Cognitive moral development and auditor independence

ACCWnting,

Organizations

and

Pergamon

Society,

Vol. 22. No. 3/4, pp 337-352,

1997 \C 1997 Elsevier Science Ltd All rights reserved. Printed in Great Britain 0361.3682/97 $17.00+0.00

PII: SO361-3682(96)00025-6

COGNITIVE

MORAL DEVELOPMENT

AND AUDITOR INDEPENDENCE

JOHN T. SWEENEY University of Missouri-Columbia

and ROBIN W. ROBERTS Iowa State University Abstract

This paper examines the influence of cognitive moral development on an auditor’s independence judgments. Over three-hundred audit professionals participated in a field experiment in which they completed a measure of mom1 development and responded to an ethical dilemma involving auditor independence. The most significant findings are that an auditor’s level of moral development affected his or her sensitivity to ethical issues and independence judgments. Additionally, the influence of the audit firm, partitioned by size, moderated the moral development-independence relationship. U; 1997 Elsevier Science Ltd

The independence of financial statement auditors has been the focus of recent investigations by the Securities and Exchange Commission (1994) and the Public Oversight Board of the American Institute of Certified Public Accountants (POB, 1993, 1994). Recognizing that many observers of the accounting profession view the auditor as less than objective and independent, the POB (1994, p. 4) concluded that the “profession is at a critical juncture” in maintaining the public trust. The primary objective of this study is to examine the influence of cognitive moral development on independence auditor judgments within the framework of a widely accepted psychological model of ethical behavior. We hypothesize that an auditor’s level of moral development affects both sensitivity to ethical issues in work-related dilemmas and independence judgments. We also hypothesize that the effectiveness of The authors gratefully acknowledge the helpful Missouri, Iowa State University, and the University Wilson, and two anonymous reviewers.

potential penalties imposed for nonindependent behavior are dependent upon an individual’s level of moral development. Furthermore, we investigate the effect of firm size on auditor independence judgments. Prior research on auditor independence has generally focused on the audit firm as the level of analysis (DeAngelo, 1981a,b) or developed formal analytical models of auditor independence (Antle, 1984; Magee & Tseng, 1990). Underlying both streams of research is the stated assumption that auditors always act as rational, economic agents. Accountants, however, often find themselves in situations where conflict exists between their economic self-interest and what moral principles indicate ought to be done (Gas, 1992, 1994). In fact, the definition of independence embodied in the Code of Professional Conduct (American Institute of Certified Public Accountants, 1988, sec. 101,102) requires auditors “to act against self-interest

comments of the research workshop participants at the University of of Kansas and also the contributions ofJere Francis, Larry Ponemon, Earl

337

33x

J. T. SWEENEY

and R. W

and ignore the various economic and social incentives affecting them” (Ponemon & Gabhart, 1990, p. 221). More recently, accounting researchers have begun to study whether or not economic self-interest is a sufficient basis for analyzing independence (Farmer et al., 1987; Ponemon & Gabhart, 1990). Ponemon & Gabhart (1990) examined the relationship between moral development and ethical decision making in the context of an auditor independence dilemma. Their results indicated that auditors with a relatively low level of moral development were more likely to believe a hypothetical auditor’s action was in compliance with independence rulings and were influenced to a greater extent by the existence of a potential penalty than auditors high level of moral with a relatively development. Windsor and Ashkanasy (1995) found that when faced with strong economic pressure from client management, an auditor’s moral development may interact with personal beliefs in affecting independence. Tsui & Gul (1996) found that moral development moderated the relationship between locus of control to client and the auditor’s acquiescence management. We extend the prior research on moral development and auditor independence in several ways. First, we examine the relationship between an auditor’s level of moral development and sensitivity to contextual ethical factors when formulating an independence judgment. Second, the relationship between auditor independence and moral development is explored in a richer context devoid of any manifest economic incentives to violate professional rules. Third, we examine the influence of the audit firm in moderating the relationship between an auditor’s level of moral development and independence judgment. Utilizing a field experiment, we tested the hypotheses with a sample of 312 auditors, from staff through partner levels, at eight different public accounting firms representing three distinct size classifications. Our results indicate that an auditor’s level of moral development affects (1) sensitivity to ethical issues in an

