation in the public accounting profession: The structural response of the large public accounting firms to a changing environment Baron, J. 1996. Do no harm. In D. M. Messick, & A. E. Tenbrunsel (Eds.), Codes of conduct: 197-213 Baron, J. 1998. Judgment Misguided: Intuition and error in public decision making. New York: Oxford University Press. Bazerman, M. H., Baron, J., & Shonk, K. 2001. You can 't enlarge the pie: The psychology of ineffective government Bazerman, M. H., Loewenstein, G., & Moore, D. A. 2002. Why good accountants do bad audits. Bazerman, M. H., Morgan, K. P., & Loewenstein, G. F. 1997. The impossibility of auditor independence Beck, P., Frecka, T., & Solomon, I. 1988. An empirical analysis of the relationship between MAS involvement and auditor tenure: Implications for auditor independence Becker, G. S. 1983. A theory of competition among pressure groups for political influence. Beeler, J.D., & J.E. Hunton. 2003. Contingent economic rents: Insidious threats to auditor independence Brockner, J., & Rubin, J. Z. 1985. The social psychology of entrapment in escalating conflicts. Bower, A., & Burkett, G. 1987. Family physicians and generic drugs: A study of recognition, information sources, prescribing attitudes, and practices Buchanan, J., & Tullock, G. 1962. The Calculus of Consent. Ann Arbor: University of Michigan Press. Buchman, T. A., Tetlock, P. E., & Reed, R. O. 1996. Accountability and auditors ' judgment about contingent events Burger, W. 1984. United States v. Arthur Young & Co., Vol. 82-687: Supreme Court of the United States. Butler, M. B., Leone, A. J., & Willenborg, M. 2002. An empirical analysis of auditor reporting and its association with abnormal accruals Camerer, C. F., Loewenstein, G., & Weber, M. 1989. The curse of knowledge in economic settings: An experimental analysis Carey, J. L. 1970. The rise of the accounting profession: To responsibility and authority, 19371969. New York: American Institute of Certified Public Accountants. Caudill, T., Johnson, M., Rich, E., & McKinney, P. 1996. Physicians, pharmaceutical sales representatives, and the cost of prescribing Center for Responsive Politics. 2002. http://www.opensecrets.org Cialdini, R Chung, H., & Kallapur, S. 2003. Client importance, non-audit fees, and abnormal accruals. Cowen, A., Groysberg, B., & Healy, P. 2004. Which types of analyst firms make more optimistic forecasts? Working paper, Harvard Business School. Craswell, A., Stokes, D. J., & Laughton, J. 2002. Auditor independence and fee dependence. Cuccia, A. D., Hackenbrack, K., & Nelson, M. W. 1995. The ability of professional standards to mitigate aggressive reporting Dana, J., & Loewenstein, G. 2003. A social science perspective on gifts to physicians from industry DeAngelo, L. E. 1981a. Auditor independence, low balling, and disclosure regulation. Journal of Accounting and Economics, 3: 113-127. DeAngelo, L. E. 1981b. Auditor size and audit quality. Journal of Accounting and Economics, 3: 183-199. Diekmann, K. A. 1997. 'Implicit justifications ' and self-serving group allocations. Journal of Organizational Behavior, 18(1): 3-16. Diekmann, K. A., Samuels, S. M., Ross, L., & Bazerman, M. H. 1997. Self-interest and fairness in problems of resource allocation: Allocators versus recipients Dies, D., & Giroux, G. 1992. Determinants of audit quality in the public sector. The Accounting Review, 67(3): 462-479. Dopuch, N., King, R. R., & Schwartz, R. 2001. Contingent rents and auditors ' independence: Appearance vs Eichenseher, J. 1984. The effects of foreign operations on domestic auditor selection. Journal of Accounting, Auditing, and Finance, 8(3): 195-209. Farmer, T. A., Rittenberg, L. E., & Trompeter, G. M. 1987. An investigation of the impact of economic and organizational factors on auditor independence Fehr, E., & Gächter, S. 2000. Cooperation and punishment in public goods experiments.