Assessing Management Integrity: Insights from Big 4 Auditors in Egypt Free

The increasing number of corporate fraud cases has put more pressure on external auditors to improve their assessment of management integrity (Attard 2000; Petrick and Scherer 2003). The value of external audits is weakened when a client's integrity is questionable (Bernardi 2008; Jamal, Chen, and Luo 2014). Stakeholder's confidence in the independence of external auditors is strongly linked to their confidence in an auditor's ability to challenge management; unfortunately, this function does not seem to be one much expected of external auditors (FRC 2015). Therefore, improving auditor's skills in evaluating management integrity is crucial to reinforce stakeholder's confidence in the audit process.

The audit standards (ISA 240, IAASB 2009; SAS 99, AICPA 2002), while requiring external auditors to evaluate management integrity, provide no guidance on methods of assessing that integrity. This could have an impact on audit quality and the likelihood of detecting fraud. Emma, Okafor, and Ijeoma (2009) find that the evaluation of management integrity has a great impact on audit risk and that it is a critical part of developing an opinion on the fair presentation of financial statements.

Audit standards act as benchmarks for ensuring audit quality. Therefore, the lack of guidance in this area could lead to great differences among audit firms in their fraud risk assessment methodologies and, in turn, their audit quality. Evidence from the literature indicates that inconsistencies do exist among audit firms in their fraud risk assessments (Shelton, Whittington, and Landsittel 2001; Hassink, Meuwissen, and Bollen 2010) and that auditors still need guidance in this area (Kassem and Higson 2012).

Research in this area focuses on the impact of management integrity (Rezaee and Riley 2010; Chen, Cumming, Hou, and Lee 2013; Rittenhouse 2015) while paying little attention to methods of assessing that integrity. This lack of evidence raises questions about how external auditors might comply with the audit standards in this area and what best practices and deficiencies exist in the assessment of management integrity. This study examines the methods of assessing management integrity by drawing on the experience of the Big 4 auditors in Egypt. The Big 4 auditors are known for their high audit quality (Eshleman and Guo 2014). Thus, the methods suggested by these auditors to assess management integrity may be regarded as best practices in the audit industry. External auditors in Egypt, particularly the Big 4, closely adhere to International Standards on Auditing (ISA), which may make the findings of this study generalizable to other contexts.

Assessing management integrity is an integral part of any audit. An underestimated perception of management integrity could lead to inefficient audits, while overestimation could lead to an overreliance on management's representations, which could result in ineffective audits and legal liability (Love and Manisero 2011; Maksymov 2015). Management integrity is the most important factor in an auditor's budget decisions (Blaskovich and Mintchik 2007) and in evaluating engagement risk (Ethridge, Marsh, and Canfield 2005). Management attitude and reactions toward the audit could give auditors an idea about management's level of integrity and could be a good indicator of fraud risk (Abdullatif 2013). Further, management staff who lack integrity are more apt to ignore policies and procedures to pursue their own self-interests. This practice increases the risk of fraud and abuse by management (Fuller and Jensen 2002).

External auditors are required to understand the client's internal control system and in particular the client's control environment. The control environment is key to evaluating management's integrity (Kizirian, Mayhew, and Sneathen 2005). This environment consists of the actions, policies, and procedures that reflect the overall attitude of top management about internal controls. This includes management's commitment to integrity and ethical values, commitment to competence, board of directors or audit committee participation, management's philosophy and operating style, organizational structure, and human resource policies and practices (COSO 2014). Weak integrity encourages unethical decisions and fraudulent behavior (Callaghan, Savage, and Mintz 2007; Rezaee and Riley 2010; Chen et al. 2013; Rittenhouse 2015).

This study provides insights about the assessment of management integrity through questionnaires and semi-structured interviews of Big 4 auditors in Egypt. An online questionnaire was distributed to 150 auditors working in the Big 4 audit firms in Egypt, with 70 questionnaires returned (a response rate of 47 percent).¹ The questionnaire included a question seeking participants' consent to take part in a semi-structured interview related to the current study. Twenty-four participants agreed to take part in the interview. Fourteen interviews were conducted via Skype and ten interviews were conducted via Viber. Each interview lasted for approximately 30–45 minutes, and all interviewees agreed to have the interview recorded, except for one. Notes were taken in all cases during the interviews.² The data were analyzed using content analysis and SPSS. A summary of participants' demographic details is available, see Appendix A, Tables 1 through 4.