ROBERTS

audit context, (2) independence judgments, and (3) the effectiveness of potential penalties for violating independence standards. Furthermore, we find that auditors incorporate contextual information when processing ethical judgments and that auditors from different sized public accounting firms in the United States may hold differing beliefs or perceptions regarding their independence with respect to client management. The remainder of the paper is organized as follows. The second section provides a brief background for the study and a description of cognitive moral development theory. The research hypotheses are presented in section three and our methodology is explained in section four. Data analysis and results are discussed in section five, followed by our conclusions in section six.

MORAL DEVELOPMENT AND AUDITORS’ INDEPENDENCE JUDGMENTS Moral development theory (Kohlberg, 1969; Rest, 1979) attempts to explain the cognitive framework underlying individual decision making in the context of an ethical dilemma. The objective of moral development theory is not to classify a behavior as inherently right or wrong, but rather to understand the cognitive reasoning processes an individual follows in resolving an ethical dilemma. Kohlberg’s stage-sequence model (Kohlberg, 1969) identifies a series of three qualitatively different levels of individual cognitive moral development: preconventional, conventional, and principled or postconventional. Each level is composed of two stages, with the second stage a more advanced form of the general perspective. Individuals progress through these hierarchically arranged levels in a sequential, irreversible pro gression. An individual’s moral growth results from exposure to more advanced forms of moral judgment. The ensuing cognitive conflict or disequilibrium produces tension, which results in the individual attempting to reconcile the contradiction.

COGNITIVE

MORAL DEVELOPMENT

The conventional level of moral development is the level attained by the majority of public accountants (Gaa, 1992; Ponemon & Gabhart, 1993; Sweeney, 1995) and adults in the general population of the United States and most other societies (Colby & Kohlberg, 1987; Rest, 1979). The moral development of public accountants has been associated with underreporting behavior (Ponemon, 1992a), hiring and promotion decisions in public accounting firms (Ponemon, 19926), selection of recognized alternative actions when making ethical judgments (Lampe & Finn, 1992), perceptions of client integrity (Ponemon, 1993; Bernardi, 1994) and bias in litigation support judgments (Ponemon, 1995). An auditor whose moral development is primarily at the preconventional level will follow independence standards only when it is in his or her immediate interest. An auditor whose moral development is primarily at the conventional level has a desire to maintain rules and authority and will always be independent if’ such behavior is consistent with referent group norms. The behavior of auditors who reason primarily at the postconventional level will conform with organizational and/or independence standards when such standards are consistent with internally held beliefs @onemon & Gabhart, 1990, 1993, 1994). Gaa states that postconventional reasoning “implies the ability to move beyond the rules to decide when rules ought to be broken, e.g., for the welfare of society or because justice demands it.“(Gaa, 1992, p. 35) Under the Kohlbergian paradigm, moral action is not defined simply by the conduct exhibited; rather, moral actions involve an internal or cognitive component. Consistent with moral development theory, the motivation leading to an auditor’s ethical behavior will be dependent upon the individual’s level of moral development (Ponemon, 1994). HYPOTHESES Ethical sensitivity and moral judgment

Rest (1986) contends that in order for moral behavior to occur, an individual must perform

