The Auditor’s Role in a Digital World – Empirical evidence on
auditors’ perceived role and its
implications on the principal-agent justification
Master’s Thesis 30 credits Department of Business Studies Uppsala University
Spring Semester of 2017
Date of Submission: 2017-05-30
Andreas Caringe Erik Holm
Supervisor: Fredrik Nilsson Shruti Kashyap
Abstract
Most of the theory that concerns auditing relates to agency theory where auditors’ role is to mitigate the information asymmetry between principals and agents. During the last decade, we have witnessed technological advancements across the society, advancements which also have affected the auditing profession. Technology and accounting information systems has decreased information asymmetry in various ways. From an agency theory point of view, this would arguably reduce the demand for auditing. In the same time, the audit profession is expanding into new business areas where auditors perform assurance services. The purpose of this paper is to investigate auditors’ role in a technological environment. Interviews have been used to explore auditors’ perception of the role. The result indicates that auditors’ role still is to mitigate principal-agent conflicts, though, information asymmetries are expanding to comprehend more and to a wider stakeholder group due to technology. The end goal is still the same, that to provide trust to the stakeholders, technology enable new ways of reaching there and broadens the scope towards systems and other related services. That is the perceived role of auditors in today´s technological environment.
Keywords: Auditor’s Role, Big Data, ERP, XBRL, Technology, Principal-Agent Theory
Acknowledgement
We would like to thank our supervisors Fredrik Nilsson and Shruti Kashyap for valuable discussions and highly appreciated comments. Special appreciations to the seminar group for the rewarding discussions. Finally, we would like to thank our Respondents for letting us interview them.
Andreas Caringe Erik Holm
Uppsala, 2017-05-30 Uppsala, 2017-05-30
Table of Content
1 INTRODUCTION ... 1
1.1 PROBLEMATISATION ... 2
1.2 PURPOSE AND CONTRIBUTION ... 4
2 LITERATURE REVIEW ... 5
2.1 FINANCIAL REPORTING IN SOCIETY ... 5
2.2 AGENCY THEORY AND INFORMATION ASYMMETRY ... 6
2.3 AUDITING AS MITIGATION - STILL RELEVANT? ... 7
2.4 THE ROLES OF AUDITING ... 12
2.4.1 The Stewardship (Monitoring) Hypothesis - The Monitoring Role ... 12
2.4.2 The Information Hypothesis - The Information Role ... 13
2.4.3 The Insurance Hypothesis - The Insurance Role ... 14
2.4.4 The Emerging Assurance Role ... 16
2.5 SYNTHESIS - THEORETICAL SUMMARY ... 17
3 METHOD ... 20
3.1 RESEARCH DESIGN ... 20
3.2 DATA COLLECTION ... 21
3.2.1 Interviews ... 22
3.2.2 Pilot Study ... 22
3.2.3 Selection Criteria ... 23
3.2.4 Interview Guide ... 24
3.2.5 Operationalisation ... 25
3.2.6 Analysis ... 26
3.3 METHOD DISCUSSION ... 27
4 EMPIRICAL FINDINGS AND ANALYSIS ... 29
4.1 AUDITING AS MITIGATION AND TECHNOLOGY ... 29
4.1.1 Analysis of Auditing as Mitigation and Technology ... 31
4.2 MONITORING ROLE ... 33
4.2.1 Analysis of Monitoring Role ... 35
4.3 INFORMATION ROLE ... 36
4.3.1 Analysis of Information Role ... 38
4.4 INSURANCE ROLE ... 39
4.4.1 Analysis of Insurance Role ... 40
4.5 ASSURANCE ROLE ... 40
4.5.1 Analysis of Assurance Role ... 42
4.6 SUMMARY OF ANALYSIS ... 44
5 CONCLUSION ... 46
5.1 FUTURE RESEARCH ... 47
REFERENCES ... 49
APPENDIX 1. INTERVIEW GUIDE ... 53
1 Introduction
In the last decades, we have witnessed a lot of technological advancements in the business society. The last ten years the digitalisation of society and business have exploded. It is possible to witness this shift across many sectors and to believe different reports this will sooner or later affect everyone at some level. Technical advancements and digitalisation are seen by FAR (the Swedish branch organisation for authorised auditors) (FAR and Kairos Future, 2013; 2016), and Taipaleenmäki and Ikäheimo (2013) as something that is unavoidable. Previous advancements in accounting information systems as for example ERP, (enterprise resource planning), XML (Extensible Markup Language), XBRL (Extensible Business Reporting Language), big data and cloud computing has enabled real-time accounting (Bendovschi, 2015;
Chan and Vasarhelyi, 2011; Tsai, Lee, Liu, Lin, and Chou, 2012) and increased the quality of financial reporting to a certain extent. For example, Fu, Kraft, and Zhang (2012) state that more frequent financial reporting will decrease information asymmetry. Tsai et al. (2012) state that ERP leads to decreased earnings management and higher audit quality. Yoon, Zo and Ciganek (2011), Liu, Luo and Wang (2017), Geiger, North and Selby (2014) and Kim, Lim and No (2012) claim that XBRL has decreased the information asymmetry for stakeholders in a stock- market context.
There are also upcoming technologies that might improve the financial reporting even more in the future, and these are for example blockchain technology and big data. Although big data is an established phenomenon today were large volumes of data is gathered, transformed and analysed through various software. The result is business reporting that is the basis for decision- making, this has led to enhanced insight, automation and decision-making (Janvrin and Weidenmier Watson, 2017). However, Warren, Moffitt and Byrnes (2015) state that big data will improve the relevance and transparency of financial reporting even more and both Byström (2016) and Brandon (2016) state that the blockchain technology would make financial reporting more timely and trustworthy. Yermack (2017) and van Schoten (2016) further state that the blockchain technology could reduce and change the demand for auditing as it is today due to the validation process that is provided by the blockchain.
