Report questions auditors' ethics

Auditors routinely make unethical decisions that favour the interests of their clients, an academic study examining pollution across the state of Gujarat in India suggests.

Researchers from Harvard and the Massachusetts Institute of Technology argue the relationships between companies and their auditors are fraught with conflicts of interest or "poor incentives to tell the truth".

Keen to keep companies on board as clients, auditors often bend to senior managers' whims and suppress information that might damage companies' business concerns, the academics conclude in their study, Truth-telling by Third-Party Auditors and the Response of Polluting Firms: Experimental Evidence from India.

Michael Greenstone, an MIT economist who co-authored the study, said most auditing firms have not fully absorbed the cautionary tale provided by the Enron scandal in 2001, which led to the collapse of Arthur Andersen, the accounting titan: "Every single third-party auditing market in the world has a fundamental conflict at its core. The person being audited is paying the auditor."

Two years of analysis in the field came about after environmental regulators in Gujarat tried to devise ways of addressing shortfalls in their regulatory system.

The researchers found that the auditors responsible for examining conditions at 473 plants in two industrial regions of Gujarat routinely reported pollution readings that just met the regulatory standards required; close to 30 per cent of audit reports were falsely reported as meeting regulatory standards. To address the situation, the researchers linked auditors' pay to the accuracy of their reporting.

The method worked well as the auditors received pay from a central pool and not from the plants, while their fees were set in advance at a flat rate that was high enough to cover pollution measurement and leave auditors a modest profit.

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