AND AUDITOR

INDEPENDENCE

339

at least four basic processes, which he refers to as the “Four-Component Model.” In Component 1 an individual becomes aware of the existence of an ethical issue and the possible alternative courses of action. Component 2 occurs when the individual then makes a judgment as to what course of action is morally right. The next step, Component 3, is the process whereby the individual decides what he or she actually intends to do by selecting among competing values or goals. Component 4 involves implementing and executing a plan of action. Before an individual can behave morally, the person must realize that an ethical problem exists. Ethical sensitivity, or the awareness of an individual to the ethical issues present in a social context, is a prerequisite for assessing the relationship between moral development and action (Rest, 1986). Some research has indicated that individuals with more advanced moral development [Component 21 are more sensitive to ethical issues [Component 11 (Bebeau et al., 1985; Ponemon & Gabhart, 1990; Ponemon, 1993; Bernardi, 1994X although Shaub (1989) did not find a correlation between auditors’ moral development and their sensitivity to ethical issues. Rest (1986) indicates that each type of situation contributes a specific variability in ethical sensitivity, and that professional dilemmas are usually a combination of technical and moral issues. Investments by the accounting profession and by individual accounting firms in socializing auditors to behave in accordance with professional standards (Fogarty, 1992; Lampe & Finn, 1992) may desensitize some auditors to ethical issues beyond the scope of technical rules. Ponemon contends that “progression to higher stages of ethical reasoning fosters an individual’s sensitivity to critical events, issues, and conflicts” (1993, p. 7) and that auditors “with higher ethical reasoning capacities would have greater ethical sensitivity to ethical conflict not well defined by the firm or profession” (1992, p. 254). Auditors who have developed the ability to reason at the postconventional level will be less responsive to referent group norms and more sensitive to

340

J. T. SWEENEY and R. W. ROBERTS

imbedded ethical issues when judging an ethical dilemma. The first hypothesis predicts a positive relationship between an auditor’s moral development and his or her sensitivity to ethical issues. Hl: Auditors at higher levels of moral development be more sensitive to ethical issues.

will

Before the relationship between moral development and independence judgments can be assessed, the auditor must be aware that ethical issues are present
affects his

Effect of sanctions The effectiveness of rules and punishments promoting desirable independence behavior will depend upon the moral judgment processes of auditors (Ponemon & Gabhart, 1993, 1994). The presence of a potential penalty for nonindependent behavior is more likely to influence auditors with relatively less developed

moral judgment (Ponemon & Gabhart, 1990; Arnold & Ponemon, 1991). Moral development theory predicts that auditors at the preconventional level will be independent if the perceived nonindependent potential sanctions for behavior exceed the potential benefits. Conventional level auditors are expected to be less responsive to potential penalties and more sensitive to reference group norms and to upholding the independence standards of the firm or profession. The independence judgment of postconventional auditors is affected by concerns relating to social welfare or principles of justice and is uninfluenced by potential sanctions. This leads to the following hypothesis: H3: The independence judgments of auditors whose moral development is primarily at the preconventional level will be affected by the presence of potential sanctions.

The influence of audit firm size on independence DeAngelo (1981a) maintains that larger audit firms will be more independent than smaller firms because they have greater potential future client revenues to lose from nonindependent action. A large audit firm provides a larger bond for its audit than a smaller firm (Watts & Zimmerman, 1986) and would therefore have greater incentives for ensuring a strong normative structure promoting independence. Trevino (1986) maintains that in an organizational culture which has a strong normative structure, there will be more agreement among members about what is appropriate ethical behavior. Loeb (1971) found a lower incidence of unethical behavior in large audit firms, and Palmrose (1988) reported that Big Eight firms, as a group, engage in less audit litigation than non-Big Eight firms. DeAngelo’s “collateral bond” argument (DeAngelo, 1981~) predicts a positive relationship between audit firm size and independent auditor behavior. Support for her theory would be generated if audit firm size corresponds to increased auditor independence. The following hypothesis tests whether auditors from larger

COGNITIVE MORAL DEVELOPMENT AND AUDITOR INDEPENDENCE

firms are more independent, for a given client, than auditors from smaller firms.

341

Each research instrument contained a hypothetical case (appendix A), a questionnaire attached to the case instrument, and the sixstory “Defining Issues Test” (DIT). All participants were provided with written instructions and asked not to discuss the materials with co workers. The research instruments were equally partitioned prior to distribution by treatment condition. Before delivering the research instruments to each office representative, the cases (enclosed in envelopes) were randomly interspersed to provide assurance that assignment of the experimental treatment was unbiased. A total of 34 1 envelopes (approximately 70%) containing the research instruments were returned by the eight firms participating in the study. Two subjects did not indicate a response to the case, leaving 339 completed cases and 341 completed questionnaires. One subject failed to include the DIT. From the group of 340 subjects returning the DIT, twenty-six subjects were purged from the sample for failure to pass the internal reliability checks, leaving a sample 314 usable DITs.’ After deletion of the two subjects who did not indicate a response to the case, the sample of participants who submitted a completed case and questionnaire along with a valid DIT was 312. Table 1 classifies the 312 respondents by position and years of public accounting experience for each firm size category. Every office contributed at least one subject for each of the five positional levels listed in Table 1.