Technological developments regarding different accounting information systems have been an on-going process (Bendovschi, 2015). Technological improvements and today’s accounting information systems are of interest due to the objective of financial reporting, which is: "...to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decision about providing resources to the entity." (IASB, 2010, p. 9). Previous advancements in accounting information systems are of interest because it has previously improved financial information to a certain extent and enabled real-time accounting. Especially the reduction of information asymmetry with external stakeholders is interesting since it is possible to argue that the demand for financial reporting comes from a principal-agent conflict together with information asymmetry between management and organisations’ stakeholders (Healy and Palepu, 2001). As one can see from IASB’s (2010) definition of financial reporting, stakeholders are using financial information for decision-making. Financial information is used by stakeholders and validated by external auditors (Wallace, 1991; Bushman, Chen, Engel and Smith, 2004), i.e., auditors assure stakeholders that financial statements are reliable. Thus, the reduction of information asymmetry is a result of fairly new accounting information systems that arguably also affect auditors since the demand for auditing could be seen as a request for a solution to decrease the information asymmetry and to mitigate principal-agent conflicts (Healy and Palepu, 2001;
Wallace, 1991).
1.1 Problematisation
According to Wallace (1980), the most common reason to auditing is the principal-agent problem, and this viewpoint is even today one of the most common in explaining the demand for auditing (Duits, 2012). Previous literature has pointed out that monitoring technology has inherent limitations for monitoring management. Accounting information systems are a starting point when addressing moral hazard problems, and auditors will then address this problem and validate financial statements (Bushman et al., 2004). Technological developments in accounting information systems are of interest since information is improved in various ways due to XBRL, ERP, analysis of big data. Implied that the demand for auditors arguably would be reduced from a principal-agent point of view since information asymmetries that auditors used to reduce already is diminished by technological improvements. FAR and Kairos Future (2013) states that technology is a changing factor that will have a significant impact on the
auditing profession. However, Yermack (2017) insists that the demand for auditors will remain in some form regardless of the impact of technology. Other explanations to auditing are for example the Insurance hypothesis, which says that auditors are demanded by stakeholders to manage risk due to auditors’ liability exposure (Wallace, 1991). Auditors has also been demanded to provide legitimacy via emerging assurance services in new business areas (e.g., Free, Salterio and Shearer, 2009). Arguably, technology is changing what we know about auditing today, in particular through the lens of principal-agent theory. Both Duits (2012) and Schnader, Bedard and Cannon (2015) urges to expand the view upon the principal-agent justification.
The previous paragraph implies that technology and accounting information systems are of interest to auditors from a theoretical point of view because the demand for auditing could be a request for a solution to decrease the information asymmetry and to mitigate principal-agent conflicts (Healy and Palepu, 2001; Wallace, 1991; 1980). If information already is improved by technical advancements, then this role might have changed. Early examples of the changing role are the Elliot Report from 1997 mentioned in Andon, Free and O’Dwyer, (2015) and recent examples are Boritz and No, (2016) and Stoel, Havelka and Merhout (2012). It raises concerns if Wallace’s (1980) classical roles of auditing still are viable or if changed to comprehend something more. From a practical perspective technology are indeed of interest because several actors within the auditing profession, e.g., both auditing firms and FAR highlights technology as something that will have a significant impact on the profession (FAR and Kairos Future, 2013; 2016; Deloitte, 2016; PwC 2016A and B; EY, 2016). Therefore, it is of interest to investigate the perception of external auditors’ role in today´s technological environment where advanced accounting information systems are used. Hence, the paper aims to answer the following question:
What are the external auditors’ perceived role in today’s technological environment and its implications on the principal-agent justification?
1.2 Purpose and Contribution
The purpose of this paper is to investigate technology’s impact on auditors’ role. There exists a vast amount of literature on topics regarding the auditors’ role and the demand of auditing;
however, the technology angel is up to this point lacking. The few studies and reports published illustrate that the auditing business, especially financial auditing is one that would face tremendous change if to believe the reports about technology and its impact on the auditing profession. The justification from a perspective of agency problem has received criticism the last decade, and a discussion surrounding alternative explanations for the demand of auditing has emerged (e.g., Duits, 2012). With this as a theoretical backdrop, the study builds on the perceived understanding of the auditors’ role in a technical environment. Hence, the paper contributes to the discussion about the reliance upon the principal-agent justification. This study will give insights into changing expertise that is required to meet technology, which can be of importance for academic scholars, students as well as auditing firms.
The paper is structured as follows; section 2 handles the theoretical considerations where technology’s impact on auditing and the classical roles of auditing are discussed as well as an emerging audit role. Section 3 contains a discussion of the underlying methodological assumptions that underpins the study and an account of the practical choices that has been made. Section 4 presents the empirical data and the analysis. Section 5 consist of the conclusion and suggestions for further research.
2 Literature Review
The literature review consist of five parts: financial reporting in society, agency theory and information asymmetry, auditing as mitigation – still relevant?, the roles of auditing and a synthesis that concludes the literature review.
2.1 Financial Reporting in Society
"The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decision about providing resources to the entity." (IASB, 2010, p. 9)
As a first and fundamental point, it is possible to conclude that the objective of financial reporting is to serve an external part in some form. Bushman and Smith (2001) state that financial information is a product of the financial reporting of an entity that measures and publicly disclose audited data regarding the reporting entity’s position and performance. Pelger (2016) describes the objective of financial reporting as something that support decisions usefulness and stewardship. The previous sentences indicate that the financial reporting has a great importance for outside stakeholders to the entity, i.e., to an outside interest as well as a tool to govern the organisation. Hence, the purpose of financial reporting can take on a wider view than the one represented from the IASB and serve a broad range of needs. IASB arguably take on a rather narrow view on this, in the definition above, the primary user of financial information is capital providers. An alternative approach to this is the stakeholder model (Freeman and Reed, 1983). It is possible to argue that the entity is an open system where stakeholders have relationships with the entity. These can, for example, be the community, business partners, customers and so on. The point of the model is that the entity strives to achieve a stable relationship with the environment, that is, to all stakeholders. The company’s decision is always a compromise between the different stakeholders’ desires. It is rarely or never possible to satisfy all stakeholders because their interests are often in conflict with each other. The financial information is there to help interested stakeholders to make useful decisions about the entity. Within this, it is a fundamental problem as stated in the problematisation. There exists a principal-agent relationship between management and the
owners (Watts and Zimmerman, 1979), this relationship is also present between managers and outside investors (Healy and Palepu, 2001). The principal-agent problem can take on many forms between the entity and its stakeholders. All this establishes the demand for financial reporting, but it also raises a fundamental problem and a common solution to the agency problem is auditors as mediators (ibid.).
