Do Rewards Encourage Professional Skepticism?

Abstract

It is an open question whether auditors have credible incentives to exercise professional skepticism. We focus on costly skepticism: skepticism that is appropriate and generates incremental costs, but does not identify a misstatement. Costly skepticism is typically not rewarded by audit supervisors. We theorize and find that rewarding costly skepticism may backfire and decrease skepticism on subsequent audit tasks where evidential red flags are present. We reason that auditors interpret the reward as a non-credible, better-than-expected outcome, leading auditors to view subsequent tasks from a risk-averse gain frame. As a result, auditors self-interestedly seek to avoid the risks and effort of exercising additional skepticism. This effect decreases auditors' sensitivity to red flags and auditors' willingness to inform their manager about severe red flags, compromising audit quality. Encouragingly, auditors who have experienced a history of rewards for costly skepticism are more motivated to exercise skepticism. A survey finds that audit supervisors are likely to reward costly skepticism when their own supervisors encourage the behavior and promote consultation within the engagement team. Overall, our results suggest firms may benefit from a culture shift emphasizing credible rewards for costly skepticism, but that firms currently may not "get what they reward."

Data Analytics and Skeptical Actions: The Countervailing Effects of False Positives and Consistent Rewards for Skepticism

“…One concern over the use of data analytics is the likelihood of false positives, or the extent that these tools identify transactions or relationships as potential anomalies that, after further investigation, are determined to be reasonable, explained variations in the data (AICPA [2017], Baadder and Krcmar [2018], Johnson and Wiley [2019], Austin et al [2019], Brazel, Leiby, and Schaefer [2020], Arens et al [2020]). 1 The frequency of false positives increases proportionately with the size and complexity of the data analyzed (Krahel and Titera [2015], Kogan, Mayhew, and Vasarhelyi [2019]).…”

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the Concept Release, Potential Approach to Revisions to PCAOB Quality Control Standards

“…3 In other words, performance evaluations may incentivize some auditors to not exercise heightened skepticism, since auditors often feel that their procedures are not likely to uncover misstatements or problems (Carlisle, Gimbar, and Jenkins 2019). Brazel et al (2019b) further find that incentives for auditor skepticism must be consistent to be credible. One worrisome implication of research is that auditors may be "trained" early in their careers to not follow the evidence and not behave in a professionally skeptical manner.…”

“…Still other research suggests that audit staff who are "quality minded" and exercise greater professional skepticism may not be rewarded for their efforts, but instead may receive a poor performance evaluation (Brazel et al 2016;Brazel, Gimbar, Maksymov, and Schaefer 2019a;Brazel, Leiby, and Schaefer 2019b). 3 In other words, performance evaluations may incentivize some auditors to not exercise heightened skepticism, since auditors often feel that their procedures are not likely to uncover misstatements or problems (Carlisle, Gimbar, and Jenkins 2019).…”

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on International Auditing and Assurance Standards Board Exposure Draft, Proposed International Standard on Auditing 220 (Revised): Quality Management for an Audit of Financial Statements

“…Academic research has demonstrated the importance and impact of an audit firm's culture on the exercise of professional skepticism (e.g., Gold, Gronewold, and Salterio 2014;Brazel et al 2016;Brazel, Leiby, and Schaefer 2019). To highlight this connection, we suggest adding language to paragraph 7 that describes that the engagement partner's responsibility is not only to demonstrate the appropriate exercise of professional skepticism, but also to create a culture among all engagement team members that encourages and facilitates the exercise of skepticism.…”