H4: Auditor independence is positively related to firm size.

METHOD Subjects and procedures

As a prelude to the selection of auditing sub jects, public accounting firms were partitioned into three size categories: Big Six international firms (“large”), national firms (“midsize”), and local and regional firms (“small”). Three large firms, two midsize firms, and three small firms were contacted and agreed to provide auditor subjects. The large and midsize firms each provided subjects from two different office locations. Firms participating in the study provided a representative responsible for the coordination and administration of the study in each office location. Office representatives estimated the number of available participants at each positional level. As a result, a total of 490 research instruments were delivered to office representatives with instructions for administration. Shortly after delivery of the research instruments, office representatives were instructed to prompt subjects to complete and return the materials. The completed research instruments were returned by the subjects, intact in a sealed envelope, to the office representative who then returned the envelopes to the researchers.

TABLE 1. Classification of subjects by firm size, position, and average years of experience Firm Size:

Large

Midsize

Small Totals

Position: staff Senior Supervisor Manager Partner Total:

n

exp.

n

exp.

n

exp.

56 65 20 40 21 202

1.5

23 10 8 14 9 64

2.3

7 12 7 9 11 46

1.7 5.2 6.4 7.8 14.3 7.5

3.8 6.4 7.9 21.8 6.2

4.9 6.8 10.0 20.0 7.5

n 86 87 35

63 41 312

exp. 1.7 4.1 6.5 8.4 19.4 6.6

’ The dropout rate of 7.6% in this sample falls within the 5 to 15% range which Rest (1993) indicates as typical of studies employing the DIT.

342

J. T. SWEENEY and R. W. ROBERTS

Design and measurement of variables The design of this study is a 2 x3 x3, representing two levels of a sanction manipulation, three levels of moral development, and three levels of audit firm size as the independent variables. Auditors’ independence judgments served as the dependent variable. Auditors were randomly assigned to one of the sanction conditions, while the other independent variables were measured. The moral development measure, auditor independence measure and sanction manipulation variable are discussed below. Moral development was measured by the P score value of the six-story version of Rest’s Defining Issues Test (Rest, 1979, 1986). The DIT is a structured, self-administered, objectively scored instrument, which assesses a moral development from forcedperson’s choice responses to ethical dilemmas. The most frequently used score from the DIT is the P index (“P” for “principled”), which is interpreted as the relative importance that respondents attributed to Stage 5 and 6 items. The score is expressed in terms of a percentage and can range from 0 to 95.’ While the P score is based upon Stage 5 and 6 responses, Rest (1979, p. 101) contends that the P score is the appropriate indicator “for locating a subject along the underlying developmental continuum.” Rest (1986) reports an average P score of 40.0 for American adults. The DIT has been subject to extensive reliability and validity studies (Rest, 1979, 1986, 1994; Ponemon and Gabhart 1993). The P score of the DIT (Rest, 1979, 1986) correlates only weakly with gender, ethnic background, IQ, and vocation variables. The strongest correlation with moral judgments is years of formal education, particularly with adult subjects (Rest & Thoma, 1985).