2.2 Agency Theory and Information Asymmetry
The core of the principal-agent theory is the relationship that occurs when one party (the principal) allows another party (the agent) act on its behalf in a way that affects the return of the entity (i.e. the principal) (Eisenhardt, 1989; Jensen and Meckling, 1976). Watts and Zimmerman (1979; 1990) presents in two articles, agency conflicts from an accounting perspective. Watts and Zimmerman (1990) illustrate how managers may have incentives to use accounting methods and procedures for the financial reporting that will be in favour of themselves instead of the entity. From Watts and Zimmerman, the primary focus has been on the relationship between owners (principals) and managers (agents). However, Wallace (1980) argues that a principal-agent relationship can emerge between a wider range of stakeholders, e.g., employers - employees, creditors - shareholders and government - organisations. If seen from a stakeholder approach, agency conflicts can be present in a set of different relationships, between stakeholders (principals) and agents (entity/management).
The underlying assumption is that individuals can be seen as rational utility maximisers (Watts and Zimmerman, 1979), this gives rise to opportunistic behaviour from agents. Implicit, this means that there is an incentive for the manager to see to his/her benefit rather than to the entities. It is because the manager has an information advantage over the business owner, who is not assumed to be involved in the daily operations of the entity. In a wider context, there exists a distance between the entity and stakeholders. The service provided by auditors are to mitigate the agency conflict and reduce information asymmetries between the management and the owner. There are a set of factors that create the demand for auditing, and previously established, auditing could be used to mediate the conflict of interest between different stakeholders and the entity. Secondly, auditing works to reduce information asymmetries.
Watts and Zimmerman (1979) support this view and claim that auditing plays an important role
to oversee the contracts and information risks. It is possible to look upon information asymmetries as an enabler to a set of different actions that causes problems from an agency conflict perspective. These problems refer to moral hazard and adverse selection, and under a different name, they can be called hidden action and hidden information (Arrow, 1984).
Different objectives between principals and agents create further problems (Holmström, 1979).
It is problematic, since hidden action refers to that the principal does not have complete control over the agent’s actions. The agent can then act in a way that is detrimental to the principal’s return. Hidden information means that agents have access to information that the principals does not know, which can lead to agents making the wrong decisions in contrast to principals’
perspective. Also, if agents and principals have different objectives, this can result in problems because the agent can then act in a way that is not optimal for principals.
Duits (2012) mentions that agency theory has gained a recent critique regarding its underlying assumptions, and stresses that even though agency theory can serve as a good ground to describe a phenomenon, it is dangerous to rely solely on one theoretical stream. This because the assumptions simplify the world and the organisational complexity is neglected. There is a need to broaden the spectrum of theory, and Duits (2012) highlights the critique against agency theory:
• the view of the firm as a nexus of contracts;
• the assumption of rational expectations;
• the assumption of a self-interested and utility-maximising individual actor, and
• the dominant shareholder view.
It is worth mentioning that the criticism by Duits (2012) not necessarily is against auditing and agency theory, it is an overall critique of neoclassical economic theory. What are then the implications for auditing as a mitigation of agency conflicts and information asymmetries? The next section will discuss implications for auditing and argue for the need to broaden the view.
2.3 Auditing as Mitigation - Still Relevant?
If the objective of financial reporting is considered, there is arguably need to mitigate these problems of hidden action, hidden information and different objectives. It has to a large degree been mitigated through financial information, presented in disclosures, governed by regulations
and controlled with auditing (Healy and Palepu, 2001). In the agent relationship, it is a demand to account for the agents’ action to control for the information asymmetries. As previous research has argued, everywhere where demand for accountability arise among two parties auditing can be adopted (Pentland, 2000; Power, 2003), at least in some form. Power (1999) in his series of articles (audit society) suggests that accountability, the need to measure performance, is the main reason for auditing. Arguably, it implies a wider perspective than that of just an agency conflict, basically, within this, it rests need to control when something is happening at a distance. Previous literature has pointed out that monitoring technology has inherent limitations for monitoring management, financial accounting systems are seen as a starting point when addressing moral hazard problems, and auditors will then address this problem and validate financial statements (Bushman et al., 2004). A set of factors create the demand for accountability, and these factors can be information asymmetries, depending upon distance, time and frequency. The accountability relationship can be illustrated as in Figure 1, were the inspiration is drawn from Broberg, (2013), Ittonen, (2010), and Öhman, (2007). The circles represent actors connected in the accountability relationship, the auditor’s role in this is to mitigate the information asymmetries. The arrows illustrate the relationships. Whereas the star represents the information environment, consisting of information asymmetries enabling hidden actions, hidden information and different objectives.
Figure 1 The accountability relationship (modified version of Broberg (2013), Ittonen (2010) and Öhman (2007).
Due to the increased complexity of the relationship between an entity and its stakeholders, it is urged that auditors’ role need to be expanded, especially in the light of the monitoring process (Schnader et al., 2015). It is possible to state that agency theory has a focus on the fiduciary responsibility of agents and managing the conflict between principals and agents. While stakeholder theory puts an emphasis on balancing the interest of a diverse group of stakeholders (Culpan and Trussel, 2005). Within this, it is arguable that new principal-agent relationship arises and technical advancements in information technology can potentially mean that the traditional role of auditing as a mitigation of the agency conflict between owners and management can instead be mitigated through these sophisticated accounting information systems. Where the distance between the parties are radically reduced, and it is easier for principals to follow and control if agents’ actions go in line with the principals’ goals - the factors of distance, time and frequency can be reduced.
Previous technological developments in accounting information systems, such as ERP systems (systems used to manage corporate information) and cloud computing (systems can be accessed remotely from anywhere) (Low, Chen and Wu, 2011), has increased the possibility to report and access the financial information (Bendovschi, 2015; Chan and Vasarhelyi, 2011; Tsai et al., 2012). It is indeed of interest due to Fu et al.´s (2012) findings, that more frequently published financial information has reduced information asymmetry. Furthermore, Tsai et al.
