Good financial statement audits are essential to protect investors, and skeptical auditors are essential to good audits. A recent study reveals that skepticism is discouraged among listeners – and that there are unexpected challenges and opportunities to foster skepticism among listeners in the future.
“In auditing, skepticism is having the intelligence to identify red flags and the courage to investigate them,” says Joe Brazel, lead author of the study and Jenkins Distinguished Professor of Accounting at Poole College of Management. North Carolina State University. âWithout skepticism, you won’t identify the fraud.
âBut skepticism is not free. Investigating red flags is expensive – you can go over budget. This can weaken relationships with customers. This delays additional work. And at the end of the day, most red flags have innocent explanations. “
The researchers called the skepticism that was reasonable, but both came at a cost and did not uncover fraud or error in the financial statements, “costly skepticism.”
âWe know that costly skepticism can lead to professional sanctions for listeners,â says Brazel. âWith this study, we wanted to see if reward costly skepticism has actually made people more likely to find and follow red flags. And we’ve found that under the right circumstances, it can make a positive difference, but it can also backfire. “
The study consisted of three experiments.
In the first experiment, researchers recruited 112 practicing auditors who had 3-5 years of professional experience. All participants were given an audit scenario, with a minor, moderate, or severe red flag present. Half of the study participants were told at the start of the scenario that they had been rewarded for engaging in costly skepticism earlier at work. All study participants were then invited to review the information contained in the scenario.
âWe wanted to see if a previous reward for skepticism had influenced a participant’s ability to identify the red flag and the likelihood of them acting on it,â says Brazel. âCommon sense would tell you that participants who were rewarded for costly skepticism would be more likely to take action. This is not what we found.
Participants who had been rewarded for costly skepticism were actually less likely to act on red flags. Through a post-experience questionnaire completed by participants, researchers learned that people who had been rewarded for costly skepticism were surprised.
âBasically they thought they were lucky with their reward for costly skepticism and decided to quit when they were early,â says Brazel. “The reward backfired on him.”
The second experiment was similar to Experiment 1, but it only included 36 professional auditors and 52 graduate students in accounting. The professional listeners in Experiment 2 responded similarly to the participants in Experiment 1. However, graduate students who were rewarded for costly skepticism were actually more likely to follow the red flags.
âIn short, Experiment 2 showed that graduate students were not surprised to be rewarded for engaging in costly skepticism,â says Brazel. âThis tells us that the surprise and ‘quitting when they were ahead’ that we saw from professional listeners in Experiments 1 and 2 was learned behavior. Practicing listeners are sometimes discouraged from being skeptical.
Experiment 3 involved 71 undergraduate and graduate accounting students. The scenarios remained the same, but half of the study participants were told that their supervisor consistently supported costly skepticism. This has led to a more pronounced increase in the identification and investigation of red flags.
“This tells me that if we support the skepticism from the start with the next generation of listeners, we can expect these listeners to do the right thing – when they see a warning sign of fraud, they investigate it.” Says Brazel.
âListeners need to feel supported in identifying and pursuing red flags, otherwise the workplace essentially trains them to avoid investigating potential issues,â says Brazel. âIt matters because if the red flags are not investigated, no fraud is detected and investors are hurt. “
The article “Do rewards encourage professional skepticism?” It depends â, is published in The accounting review. The article was co-authored by Justin Leiby of the University of Illinois at Urbana-Champaign; and by Tammie Rech Schaefer of the University of Missouri in Kansas City.
Note to editors: The summary of the study follows.
âDo the rewards encourage professional skepticism? It depends”
Authors: Joseph F. Brazel, North Carolina State University; Justin Leiby, University of Illinois at Urbana-Champaign; and Tammie Rech Schaefer, University of Missouri at Kansas City
Posted: July 26 The accounting review
DO I: 10.2308 / TAR-2019-0361
Abstract: In three experiments, we found that rewarding professional skepticism can backfire and reduce skepticism about future audit tasks where red flags are present. We focus on the rewards for costly skepticism: ex ante skepticism that is appropriate but that generates additional costs ex post and does not identify an anomaly. Auditors interpret a reward for costly skepticism as a better-than-expected outcome and view the following tasks from a risk-averse earning framework. As a result, auditors seek to avoid the risk of declining skeptical actions, which decreases listeners’ sensitivity to red flags and their willingness to communicate harsh red flags to their managers, thereby compromising audit quality. . However, we also find that a supervisor consistently rewarding costly skepticism decreases auditors’ risk aversion and increases their skepticism. In short, auditors believe that skeptical action carries a downside risk. A cultural shift towards credible and consistent rewards for appropriate skepticism likely helps ensure that rewards have the intended effect.