WFU Law School
Law & Valuation
3.1.3 Accounting Principles

3.1.4 Critique of Current Accounting Practices

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"EVALUATION AND RESPONSE TO RISK IN LAW AND ACCOUNTING: THE U.S. AND EU"
University of Illinois College of Law
504 East Pennsylvania Avenue
Champaign, Illinois 61820

CONFERENCE PARTICIPANTS AND PAPERS:

Professor Dr. Werner Ebke, Universitaet Konstanz "Audit Failures and their Consequences: A German Perspective"

Professor Dr. Bernhard Grossfeld, Westfaelische Wilhelms-Universitaet Muenster
"Global Financial Statements and Local Enterprise Valuation Standards"

Professor Dr. Dr. Christian Kirchner, Humboldt Universitaet zu Berlin
"Evaluation and Response to Risk: Cooperation between Lawyers, Accountants, and Auditors"

Professor Dr. Jens Wuestemann, Universitaet Mannheim
"Evaluation of Risk in International Accounting Regimes: A Comparative Perspective of Germany and the U.S."

Professor Cynthia Williams, University of Illinois College of Law
"Evaluation of Social Risk in the U.K., France and the U.S."

Professor Richard Kaplan, University of Illinois College of Law
"The Mother of All Conflicts: Auditors and their Clients"

Professor Larry Ribstein, University of Illinois College of Law
"Limited Liability in Professional firms and the Problem of Risk"

Professor Linda Beale, University of Illinois College of Law
"Evaluating and Responding to Tax Shelter Risks: The Accountants Versus the Lawyers"

Professor Larry Cunningham, Boston College Law School
Tentative title: "Internal Controls in Law and Accounting."

Professor Richard Painter, University of Illinois College of Law
"Response to Risk Are the Legal and Accounting Professions Converging?"

"Observations on the Role of Commodification, Independence and Governance in the Accounting Industry" Villanova Law Review, Vol. 48, No. 4, p. 1167, 2003

BY: JONATHAN ROSENFIELD MACEY Cornell University School of Law HILLARY A. SALE University of Iowa College of Law

Document: Available from the SSRN Electronic Paper Collection: http://papers.ssrn.com/paper.taf?abstract_id=474741

In this Article, we argue the internal corporate governance structure of the big accounting firm is fundamentally flawed, and that this flaw contributed to the current crisis of confidence in the integrity of public reporting. The incentive structure within accounting firms makes it virtually impossible for auditors to be independent of significant clients like Enron. The result has been a change in the balance of economic power between accounting firms and their clients - individual audit partners suffer from client capture. In addition, to their lack of independence, accounting firms and partners lack accountability in part due to the advent of the limited liability partnership structure. Despite these problems, federal securities laws and regulations require auditors to provide independent audits to companies. The result has been the commodification of audits and a market in which audits are bought and sold. As a consequence, audits no longer serve the economic purpose for which they were required - providing information that protects investors and leads to the efficient pricing of securities.

Although the provisions of the Sarbanes-Oxley Act offer some help in resolving the capture, governance, and commodification concerns we raise, we conclude that more is needed. Sarbanes-Oxley established the Public Company Accounting Oversight Board. This Board is to register the public accounting firms, set standards for their reports, inspect and investigate the firms, and, when appropriate, sanction firms and individuals. To be successful, the Board will have to replace the incentive system eliminated with the creation of LLPs with its own set of rules and standards, which it will have to enforce vigorously. In addition, Sarbanes-Oxley provides new standards for auditor independence, establishing a requirement that audit firms rotate the partners assigned to clients in order to prevent capture. We conclude that this provision is less likely to achieve its goal, as long as client satisfaction remains the dominant measure of partner performance. Instead, we argue that until lead audit partners are confident that they can fire dishonest clients without fear that doing so will result in the destruction of their own careers, the problems that contributed to the Enron and other significant corporate failures will continue to exist.

3.1.3 Accounting Principles

©2003 Professor Alan R. Palmiter

This page was last updated on: March 21, 2004