(2012) state that the most powerful attribute of ERP systems is a continuous integration of information inserted which results in business information that can constantly be produced instead of just quarterly. Furthermore, ERP systems with a high system quality will reduce earnings management and increase audit quality (Tsai et al., 2102), which implies that auditors have a better chance to recognise errors that might be of interest to stakeholders. Findings are however mixed, Chen, Harris, Lai and Li’s (2016) result implies that companies can use these ERP systems to manipulate accounting quality via discretionary accruals. Although they also state that companies with strong shareholders could decrease discretionary accruals. On the contrary, Morris and Laksmana (2010) indicate an increased earnings quality via the decreased value of discretionary accruals. Morris and Laksmana (2010) further state that ERP systems can counteract opportunistic behaviour by management from an agency theory perspective by creating an information environment where opportunistic behaviour can be disclosed.
Dorantes, Li, Peters and Richardson (2013) also state that these systems make data available and therefore improves the information environment and thereby also decision-making
internally. To summarise, most of the papers indicate that ERP systems improve financial information and this becomes even more interesting when looking at XBRL. XBRL defines financial data as well as non-financial data in a machine compatible format that enables automated data analysis, and this information can easily be exchanged between systems (Yoon et al., 2011; Liu et al., 2017). ERP systems can utilise data in XBRL, see for example Li, Roge, Rydl and Hughes (2007) who claim that a solution based on XBRL improves financial information transparency and provide compliance with SOX.
XBRL is an extension of XML that uses the tagging procedure associated with the data points in financial reports. The tags are based on accounting standards and determined by international standard-setters (Shan and Troshani, 2016). XBRL is used for preparation, exchange and integration of financial data as well as non-financial data that systems can utilise (ibid.). Thus, the interchangeability attribute is the main the benefit of XBRL because it is said to mitigate existing financial reporting problems (Shan and Troshani, 2014). The purpose of XBRL is to improve the analysis of financial information with regards to accuracy, reliability, efficiency and transparency (Geiger et al., 2014; Shan and Troshani, 2014). It is of interest when looking at previous research that state that the adoption of XBRL has decreased the information asymmetry and the information risk in a stock-market context across the world. The market spread has been reduced, the market liquidity has increased, information efficiency has increased, event returns volatility as well as stock returns volatility has decreased, and the trading volume has increased - these measures are well-established proxies used to measure information asymmetry (Yoon et al., 2011; Liu et al., 2017; Geiger et al., 2014; Kim et al., 2012). Yoon et al. (2011) further state that XBRL can be utilised by a wide range of stakeholders. It helps the business reporting procedures within the entity, reduces the cost of compliance and improves financial information. Regarding both how to assemble and present the data but also the quality of the content. XBRL improves the information that constitutes the basis for stakeholders’ decision (Yoon et al., 2011).
The adoption of XBRL has resulted in less information asymmetry between different stakeholder groups and the reduced volatility also indicates that financial information has been improved. It becomes even more interesting when looking at Shan and Troshani (2016) who state that XBRL has been pointed out as a factor that decreased audit fees in China. Shan and
Troshani (2014) in a similar study investigated the US market, and the results point in the direction of Shan and Troshani (2016). XBRL can also be used for other things; automated validation of calculated numbers, compliance with disclosure lists, improved audit trails, reduced spreadsheet proliferation, analysis of off-balance-sheet transactions, overvalued earnings (created via discretionary accruals) and incentives that deviate from analysts forecast can easily be carried out in a faster manner (Shan and Troshani, 2014; 2016). A somewhat similar format is the Swedish Standard Import Export File (SIE File) that has become the standard in Sweden and has a similar purpose as XBRL - to make data exports and imports more efficient (Berglof, 2015). The difference is according to Wikstrand (2015) that the SIE file is vertically adjusted to the Swedish Accounting Plan, whereas XBRL is horizontal.
Big data is another phenomenon that has been pointed out as a new buzz word. However, Gartner (2016) states that big data is "high-volume, high-velocity and/or high-variety information assets that demand cost-effective, innovative forms of information processing that enable enhanced insight, decision making, and process automation”. This implies that big data is not a new phenomenon itself, accountants have worked with large volume of data ranging from paper form to highly sophisticated enterprise systems. Auditors are validating this information where they can use audit software and scrutinise all transactions that the firm is involved in (Janvrin and Weidenmier Watson, 2017). The occurrence of big data is rather connected to a large variety of data, especially non-financial data and data generated from external open-sources (ibid.). Warren et al. (2015) mention several types of data that could be utilised by accountants e.g., videos, audios, photos that for example can monitor assets in a more efficient way. This kind of data would improve decision-making internally and improve the quality of financial information by enhancing the relevance aspect of financial numbers and enhance the transparency. Janvrin and Weidenmier Watson’s (2017) state that accounting information systems and enterprise systems have collected non-financial information for decades and automatized analyses of large volumes of data are well-established. The most interesting aspect mentioned by Janvrin and Weidenmier Watson’s (2017) is that accountants have historically been good at expanding their expertise and the current development strive towards assurance of new types of data which is an emerging area in the audit profession, see section 2.4.4. Arguably the most interesting aspect regarding big data is the ability to analyse every transaction via audit software (Janvrin and Weidenmier Watson, 2017). This implies that it is possible to obtain a higher assurance level in a more efficient manner.
As one can see from the previous paragraphs, sophisticated accounting information systems that utilise the latest technologies, e.g., ERP systems, XBRL, SIE and analysis of big data will remedy the problems of financial reporting to a certain extent. Implied that technology can mitigate a part of the underlying problem described in section 2.2 meaning that the technique arguably should have an impact on the role of auditing. In section 2.3 it is illustrated that there is a need to broaden the rather narrow view of classical agency theory to explain auditing today.
In its most extreme interpretation, from an agency conflict, there is doubt about whether auditing is relevant due to the technological advancements. However, auditing still exists today, so there is arguably a deeper explanation of auditing and its role. Even though technology can resolve a part of the agency conflict, it is plausible that new agency conflicts arise, but that the original explanation/problem is solved. It does not mean that we can reject the explanation, but it illustrates the importance to broaden the view. It further strengthens Duits (2012) argument that it is dangerous to rely solely upon one theoretical stream in explaining a phenomenon. It shows the importance to elaborate on the ground idea and expanding the explanations.