Subjects were classified by P score into three categories (P Groups: (1) Low=under 27.6, (2) Medium=27.6 to 41.5, and (3) High=41.6 and above) for hypothesis testing. These partitions are based on the theoretical P score ranges as suggested by Rest (1993). The P groups are used to proxy for the subjects’ predominant level of moral development: Low=preconventional, Medium=conventional, and High=postconventional. Of the 312 respondents completing both the case and the DIT, 175 were classified into the High group, 107 into the Medium group, and 30 into the Low group. A case instrument (appendix A) was utilized in conjunction with the DIT results to develop the measures for testing hypotheses Hl through H4. Some accounting researchers (DeAngelo, 198la; Antle, 1984; Magee & Tseng, 1990) characterize independence behavior as motivated by economic self-interest. Cushing, for example, insists that “auditor independence cannot be fully understood except in an economic context” (Cushing, 1990, p. 259). Thus, in the absence of an economic motive for nonindependent behavior, auditors are always expected to act independently. As noted previously, this research effort takes the position that independence is an ethical, as opposed to an economic, concept (Gas, 1992, p. 9; Ponemon & Gabhart, 1990, 1993). The case, therefore, was crafted to insure that the hypothetical auditor had no overt economic incentives for violating professional independence standards. The vignette involves an independence dilemma (acquiescence to the controller’s request to conceal an irregularity)” and incorporates issues designed to appeal to the perspectives of different levels of moral development. For example: the sanction manipulation in

’ The P score is converted to a percentage by dividing the sum of the number of Stage 5 and 6 items by 60, the total ranking that would occur if a subject selected only Stage 5 and 6 items for each dilemma. Because only three, not four, principled items are present on three of the vignettes, the P percent has a maximum value of 95. 3 Independence “concerns an individual’s ability to act with integrity and objectivity” (AICPA, 1988). Rule 102 defines integrity and objectivity, and requires that a member shall “be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.” Furthermore, SAS 60 requires an auditor to notify higher levels of management if an irregularity is discovered, regardless of materiality

COGNITIVE

MORAL DEVELOPMENT AND AUDITOR INDEPENDENCE

the case (the likelihood that the auditor’s lack of independence will be discovered) is expected to affect the independence response of preconventional auditors. Conventional level auditors are expected to base their independence response primarily in reaction to the hypothetical auditor’s violation of professional norms for independence. Postconventional auditors are expected to consider the following issues related to justice concerns: the company suffered no financial harm, the controller saved his son from serious physical injury, and revealing the controller’s breach of company policy will cause the controller to lose his job. Consistent with the case construction strategy emphasized by Rest (1979), the dilemma depicts a hypothetical auditor’s actions. Rest stresses that evaluation of moral judgments must be in reference to a third person to mitigate the potential social desirability response bias present in self-reports concerning sensitive issues (Randall & Fernandes, 1991). The response scales require the subject to make a judgment regarding what the hypothetical auditor should have done, as opposed to asking the subject what action he or she would have taken in the scenario (Ponemon SZGabhart, 1990). The case required subjects to allocate 1000 points between an “approval” versus a “disapproval” response to the hypothetical independence behavior of the auditor in the case. Both statements are equivalent measures of independence, and subjects’ point allocation to category A (“Chris should not have disclosed the disbursement”) served as the dependent variable (POINTS) in testing hypotheses H2 through H4. The potential number of POINTS allocated to category A ranged from zero (absolute independence) to 1000 (absolute nonindependence). Requiring subjects to assign a fixed number of points to mutually exclusive categories is consistent with prior research in ethics (Arnold

343

& Ponemon, 1991; Ponemon 8z Gabhart, 1990; Ponemon, 1993). The advantage of this scale over a conventional likert-type scale is that subjects can assign zero points to the dilemma, signifying absolute compliance with independence standards, or a positive number of points over the range, indicating their relative empathy or sensitivity to factors which may have affected the hypothetical auditor acquiescence to management. Assigning zero points is indicative that the subjects were not sensitive to the contextual factors of the case and saw the issue in strictly black-and-white terms as an independence violation. The assignment of ZERO points (ZERO point group) or a positive number of points (NONZERO point group) is used as a dichotomous variable in testing hypothesis H 1. A treatment manipulation was incorporated in the case for testing hypothesis H3 and auditors were randomly assigned to one of two conditions. The manipulation varied the probability of detection of the hypothetical auditor’s acquiescence to the client by stating either (a) “. . .Cbris is certain that the disbursement will not be subsequently examined’ (NOSANCTION case) or (b) “. .Cbris is aware that the disbursement

may

be

subsequently

exam-

ined’ (SANCTION case).4

DATA ANALYSIS Of the 312 subjects available for testing hypotheses Hl through H4, 113 (36%) assigned a value of zero points (ZERO point group) to category A of the case, indicating complete adherence to technical independence standards. The remaining 199 participants (64%) assigned one or more points (NONZERO point group) to category A, suggesting at least some degree of nonindependence. The mean number of points assigned by the 199 NONZERO auditors was 319 (s.d.=265), with a range of 1 to 1000.

