Lecture 1/2 Agency Theory And The Role Of Audit

Front 1

Audits

Back 1

Reinforce trust and confidence in financial reporting

Front 2

agency relationship

Back 2

1. Principals engage agent (or steward)
2. Information asymmetries and self- interest

Front 3

Mechanisms to align interests and the role of audit

Back 3

1.Remuneration packages and incentives
2. Market-hiring, firing
3.Basic salary +bonuses+options
4. An audit provides an independent check on the work of agents and of the information provided by an agent, which helps to maintain confidence and trust.

Front 4

History

Back 4

1.Audits developed as a means of protecting shareholders’ interests
2.Guild members and in the mid nineteenth century principals acted as auditors.
3.May have no sufficient expertise skills turn to expert auditors
4.Auditors appointed by shareholders

Front 5

Complicating factors

Back 5

1.Auditors as agents affect ==>objectivity independence.
2. Information asymmetry-
Differing incentives- limit scope of an audit
3. Reputation- incentive to maintain independence to protect their reputation and thereby help them to retain and win audits.

Front 6

Regulators

Back 6

1. Can compensate for the weak rights of principals
2. Benefits whole market, less volatility
3. SEC -1933

Front 7

Stakeholders

Back 7

1.Creditors, lenders, credit agencies, customers and employees may claim an interest in the audit.
2.

Front 8

The shareholders in many private companies are also the directors. no principal-agent problem

Back 8

1. Still want an audit
2. Price for limited liability
3. Unconscious bias (the self-review threat)
=>subjective nature of financial statements.
4. Improve internal decision-making and can act as a check on errors in financial information as well as encouraging the careful preparation and recording of financial information by employees

Front 9

Summary and implications

Back 9

confidence trust statements.
agency theory
audit
ensure
shareholders’ best interests
agency model cannot provide a complete explanation.
regulators, creditors and lenders
interest
auditors are agents too
opinion to existing shareholder