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SYNOPSIS: An audit consists of two main components: (1) the assessment of risk, and (2) the planning and execution of audit procedures. Both activities require a great deal of professional judgment. In this sense, the auditor is an expert who is best positioned to assess the risk and to conduct the audit in accordance with professional auditing standards. We use a simple decision-making framework to illustrate an auditor's possible strategies when an auditee cannot directly determine the effort level required to conduct an audit appropriately. We discuss and compare three economic perspectives for the audit: search goods, experience goods, and credence goods. Based on the economic theory of credence goods, we predict that a seller has incentives to act strategically when buyers are faced with considerable uncertainties relating to a service they purchase. Specifically, we argue that an auditor might have incentives to (1) under-audit, (2) over-audit, or (3) overcharge. These strategic actions have important implications for audit quality, efficiency, and regulation. We also discuss the professional and institutional arrangements that serve to limit the strategic behavior of auditors. Finally, we discuss previous empirical and behavioral audit evidence in the context of the credence aspects of an audit.
Keywords: credence attributes; audit quality; audit efficiency.
INTRODUCTION
This study uses a simple decision-making framework to illustrate how an auditor's potential information advantage about the audit process may impact auditor behavior. The discussion is grounded in the theory of credence goods, which predicts that an auditor's knowledge and expertise may create incentives for the auditor to act with strategic self-interest. In general, economists define a credence good (service) as one that meets three conditions: (1) the seller is an expert who both recommends and provides a level of service to a buyer; (2) buyers of credence services cannot assess how a service is delivered and, perforce, must rely on a seller's recommendation; and (3) buyers cannot assess how well the service was performed (Darby and Karni 1973; Dulleck and Kerschbamer 2006). In a credence setting, buyers make their decisions based on their trust in a producer or service provider (hence the ''credence'' label).
The auditor possesses the expertise to plan and perform the audit in accordance with professional auditing standards. During the audit process, the auditor...