2.4 The Roles of Auditing
The three roles of Monitoring, Information and Insurance originated in Wallace (1980), are well-established explanations of auditing. There is also an emerging interest in a new role of assurance that seems to comprehend a wider spectrum than the classical roles. These are the roles used in this paper, presented and discussed in section 2.4.
2.4.1 The Stewardship (Monitoring) Hypothesis - The Monitoring Role
“The origin of auditing goes back to times scarcely less remote than that of accounting… Whenever the advance of civilization brought about the necessity of one man being entrusted to some extent with the property of another the advisability of some kind of check upon the fidelity of the former would become apparent” (Wallace, 1991, p. 18).
Wallace (1991) state that the quote above implies that there is a stewardship function of the audit used for the agency problem. Maximisation of utility is often a trade-off between work
and leisure. The combination of some autonomy and self-interested can create the problems within the agency relationship, agents’ will act to maximise their interest instead of the principals’ (Roberts, 2005). Problems that occur due to moral hazard and information asymmetry between principals and agents, where agents can utilise this information advantage at the expense of principals (Beaver, 1989). Implied that there is a need to monitor agents. The danger of agents acting in their interest can be managed through incentives such as wages and stock options (Wallace, 1991). In an audit context, principals are using auditors to see if agents’
activities are in line with their interest. This is further strengthened by Dedman, Kaisar and Lennox (2014) whom investigate the demand for audit in UK private firms, they find that firms are more likely to hire an auditor if they have a certain degree of agency costs and Knechel, Niemi och Sundgren (2008) claim that agency theory has consequently been used to explain why auditing is demanded.
To summarise, auditors’ role is according to the Monitoring hypothesis to mitigate information asymmetry and to validate financial information that measures performances by agents. Earlier research has found that sophisticated accounting information systems (e.g., ERP, XBRL and big data analysis) have decreased earnings management, enhanced earnings quality and reduced information asymmetries (see section 2.3). Thus, technology’s impact on this role might diminish auditors’ role to reduce agency costs by decreasing information asymmetry.
Auditors’ perception of this hypothesis will indicate if this role has changed due to advanced accounting information systems that have improved the accounting procedure.
2.4.2 The Information Hypothesis - The Information Role
The Information hypothesis also takes its starting point from the problem of information asymmetry. Wallace (1980) states that the principal-agent relationship can take on many forms. The point of the audit from this perspective is not to remedy the problem by examining the company’s financial information as the Monitoring role. Instead, the focus is on improving it, and the auditor engages more directly with the information asymmetry (Wallace, 1991; Carrington, 2014). Thus, the auditors’ role according to this hypothesis is to improve the information that constitutes the basis for decision-making. Auditing is according to the Information hypothesis demanded because investors make decisions based on financial
information (Wallace, 1991). One example is that future cash flow of an entity correlates well with information in financial statements and this information constitute the basis of valuation models that are used to calculate net present value of assets (Wallace, 1980; 1991; 2004).
Besides this, internal stakeholders can utilise auditors to improve the information that will enhance decision-making internally. More accurate data will also benefit creditors, negotiation decisions and regulatory decisions, this can also improve managers’ performances (Ibid; ibid;
ibid.).
Furthermore, financial information is of use since it benefits stakeholders because the information that is improved reduces the risk of investments, it improves decision-making and earnings of trading profits (Wallace, 1991). Strengthened by Fama and Laffer (1971) who state that reduction of risk, improvement of decision making and earnings associated with trading activities can be related to financial statements that have been audited. Bushman and Smith, (2001), Healy and Palepu (2001), Lambert, Leuz, and Verrecchia (2007) and Biddle, Hilary and Verdi (2009) also indicate that high-quality financial reporting will increase investment efficiency. The above implies the value of auditing, and it improves the financial information before it is provided to stakeholders. The Information hypothesis assumes that the audit procedure is going to increase the value of financial information, which is assumed to be the basis for stakeholders’ decision-making. If the risk premiums obtained from investments exceeds the cost of auditing, all parties will gain the reduction of uncertainties generated by the audit (Wallace, 1991). To summarise, auditors’ role is according to the Information hypothesis to validate, increase and improve the quality of financial information that is used by stakeholders. Section 2.3 illustrates that ERP and XBRL have increased the quality of financial information to a certain degree. If the financial information has been improved, would that mean that the Information Role, has been diminished? Auditors’ perception of their role will indicate whether it has changed due to the impact of technology.
2.4.3 The Insurance Hypothesis - The Insurance Role
Wallace (1980) states that the demand for auditing is related to managers’ liability exposure, they are hiring an auditor to transfer a part of the risk. This is because auditors and auditees in some jurisdictions are jointly and severally responsible for third party losses that relate to defective financial statements (Wallace, 1991; O’Reilly, Leitch and Tuttle, 2006). Carrington
(2014) state that the Insurance hypothesis looks upon moral hazard differently, the hypothesis does not look upon the auditor as something that will remedy and engage directly with the problem of information asymmetry and moral hazard. Instead, auditors’ role is to manage the risk transferred from companies. An alternative view on the role can be presented, as argued by Carrington (2014) the Insurance role can be seen as a guarantee for the investors and that the Monitoring and Information roles are an effect of that the auditors want to minimise insurance risk.
Both Schwartz (1997), O’Reilly et al. (2006) and Hillison and Pacini (2004) indicate that the insurance premium that is issued by auditors has greater value than the going concern opinion when it comes to high-risk investments and that investors value the insurance aspect of auditing. O’Reilly et al. (2006) further state that there is a relationship between auditors’
liability limit and overinvestments in risky equities – if the liability is limited, investments in risky equities will be reduced and vice versa. This relationship is strengthened by Lee and Mande (2003) and Venkataraman, Weber, and Willenborg (2008) who claim that audit quality is higher in jurisdictions with higher liability exposure.
To summarise, the Insurance hypothesis says that auditors’ role is to manage the risk transferred from companies and managed as insurance, but it is not an insurance per se.
