Arnold Kling

Changing the Accounting Game

Arnold Kling, Great Questions of Economics
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Dave Cotton, an accountant, writes in today's Washington Post that the fundamental conflict of interest in the accounting profession is that accountants are hired by management rather than by shareholders.

Let's set up a system by which the stock exchanges would use a competitive process to select CPA firms to audit the financial statements of companies whose stock is traded on their exchanges.

This proposal raises a number of questions. For example, the process of choosing a CPA firm could be contentious. Would the firm that offers to conduct the audit at the lowest price be skimping on quality?

On balance, there is much to be said for Cotton's proposal. If what we want are outside auditors, then taking the selection process out of the hands of senior management is an obvious improvement.

Discussion Question. Once an accounting firm has audited a company once, it has a competitive advantage in auditing the firm in subsequent years. Would this lead auditing firms to become closely tied to the companies that they audit, even though the audit process is paid for by the stock exchange? What could the stock exchange do about this?

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