4 Given the inability of the researchers to prevent subjects from altering their original responses, a manipulation check was not incorporated into the research instrument and this represents a limitation of the study. However, auditing students involved in a post-test assigned different probabilities to the likelihood of subsequent discovery of the hypothetical auditor’s action based upon the manipulation.

J. T. SWEENEY and R. W. ROBERTS

344

The DIT P scores of the 312 participants ranged from 8.3 to 70 with a mean of 42.8 and a standard deviation of 11.4. The P scores of the subjects in this study are consistent with those reported in prior research of public accountants in the United States (Gas, 1992; Ponemon & Gabhart, 1993).5 Hypothesis

HI: ethical sensitivity

participants were not necessarily expected to agree with the hypothetical auditor’s decision (pOINTS>SOO), an ethically sensitive auditor would have evaluated the decision in contemplation of all the issues present in the case, incorporating both the technical and ethical components. As Rest notes, professional dilemmas are usually a mix of technical and moral issues (Rest, 1986, p. 23) but professional training may so strongly highlight the technical aspects of the job that the individual is blinded to ethical concerns exogenous to formal rules. Assigning at least one point is prima facie evidence that the subject recognized the existence of one or more ethical issues which influenced the hypothetical auditor’s decision to violate the principle of independence (acquiescence to management’s request to not report a defalcation incident). Auditors who assigned zero points to category A responded in strict accordance with professional independence standards; however, their response may indicate that they lacked sensitivity to the ethical issues present in the dilemma, a prerequisite in the Four-Component Model (Rest, 1986) for testing the relationships hypothesized in H2, H3 and H4. While

A comparison of the P scores of subjects who assigned zero points (ZERO) to category A, indicating absolute compliance with independence standards, to those subjects who assigned at least one point (NONZERO) provides evidence in support of hypothesis Hl. A t-test indicated that the mean P score of 40.2 for the auditors in the ZERO group was signiticandy lower (p ~0.002) than the mean P score of 44.3 for auditors in the NONZERO group. Table 2 classifies the ZERO and NONZERO auditors by P Group. A chi-square test indicated that the ZERO and NONZERO groups systematically differ @
TABLE 2. Classification of ZERO and NONZERO auditors by P group ZERO

Point Group:

P Group: High Medium Low Totals

NONZERO

Totals

n

%

n

%

n

47 54 12 113

(27%) (51%) (40%)

128

(73%) (49%) (60%)

175 107 30

(36%)

199

53 18

(64%)

12

Chi-square value 16.23; p
s In contrast to prior research which found relatively minor differences in moral development between males and females in the general population (Thorna, 1986) gender was highly correlated (p
COGNITlVE

MORAL DEVELOPMENT AND AUDITOR INDEPENDENCE

The lower P scores and P group classifications of the auditors in the ZERO group are consistent with the proposition that they are more readily socialized to strictly adhere to independence standards and less likely to attend to ethical issues not addressed by professional standards than auditors from the NONZERO group.’ By relying solely upon professional rules in resolving dilemmas, the ZERO group auditors may lack the sensitivity to adequately identify the ethical issues and the possible consequences of alternative actions. A limitation of this research design is that the assignment of zero points by a subject only infers a lack of sensitivity to ethical issues, and is not a direct measure of ethical sensitivity.’ Hypothesis H2: Moral Development and Auditor Independence The basic premise of this study is that variations in individual moral development will result in differences in independence judgments when confronted with an ethical dilemma (Ponemon & Gabhart, 1990, 1993). Our position is that auditor independence is not linearly related to moral development or that individuals with higher P scores will be more or less independent. Rather, assuming the referent group maintains expectations for independent behavior, conventional level auditors will always be independent. Pre- and postconventional level auditors may deviate from independence, but for different reasons. Relatively minor differences in P scores may not result in significant variations in independence judgments; however, it is expected that over certain thresholds or ranges of moral development, variations in judgment can be observed. As indicated in the tests of hypothesis H 1, the ZERO point group auditors, who responded in

