Clients' Preferred Relationship Approach with their Financial Statement Auditor Free

In this article, we summarize the findings, conclusions, and practical applications of our recently published article, “An Empirical Study of Canadian Companies to Determine Clients' Preferred Relationship Approach with Their Financial Auditor” (Fontaine and Pilote 2011).¹ The objective of the research is to examine audit clients' preferred relationship approach with their financial statement auditor.

Our study originated from an informal discussion with an audit partner from the Montreal office of a Big 4 firm. The audit partner expressed the importance of client relationships for the firm, and the need to better understand what type of relationship the client wants to have with their auditor. Our subsequent review of the academic literature highlighted the need to pursue a study to obtain direct evidence from clients regarding their relationship preferences with their auditor. There is very little evidence from the client perspective about relationship preferences with auditors. This perspective is important because the type of relationship that clients have with auditors can impact audit quality (Beattie 2001).

To examine this issue, we report the results of a survey of 306 Canadian private corporations to determine their preferred relationship with their auditor. The results highlight the clients' desire for trusting, long-term, and cooperative relationships with auditors. At the same time, clients also want to remain at arm's length, as required by audit standards.

The auditor-client relationship is a concern for those interested in auditor independence, and has sparked debate about the duration of auditor-client tenure (the length of time that the auditor and/or audit firm have a relationship with a particular client). The central question in the debate regarding auditor tenure is whether long-term relationships between clients and their auditors reduce audit quality. Long-term auditor-client relationships have been blamed for causing auditors to acquiesce to client demands, resulting from reduced auditor independence (Shafer et al. 2004). Acquiescence to client requests may result from auditors not wanting to lose the client before recuperating costs invested in the audit process (i.e., start-up costs) (DeAngelo 1981), or wanting to please the customer (Shafer et al. 2004).

These arguments underlie the calls for audit firm mandatory rotation. Proponents of mandatory rotation, such as the U.S. Securities and Exchange Commission (SEC), claim that poor audits are associated with impaired auditor independence, a by-product of longer auditor tenure (Arel et al. 2005; George 2004). In contrast, opponents of mandatory rotation, such as the American Institute of Certified Public Accountants (AICPA), argue that mandatory auditor rotation increases audit start-up costs and could cause overreliance on client estimates, because the auditor would not have time to obtain firm-specific knowledge (George 2004). Therefore, there are questions about whether auditors are able to create cooperative working relationships with clients and, at the same time, maintain independence, which is considered a potential paradox (Beattie et al. 2000).

To gain greater insight into the auditor-client relationship, some recommend referring to the marketing discipline (e.g., Beattie 2001). Accordingly, the following section presents a theoretical framework that describes an applicable marketing model, as well as the auditor-client relationship, which differs from typical buyer-seller relationships.

In the relationship marketing literature, relationships between clients (i.e., buyers) and their service providers (i.e., sellers) are defined as relational or transactional. Specifically, clients prefer either a relational approach (RA) or a transactional approach (TA) with their service provider in a given marketing situation (Gronroos 1991, 1997, 2000; Paulin et al. 1997, 2000). An RA is a relational exchange that reflects an ongoing process based on cooperation, communication, and trust (Dwyer et al. 1987; Morgan and Hunt 1994). In contrast to the RA, the TA approach is based on competition and self-interest, resulting in an arm's-length relationship between buyers and sellers (Morgan and Hunt 1994). In other words, clients typically will prefer either a close relationship or a distant relationship with their service provider, but not both.

The auditor-client relationship differs from typical seller-buyer relationships primarily because the intended user of the audit service is not the client, but rather a third-party financial statement user. The auditor, hired and paid for by the client, audits the client for the benefit of a third party, creating a three-party relationship. In order for the third party to have confidence in the audit, the auditor needs to be independent from the client. However, in addition to being independent, the auditor and the client need to collaborate, a challenging balance to maintain.

Considering relationship marketing concepts and the three parties involved in a financial statement audit (i.e., client, auditor, and third-party users), we explore theory to determine clients' relationship preferences. Goldman and Barlev (1974; hereafter, GB) argue that clients have power over auditors because the audit is an easily attainable commodity and, therefore, perceived as not important. According to GB, even though the auditor is asked to handle non-routine problems, the majority of audit issues are routine and do not add value to the paying party; therefore, the client will perceive the audit as a commodity and not important. In the relationship marketing literature, when a service is perceived as not important, the client prefers a transactional approach over a relational approach with the service provider (Pels et al. 2000).

In contrast to GB, Eilifsen et al. (2001) argue that auditors add value to clients because of value-added items related to the audit service, but not the actual audit service (referred to as the “new” audit approach). This audit approach includes business risk analysis, an expanded management letter, and feedback on processes. Moreover, Beattie et al. (2000) assert that clients desire more than auditing services, including guidance on accounting principles, advice on internal controls, and general business advice, referred to as the “added-value audit.”² When a service is perceived as added-value (i.e., important), the client typically prefers a relational approach to a transactional approach (Pels et al. 2000). We predict that even though GB positions the audit service as non-value-added, it is more likely that clients would benefit from the added-value audit and, therefore, desire a relational approach.