Auditors will take some of the risks by assuring that companies will comply with regulatory frameworks and if not, auditors will solve potential problems due to reputation and legal issues in one way or another (Wallace, 1991). However, more sophisticated accounting information systems have reduced compliance costs and has made it easier to comply with regulatory frameworks (see for example Li et al., 2007; Yoon et al., 2011). Moreover, as illustrated in section 2.2 information asymmetries are to some extent decreased thanks to technological developments. If this is the case, then the transfer of risk would likewise diminish because the risk is arguably already known by stakeholders. Hence, the role of Insurance should diminish.
Auditors’ perception of their role today will indicate whether the Insurance hypothesis has changed or if the Insurance role has diminished due to the impact of technology.
2.4.4 The Emerging Assurance Role
In contrast to the three classical roles of auditing that Wallace (1980; 1991; 2004) presents, a new stream of research regarding the roles of auditing and assurance services has gained ground (see for example Andon and Free, 2012; O’Dwyer, Owen and Unerman, 2011; Free, Salterio and Shearer, 2009; Jeacle, 2017; Jeacle, 2014; Andon et al., 2015; Andon, Free and Sivabalan, 2014). Jeacle (2017) argues that when expanding the role of auditing to new domains the core of traditional financial statements audits diminishes and the audit scope expands. Auditing is part of something that is constantly changing. If the profession does not embrace the change and adapts to the new demands of society, then there is a risk that auditing will be marginalised to something else or even disappear (Power, 1999).
The above implies the importance for auditing to change to be up to date with an external environment constantly evolving especially with regards to technical developments. Due to that auditing has changed through times, some new audit practices have entered the core of auditing (Andon et al., 2015). Auditing has for example successfully entered areas such as the public sector (Power, 1996), assurance and auditing of sustainability reports (Power, 1996;
O’Dwyer et al., 2011), auditing of MBA rankings (Free et al., 2009) and the world of sport (Andon et al., 2014). These are some examples of when the profession expands to areas that arguably are atypical for the profession. The auditing service demanded in this context is called assurance and an increased demand for this type of assurance has been seen in the previous decades (Andon et al., 2014). Free et al. (2009) state that legitimacy is the one product that organisations buy when purchasing assurance services and Carter and Jeacle (2011) indicate that assurance is expert systems that generate trust. Assurance is arguably a broad term defined as independent services that will make trustworthy information available to stakeholders that should help them to make better decisions (Andon et al., 2015). In this context assurance is distinguished to auditing. Assurance comprehended more than just to form an opinion about the financial statements.
Auditors have been a great fit for providing high-quality assurance because of the attributes of the profession such as independence, well-developed standards, quality control mechanism and reputational capital (Andon et al., 2014). In the same time, Andon et al. (2015) state that new opportunities for the profession are within the assurance area and in particular assurance of risk
assessments systems, business performance measurements, accounting information systems reliability, electronic commerce, health care performance measurement and care of elderly.
Another example of increased assurance requirements related to growing demand for IT systems that supports the business, these needs to work correctly, and therefore assurance services are required (Stoel et al., 2012). Boritz and No (2016) provide another example of assurance where the limited guidance and experience of XBRL cause an assurance demand of XBRL.
This assurance aspect of auditing is clearly a concept that can be applied to a wide range of contexts and arguably another reason of why auditing is demanded. With regards to that assurance is a phenomenon which auditors can perform in contexts atypical for the audit profession, it could also be another hypothesis of why auditing is demanded and another role of auditing. The roles of auditing are changing and Cooper and Morgan (2013) state that the assurance aspect of auditing may provide indications and inputs regarding the development of auditing. Hence, this role is of interest since assurance of information systems has been pointed out as an emerging area for assurance (Andon et al., 2015) and both Boritz and No, (2016) and Stoel et al. (2012) indicate the importance of assurance of accounting information systems.
However, are the assurance services adapting to new rules under the same assumptions as Wallace presented but in new areas? This is not so clear, Jeacle (2017) states that when expanding the assurance to a wider spectrum it means that we are moving away from the classical financial audits. It is not clear, however, if it is just the audit regarding financial numbers that diminish, or if it the assumptions regarding the agency conflict that we are moving away from. Alternatively, is this, as we choose to call the Assurance role an illustration of what Schnader et al. (2015) argues for, that new relationship arises in the increasing demand to account for almost everything. It is not evident in previous research meaning that this could be a new role of auditing as Cooper and Morgan (2013) points out that the assurance aspect provides indications of how auditing might develop.
2.5 Synthesis - Theoretical Summary
The literature review illustrates the typical justification and the classical roles of auditing are based primarily on agency theory. Evidently, previous research has found that it still holds up
as a good base. Although, there exist a profound critique of the underlying assumptions of agency theory and earlier research has urged to broaden the view. There is also an increasing research that shows how technology developments in accounting and business systems are improving the quality of the information. There is research that indicates that the information asymmetries are diminishing with new technology. Along with section 2.4.4, it is possible to identify an increasing interest in the roles of auditing. Altogether, this raises concerns if the classical roles still are present in the auditors’ perceived role or if these has changed. Recent research has illustrated that auditing takes on new roles and evolving outside its ordinary domains. Up to this point, there is no such evidence that the new roles are based on the same assumptions as Wallace three hypotheses. However, it is possible to identify an emerging interest in the roles of auditors. This can be summarised in a theoretical illustration (see Figure 2) of the roles of auditing, where the auditors are the centre of attention, and the bubbles around it represent the different roles. The upper tier illustrates the classical roles that Wallace (1980) presents and the Assurance role illustrates the increasing interest in alternatives to Wallace roles.
Figure 2 Theoretical illustration of the roles of auditing.
One of the objectives of the study is to build knowledge to the classical justification of agency conflict in the request for auditing. By looking how technological advancements reduces information asymmetries, improves financial information and facilitates a closer relationship
between principals and agents. Thus, diminishing the need for the classical roles of auditing, presented in Figure 3, an illustration drawn from Figure 1.
Figure 3 Extended version of Figure 1.
