Regulatory Oversight and Audit Quality

In a recent article published in the Journal of Accounting and Public Policy, Professors Francois Larmande, Université de Sherbrooke, and Cédric Lesage, Concordia University, examine the impact of regulatory oversight and legal liability on audit quality and efficiency.

Findings of legal liability require that a firm has failed to produce reliable disclosures, through failed accounting practices or something akin. Regulatory action, however, can be undertaken more readily than legal action, and penalties are therefore more likely to be assigned in the wake of regulatory intervention rather than legal proceedings. The authors find that the greater threat of regulatory fines produces higher audit effectiveness — often referred to as “audit quality.”  But at the same time, regulatory oversight is found to also produce less efficient audit practices. The authors suggest that this may be the result of a reduced likelihood on the part of audit staff to accept the risk inherent in trialing new tools or approaches to their work, implying a failure to evolve their practices.