To test our prediction, we mailed a survey to 1,090 Canadian financial executives (CFOs), and used the 306 responses to measure clients' relationship preferences as either RA or TA. Each survey contained 16 questions that we used in our analyses.³ Our respondents represented private companies with over 100 employees, with head offices in Canada.⁴ Participants marked their responses with an “X” on a line, and we report their responses based on a scale labeled from 0 to 100.⁵ We use the scale midpoint of 50 to determine if a result significantly differs from the midpoint, and to classify a preference for TA (lower numbers, to the left of the midpoint) or for RA (higher numbers, to the right of the midpoint).

Respondents were 69 percent male and averaged 11 years in their current position. In addition, 44 percent are audited by Big 4 firms and 56 percent by non-Big 4 firms; the average audit firm tenure was 11 years. Surprisingly, even though we surveyed only private companies, 89 percent were audited, 9 percent were reviewed, and only 2 percent received a “notice to reader.”⁶ The high percentage of audits versus reviews is consistent with a high demand for audit services from private companies. We confirmed that none of the above-mentioned demographic variables influence the relational preferences reported below.

Overall, and consistent with our prediction, clients have a preference for an RA over a TA with their auditor (i.e., the mean of 71 is significantly higher than the scale midpoint of 50). Additional analyses yield other interesting results. For example, the relationship with the auditor plays a more important role than the audit service, but only to the extent that the relationship facilitates the service and the service is satisfactory. In other words, a close relationship does not make up for poor audit service. These results are consistent with service marketing theory, which asserts that service quality is a minimum customer expectation and is the starting point for a buyer-seller relationship (Gronroos 2000).

Moreover, clients want auditors to be a source of information (mean = 78), and want auditors to provide services beyond the audit (mean = 70). In addition, clients want a cooperative (mean = 82), trusting (mean = 88), and long-term (mean = 78) relationship. Our results are consistent with Beattie et al. (2000) and Eilifsen et al. (2001), who argue that the value of the audit is in the added-value services beyond the core audit service, which results in cooperative efforts from the client. However, at the same time, and surprisingly, clients also want to remain at arm's length with their auditor (mean = 16).⁷

Auditors are faced with a challenge unlike many other service providers, because they must create close client relationships (to add value and encourage client cooperation), but not so close as to lose their independence. We believe that the results of our study could help audit practitioners achieve this difficult balance.

Clients appear to want added-value information from auditors, in addition to a cooperative, trusting, and long-term relationship. The problem is that even though clients desire an added-value, collaborative service (with a relational approach), auditors might find it difficult to provide this type of service because of the need to remain independent. However, clients also want to remain at arm's length with their auditor. Therefore, from the client's perspective, an added-value service (with a relational approach) does not have to be provided at the expense of an independent relationship—clients believe that the two types of relationships can coexist.

The client's preference to remain at arm's length indicates an understanding and respect for the auditor's ethical requirement to remain independent. This preference should help auditors maintain a certain distance from clients, which is important because threats to independence have been blamed for auditors acquiescing to client demands. Knowing that clients want to remain at arm's length should encourage auditors to communicate independence requirements to clients, allowing auditors to refrain from giving in to client demands without damaging the relationship.

In a background paper issued by the International Monetary Fund (IMF), the question was asked: “How can the auditors maintain independence while at the same time maintaining good relations with the audited organization?” (Watson 2009, 4). The IMF article recommends best practices for the auditor-client relationship, among which is the recommendation that auditors discuss with clients the nature of the relationship between the two parties during the audit (Watson 2009). In this spirit, now-superseded Canadian auditing standards (which were in effect at the time of our survey) required that auditors inform clients, by letter, of the auditor's necessity to remain independent throughout the audit (Canadian Institute of Chartered Accountants [CICA] 2006, Section 5751.32).⁸ Our finding that clients desire to remain at arm's length could indicate that the standard-mandated auditor communications with clients were effective, which should encourage audit practitioners to continue communications with clients regarding the nature of the relationship and the need to remain independent.

Finally, our study's results could help auditors redefine what it means to have a close relationship with their clients. Because clients want information beyond the audit, but also want to remain somewhat distant, maybe it is not entertainment that interests the clients, but rather activities that inform (e.g., information sessions for clients, perhaps with specialists as guest speakers). In addition, some assume that only extroverted auditors can build relationships with clients. However, our results support the need for audit partners and audit personnel (sent to the client location) to build close relationships by being helpful and knowledgeable and providing good service, which, in turn, should build trust and lead to a cooperative, long-term relationship.

We recommend that researchers examine these issues from the auditor's perspective. A study including both auditors and their clients would allow researchers to examine how the relationship that the client wants compares to the auditor's desired relationship.