Figure 3 illustrates that the classical role of the auditor as a mediator to information asymmetries is changed due to the impact of technology. Earlier research has shown that technology is ought to decrease the information asymmetries, decrease earnings management and increased earnings quality. Figure 3 illustrates the problematisation of this paper, namely the potential impact of technology on the principal-agent relationship where the auditors interviewed will illustrate if the scope needs to be expanded in line with the argumentation depicted in the sections above in the literature review. The bold arrows illustrate technology’s potential impact on the accountability relationship.
3 Method
In this section, the research design, data collection, pilot study, selection criteria, interview guide, operationalisation, analysis, and method discussions are presented.
3.1 Research Design
The study seeks to create a deeper understanding of how technology has impacted the auditors’
role, and this will be looked upon from auditors’ perspective. Auditing is described as a socially constructed phenomenon (Power 1996; Power, 2003). That auditors’ reality and the trust and legitimacy they as a profession contribute to the financial reporting are created by the auditors as social actors in society. Andon et al. (2015) point out that auditing is not to be seen as a static phenomenon. Instead, it is something that is changing and is redefined through time.
Hence, to achieve auditors’ perception of their role, it is arguably needed to look upon auditing as something that is created by auditors and not something absolute predetermined phenomena.
These assumptions are in line with a constructionistic idea as Bryman and Bell (2015, p. 43) state "constructionism means that social phenomena and their meaning are something that social actors continually create". Aiming to create this understanding and to learn more, it is of importance to capture the meaning of the subject’s actions, i.e., auditors’ actions. This because as Andon et al. (2014) describe auditing as a vague phenomenon rather than something absolute, it is a craft that is providing comfort, trust and not absolute proof. Bryman and Bell, (2015) argue that an interpretivist view upon knowledge concerns the subject’s actions of social actors in society. Because of this, the paper has an interpretivist approach towards knowledge.
The study has an approach inspired by an exploratory and explanatory approach. This because in the outset the study explores a new role of auditing, the objective is to identify key factors for a new role of auditing. It is facilitated through auditors’ understanding of their role. This is the main reason why the exploratory approach is suitable for the study, where it allows to identify new issues and variables for the identified problem (Bryman and Bell, 2015; Saunders, Lewis and Thornhill, 2012). This allows to develop new theoretical concepts (Saunders et al., 2012) and build to the knowledge of auditing. This approach comes with its limitations, that it can be hard to find suitable theoretical concepts in previous research and the question the study
intended to answer can result in ambiguous results (Saunders et al., 2012). To make sense of the exploratory nature of the study, inspiration from an explanatory approach (Saunders et al., 2012) were applied. This to facilitate the operationalisation between the theoretical model, which consists of the developed theoretical concepts of the role of auditing in general, the monitoring, information, insurance and the emerging assurance role on our knowledge about external auditing, and the empirical findings. The explanatory idea gives the opportunity to make sense of the answer given by the Respondents, and it facilitates the understanding of why they are arguing as they do. Through the explanatory approach, it is possible to discuss the newly identified key factors for a new perceived role of auditing. Which gives the study the opportunity to discuss the role´s implications on what we know today about auditing and the classical roles of auditing. This to fulfil the second objective of the question, to draw knowledge to how this impacts the principal-agent justification of auditing. The intertwined approach of exploratory and explanatory nature gives the possibility to explore this new technological environment and its impact on external auditing. Additionally, draw knowledge from what we know today about auditing and the impact technological advancements can have on the entire profession.
3.2 Data Collection
This thesis investigates auditor’s perceived role in today’s technological environment. Hence, a qualitative research method deemed suitable since this approach is in line with Bryman and Bell (2015) who state that a qualitative approach is appropriate when it comes to investigating individual’s understanding of a phenomenon. The characteristic of an exploratory study is something that makes a qualitative research method deemed to be appropriate because it could be difficult to have a narrow approach since the aim is to explore a role. The collection of the empirical data consists of qualitative interviews. Many of the questions used when collecting the data are therefore of a more general fashion. More basic questions were used to define the context of the scope which could be a sensitive aspect of a qualitative research method (Bryman and Bell, 2015). The collection of the literature has mainly been carried out through systematic searches in Business Source Premier, Scopus and Google Scholar.
3.2.1 Interviews
Semi-structured interviews have been used to collect the primary data, according to Bryman and Bell (2015) semi-structured interviews is a bit more structured in its shape compared to unstructured interviews, still it allows some flexibility. This characteristic is the main reason of why semi-structured interviews were used because it is possible to gain a deep understanding and rich information from the interviewed auditors. At the same time, semi-structured interviews allow for steering the interview on topic and both new and follow-up questions could be used to capture as much information as possible (ibid.).
The approach of a study classified as qualitative and exploratory is also arguably more favoured by a more general approach which allows the Respondent to use as much of his/hers experience and knowledge to capture as much understanding as possible of the research subject. This also implies that open questions will be the most appropriate type of questions since these allows Respondents to answer the questions as they wish (Bryman and Bell, 2015; Saunders et al., 2012). Questions that were of an open character concerned the auditor’s role and how it has changed over the years. Also, questions characterised as open concerned the technology and how auditors look upon technological developments. To discuss a new role and build on the understanding of the classical roles and justification of auditing there were also questions formulated in a more narrow fashion. These concerned the Respondents understanding of the roles of auditing and how these interacts. The interviews have varied in a time span of 40 – 90 minutes.
3.2.2 Pilot Study
A pilot study was carried out in the onset of the thesis, this to test the design of the study. In this way, it was possible to see whether the proposed methodology and theoretical framework were sufficient to conduct the study. It also gave valuable insight to the feasibility of the study.
This kind of small testing of the research design is supported by Yin (2009), who argues that a pilot study enables the researchers to get indications on how well both the theoretical framework and design fits the aim of the study. A senior auditor was interviewed, which gave valuable insights into how well informed auditors are on the subject. The interview also gave the possibility to get information on new Respondents to approach for the study, a sort of
snowball selection. The pilot interview gave ideas to questions for the upcoming interviews, and it indicated what type of questions that were more successful than others.
