The Hindu Business Line : An inquiry into independence

AT A RECENT conference in Hyderabad, the CEO of a leading software company in Andhra Pradesh is reported to have said that what matters is not the quantity but the quality of independent directors. This left one wondering whether this hypothesis would apply to auditors who are supposed to reveal all and hide nothing from the shareholders. After all, an independent auditor cannot be compared to an independent director, considering the more responsible role of the former.

A bit of research was done by Brian W. Mayhew of the University of Wisconsin and Joel E. Pike of the University of Illinois. The centrepiece of their research was whether investors selecting auditors would enhance their independence? In the US, auditor independence has been hogging prime news space, especially after the steps taken by the former SEC Chairman Arthur Lewitt. One is tempted to use the words of Warren Buffet: "Though auditors should regard the investing public as their client, they tend to kowtow instead to the managers who choose them and dole out their pay."

One can quote Hilzenrath, who said: "Whose bread I eat, his song I sing." What is probably not so commonly known is that auditor independence has at least been Page 3 news in the US for long. The Metcalf Committee in 1977 and the Cohen Commission in 1978 made some noise about this, although this did not prevent the collapse of the savings and loan industry in the 1980s. The mid-1990s were focused on the consulting fees paid to auditors with some action from the AICPA. The final nail in the coffin was the death of Enron and the consequential passing of the Sarbanes Oxley Act in 2002.

The discomfort appears to stem from the fact that auditors abroad appeared to the turning into client advocates, merely a mouthpiece for the client. Despite the huge packets of consulting fees paid to the audit firms, it would appear difficult to prove that the auditors threw caution to the winds as far as their bread and butter was concerned.

The Panel on Audit Effectiveness in 2000 appeared to have broken new ground when it reported that "Audit personnel constantly receive messages from client management about audit effectiveness and quality. These messages only indirectly imply that quality audit service is an integral part of quality client service. They often do not focus directly on audit quality". The researchers designed an experiment by which managers were given the option to overstate investment values to auditors and then the auditors' reaction was captured under:

Auditors do not investigate and always agree with the managers' report;

Auditors investigate and report objectively.

The managers were then swapped for investors in a different sort of way and the same results reported. It was noticed that there was a discernible change in the opinion of the auditors when they were appointed by the investors than when they were appointed by the managers. Hence, the concept of becoming client advocates seemed to be true at least in the case of a few audit firms abroad.

In India, it is probably our good fortune that we do not have scams of the magnitude of Enron that can enable companies and audit firms to disappear overnight and force stringent regulation. This could be due to the early efforts of the Institute of Chartered Accountants of India to provide for professional misconduct of firms and individual chartered accountants.

However, as a muted response, Bills have proposed rotation of the main partners in audit firms. This could be with the twin intents to have local legislation for international firms as also as a measure of checks and balances for local firms. It would, however, be difficult to visualise a situation in India wherein the auditor receives his appointment letter from the investor community instead of the corner room in the client's office.

(The author is a Hyderabad-based chartered accountant.)

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