The findings reveal that the most commonly used methods (each mentioned 15 times) to assess management integrity include:

• (1) 

  Inquiries of management and those charged with governance regarding fraud controls, past fraud cases, and how management dealt with them;

• (2) 

  Open communication with employees regarding management's practices and ethical behavior;

• (3) 

  Evaluating the company's code of ethics and the message it delivers to employees about management's tolerance of unethical behavior;

• (4) 

  Understanding the extent of management's involvement in related-party transactions;

• (5) 

  Conducting background checks on managers;

• (6) 

  Checking if management had any financial statements restatements history; and

• (7) 

  Asking the same question in multiple forms to determine whether a manager tends to hide information or falsify facts.

Use of “probing questions” during the interviews shows that external auditors use the following methods to conduct background checks:

• (1) 

  Looking at management's curriculum vitae (cv) or personal websites;

• (2) 

  Using Google search to check management's reputation in the market;

• (3) 

  Looking up management's profile on the company's website; and

• (4) 

  Conducting personal interviews with management to learn about their experience, qualifications, and educational background.

One interviewee said:

Assessing management's commitment to ethical behaviors and values in an organization was mentioned 11 times. This supports the suggestions of COSO (2014) and Callaghan et al. (2007). The key to successful internal controls is having a control environment that sets a tone of integrity that influences the ethical and control consciousness of employees. Using probing questions during the interviews reveals that the following methods are used to assess management's commitment to ethical values:

• (1) 

  Determining if management provides staff with ethics training or guides about acceptable ethical behavior;

• (2) 

  Verifying whether there is a code of ethics published on the company's website;

• (3) 

  Checking whether the code of ethics is communicated across the organization; and

• (4) 

  Asking questions such as, “Does management lead by example and adhere to the company's policies and procedures?” “Does management impose any scope limitations on auditors?” And, “Does management treat employees fairly and with respect?”

This finding aligns with COSO (2014) in the importance of having a code of ethics and communicating ethical values to employees across the organization. It also supports Fuller and Jensen (2002), who pointed out that those executives who lack integrity tend to ignore policies and procedures to pursue self-interests. Thus, by asking if management adheres to a company's policies, external auditors could get an idea about management's level of integrity.

Observing and assessing management's attitude and reaction toward identified control deficiencies and audit adjustments, and its willingness to improve processes, were cited nine times. This finding agrees with Abdullatif (2013) that management's attitude toward the audit could be a sign of low management integrity and high fraud risk. One interviewee mentioned that:

Understanding and testing a client's internal control, especially the control environment, was mentioned five times. This finding agrees with Kizirian et al. (2005), who believed that the control environment is key to assessing management's integrity. One interviewee added that:

For a summary of the findings, please see Appendix A, Tables 5 and 6. Table 6 shows the most to the least commonly suggested methods of assessing management integrity.

Content analysis was then used to determine whether auditors with different experiences and qualifications lean toward specific methods of assessing management integrity. The results of the analysis indicate that there is no noticeable difference in the methods suggested by auditors with varying years of audit experience. However, all auditors with a professional qualification in fraud examination (seven auditors held CFE credentials) tend to focus more on nontraditional assessment methods, including:

• (1) 

  Management's attitude and reactions toward the audit and control deficiencies;

• (2) 

  The existence of consistent misrepresentations in the financial statements that indicates management's intent to deceive;

• (3) 

  Evaluating the code of ethics and the message it delivers about ethical values and integrity; and

• (4) 

  Asking the same questions in varying ways to determine whether management tends to falsify facts.

This finding indicates that educating auditors about fraud could help them be more creative in their approach and perhaps design nontraditional audit procedures that could be more effective in fraud risk assessment. This is supported by Asare, Wright, and Zimbelman (2015), who found that knowledge of likely fraud schemes and gaining forensic skills would help auditors in designing effective audit tests.

This study is the first to examine the methods of assessing management integrity by drawing on the experience of Big 4 auditors in Egypt. The guidance provided by this study could be useful to audit firms in their professional audit training programs and to auditors in their fraud risk assessments. The findings indicate that auditors having a qualification in fraud examination are more likely to design nontraditional audit tests that could help in effectively evaluating management integrity and assessing fraud risks. Future studies should explore other practices used by experienced external auditors in different contexts to assess management integrity.