345

strict accordance with technical rules, may have lacked sensitivity to the imbedded ethical issues in the case as required for testing the relationship between moral development and independence judgments. Therefore, only those auditors who indicated sensitivity to the ethical issues (NONZERO point group) will be included in the ANOVA model for testing hypotheses H2, H3, and H4. The ANOVA model for the NONZERO point group is presented in Table 3. The results of the ANOVA model provide support for the hypothesized relationship between moral development and auditor independence judgments. The significance of the P Group variable indicates that level of moral development is an important factor affecting the independence judgment of the NONZERO point group. Furthermore, the results of hypothesis Hl could also be interpreted as providing support for the moral developmentauditor independence relationship in that conventional level auditors were more likely to be absolutely independent (ZERO point group). A discussion of the interaction of the moral development variable (P Group) with audit firm size (SIZE) is undertaken in the discussion of hypothesis H4. Hypothesis H3: effect of sanction Hypotheses H3 posits that the independence judgments of auditors whose level of moral development is predominately preconventional (Low P Group) will be affected by the presence of potential sanctions, because their judgments are conditional upon perceived penalties resulting from misconduct (Ponemon & Gab hart, 1990). Table 4 presents mean Points assigned for the NONZERO subjects by case manipulation for each P Group.”

_ Auditors at higher positional levels are signilicantly more likely to have lower DIT P scores and to be members of the ZERO point group (p
of the ZERO

346

J. T. SWEENEY and R. W. ROBERTS

Although the P Group by Sanction interaction term in the ANOVA model (Table 3) is moderately significant @ <0.095), the mean POINTS for the Low P Group receiving the SANCTION case is higher than the mean for the NOSANCTION case, which is inconsistent with the direction hypothesized in H3. A MannWhitney U-test indicated that the difference in means is not statistically significant (p cO.557). Given the small number of Low P Group auditors, the higher POINTS for the SANCTION group (n=g> may be driven by the effect of a few extreme observations. While the results of the sanction manipulation for the Low P Group are inconsistent with theoretical expectations, the small sample sizes prohibit any inference beyond a failure to reject the null hypothesis under H3. Although H3 hypothesized that the sanction manipulation would only affect the indepen-

TABLE 3. NONZERO point group

dence judgments of Low P Group (preconventional) auditors, a t-test indicated that the mean POINTS (Table 5) for the Medium P Group members responding to the SANCTION case was significantly lower (p ~0.025) than the mean POINTS for those receiving the NOSANCTION case. A possible explanation for this result is that the moral development of individuals in the Medium P Group may have overlapped with characteristically preconventional reasoning processes to the extent that the specific case context and stimuli elicited self-interested behavior. Research indicates that individuals often utilize lower level moral judgment in resolving work-related ethical dilemmas than in resolving non-work related ethical dilemmas (Trevino, 1992). Auditors whose level of moral development was primarily postconventional (High P Group)

auditors

independence

judgments

Results of analysis of variance Source

ss

d.f.

MS

F-stat

Signif

Main effects P Group

376 584

2

188 292

2.92

0.056

Sanction

33 745

1

33 745

0.52

0.470

Size Interactions

74 697

2

37 348

0.58

0 561

P Group’Size

307 255 953 227

2 4

153628 238 307

2.39 3.70

0.095 0.006

Sanction’Stie P Group*Sanc.*Size

214924 195 214

2 2

107462 97 607

1.67 1.52

0.191 0.222

11782148 13 937 794

183 iG

64 383

P Group’Sanction

ElKX Total

Model F: 2.23; p&007.

TABLE 4. Points assigned Manipulation:

to case manipulation

by P Group

NOSANCTION

SANCTION

n

mean

s.d.

n

mean

s.d.