3.2.3 Selection Criteria
Auditors as Respondents is motivated because different reports have indicated that auditors are one stakeholder group that could face tremendous change due to the technological advancements in society. For example, FAR and Kairos Future (2013; 2016), pointed out that technological advancements could reshape the profession. Digitalisation is also seen by FAR and Kairos Future (2013; 2016) as something that is unavoidable and that auditors need to adapt to this change. Also, choosing one stakeholder group will enable comparisons due to that auditor most often have a similar background with regards to education, training and experience of working at an accounting firm. A most similar basis approach benefits comparisons between the Respondents. The above led the study to focus on auditors because they are facing new challenges and the opportunity to study the role of auditing from the auditor’s perspective.
The Respondents were chosen using a convenience sample, which means that the availability and the access to Respondents were prioritised and it also means that the results of this paper cannot be generalised to different contexts or populations (Saunders et al., 2012). This because the selection does not follow a random sample, this is not a problem per se, because statistical generalisability is not a purpose of its own. Instead, focus has been on a deeper understanding of auditors perceived role and the theoretical contribution towards the understanding of auditing. This is what Yin (2009) call analytical generalisability. To enhance the possibility to contribute to existing theory, as many interviews as possible have been performed. The fact of choosing one stakeholder group is also strengthening comparisons between the Respondents, this is an attempt to replicate the interviews to strengthen and provide solid data. Yin (2009) argues that this is a critical factor for achieving some degree of analytical generalisability.
There were also some criteria regarding knowledge and experience used, this to capture the understanding of auditor’s role and if it has changed. Respondents deemed to have the appropriate knowledge and expertise all had a long background and a current position as
auditors as well as knowledge within technology and digitalisation. The Respondents were initially recognised via the Internet, basically via accounting firms’ websites and LinkedIn. The Respondents were then introduced to the subject via E-mail and asked if they knew someone who had the appropriate knowledge and experience – which resulted in additional Respondents.
There are also auditing firms that are specialised within the digitalisation and technology field and some papers about technology figured within this thesis are produced by certain departments in larger auditing firms (see for example Deloitte, 2016; EY, 2016) and these departments were also contacted via E-mail. The Respondents are certified auditors in Denmark and Sweden. The table below consist of the Respondents interviewed:
Table 1 Respondents interviewed
Respondents Years of experience within the auditing industry
Date of interview
Auditor 1 8 2017-03-07
Auditor 2 26 2017-03-07
Auditor 3 6 2017-03-08
Auditor 4 11 2017-03-08
Auditor 5 7 2017-03-09
Auditor 6 26 2017-03-09
Auditor 7 6 2017-03-10
Auditor 8 15 2017-03-10
Auditor 9 26 2017-03-15
Auditor 10 35 2017-03-22
Auditor 11 5 2017-03-22
Auditor 12 4 2017-03-23
Auditor 13 30 2017-03-30
Auditor 14 31 2017-04-19
Auditor 15 30 2017-04-20
3.2.4 Interview Guide
As mentioned, semi-structured interviews were used to collect the data; therefore, an interview guide (see Appendix 1) has been used as a basis for the interviews. The interview guide consists of themes with related questions. All themes concern various parts of the literature review and the research question as well as the purpose of this paper. The first theme concerns auditors’
role from a general perspective. The second theme concerns technical advancements and its potential impacts on auditors’ role. The third theme is about Wallace’s classical roles of auditing, and the last theme is about the emerging assurance/alternative role of auditing.
Theoretical concepts were not disclosed during the interviews because it could impose a research bias, this was especially important when asking questions about theme three to four which all were narrowly defined and more closely connected to the theory in the literature review.
3.2.5 Operationalisation
As mentioned, the literature review was the basis when formulating questions that were used to collect the data. This has been done to fulfil the aim of the study, to create an understanding of auditors’ perceived role and its implications for the principal-agent justification. To facilitate the operationalisation between the theoretical synthesis and the empirical data, four different themes and associated questions has been drawn from the literature. Where the starting point is of a more open character and narrows down to be more and more accurate, the reason to do this is two-folded. Firstly, it gives the Respondents room to talk freely about the role without imposing the author’s understanding of the role, from this it is possible to draw links and connection to the theoretical understanding. Secondly, the more narrow and specific themes and questions work partly as a confirmation of what the Respondent has answered regarding the earlier themes. It also facilitates a deeper understanding of the different roles and how the Respondents perceive the roles of auditing.
The Role in General
These types of questions enable analysis of how and why auditing is changing. This facilitates the general role of auditing in a context and to see how the auditor first in mind would describe the role. This without imposing the technological focus or the classical roles of auditing.
Technical Advancements
Section 1 and 2.3 of this paper outlines technical advancements that have had a certain impact on the financial information and the auditor. These questions facilitate an understanding of how
technology impacts the auditors’ role and if the development forces new forms of auditing and how technology changes the classical justification.
The Classical Roles (Stewardship/Monitoring, Information and Insurance)
Under this theme, questions are constructed to aid our understanding how auditors perceive their role and if it is possible to identify the classical roles. These questions facilitate an understanding if auditors still identify their role with the principal-agent dilemma and how technology has impacted the roles.
Assurance/alternative Roles
Questions related to this theme enables analysis of auditors’ role and if it has changed. This theme also makes it possible to see if new and emerging roles appears in the auditor’s perceived role. These questions are trying to seek an understanding if the new roles of auditing are under the same assumptions as the classical roles or if they take a wider stance or an entirely different one. This theme also puts technology in a context, to see whether the changes and new forms of auditing come from technological developments or if other forces drive the change.
3.2.6 Analysis
The answers transcribed constitutes the basis for the result and the analysis. The thoughts and citations from each interview were summarised and sent back to the Respondent for validation.
This so the understanding and interpretation of the Respondents’ answers were in line with the Respondents’ thoughts. The concepts that figure in the theoretical framework have been used to interpret the data, and every concept has been linked to one or several interview questions.
A thematic analysis of the result was then conducted to link the collected data to the theoretical concepts and get a deeper understanding of external auditors’ perceived role in today’s technological environment. The analysis consists of several steps, the first step was a separate mapping into the corresponding theme of the transcribed interviews. This to get an overall picture of the Respondents’ answers and to easily follow back to each and one recording and transcription. After the mapping of the Respondents’ data, all the material was summarised into one document. This is what constitutes the empirical summary in this paper. From that material,