Low Medium

10 31

242 453

205 295

8 22

381 304

340 222

High

65

292

255

63

292

260

P Group

COGNITIVE MORAL DEVELOPMENT AND AUDITOR INDEPENDENCE

were unaffected by the potential penalty. Consistent with theoretical expectations, the mean POINTS of the NOSANCTION and SANCTION groups were equal for the High P Group members, indicating that the presence or absence of adverse personal consequences in the case dilemma did not affect their independence judgments. This result is consistent with Windsor and Ashkanasy (1995), who found that postconventional auditors were indifferent to client economic pressure when forming independence judgments. Hypothesis H4: the in.uence of auditJirm size on independence judgment Hypothesis H4, which tests DeAngelo’s “collateral bond” argument (DeAngelo, 1981a), was not supported by the data. The SIZE variable in the ANOVA (Table 3) model was not significantly related to the independence judgments of the NONZERO auditors. Additionally, audit firm size was not systematically different between the ZERO and NONZERO point groups Cp <0.58), indicating that auditors from larger firms were no more likely to comply absolutely with independence standards than auditors from midsize and small firms. While a main effect for the SIZE variable was insignificant, the interaction of the moral

347

development variable (P group) with firm SIZE was significant (p <0.006) in the ANOVA model.“’ Table 5 presents a breakdown of mean POINTS by P group for each audit firm SIZE level. A chi-square test (p <0.320) indicated no systematic difference in P Group classifications among different size firms. The lack of a systematic difference in P Group classifications among the three firm size categories suggests the possibility that the significant interaction term (P Group*SIZE) in the ANOVA model may be attributable to differing ethical proclivities, cultures, or environments among different sized firms. 1’ Ponemon and Gabhart (1993) and Ponemon (1994) contend that an auditor’s moral development is enhanced or repressed by the moral atmosphere of the referent firm. The moral atmosphere can be viewed as the firm’s collective organizational norms or ethical culture. Variations in the ethical behavior of auditors can be partially attributable to differences in organizational culture (Ponemon, 1990, 1992a, 1994). Farmer et al. (1987) found that organizational acculturation affected auditors’ independence judgments. Research has indicated that organizational culture can be differentiated by firm size (Pratt & Belieau, 1992).

TABLE 5. Mean points by P Group by firm size for NONZERO Point group Firm Size:

Small

Midsize

Large Totals

n

mean

n

mean

n

mean

n

mean

3 11 18

617 266 361

I 13 28

120 477 210

14 29 82

250 401 305

18 53 128

304 391 292

32

352

42

290

125

z?

1s)9

319

P Group:

Low Medium High Totals:

“’ Audit firm size was not systematically different between the ZERO and NONZERO point groups (p ~0.58). The SIZE variable in a one-way ANOVA model with POINTS as the dependent variable was also insignificant. i’ Substitution of the Firm variable for SIZE in the ANOVA model results in a nonsignificant (p ~0.267) interaction term Firm). For the Nonzero point group, variations in moral atmosphere among different size firms is apparently a more influential moderator of independence behavior than variations in the moral atmosphere at the firm level of analysis.

(P Group

l

J. T. SWEENEY

348

and R. W. ROBERTS

Figure 1 contains a graphical representation of the P Group by SIZE interaction. The small number of NONZERO subjects in the Low P Group for the Small and Midsize audit firms (Table 5) however, narrows any potential interpretation of the interaction to the Medium (conventional orientation) and High (postconventional orientation) NONZERO P Groups. conventional reasoning auditors While (Medium P Group) were more likely to be represented in the ZERO point group than preor postconventional auditors (Table 2) they also assigned the highest mean number of points in the NONZERO point group (Table 5). In the midsize and large firms, which are often heavily dependent upon audit revenues, the mean response of the conventional reasoning auditors nearly approaches nonindependence (points > 500) despite any explicit economic incentive in the case dilemma which would motivate acquiescence to the client manager.

This apparent inconsistency can be explained by the propensity of conventional auditors to follow group norms. If the norms of the referent firm emphasize strict adherence to professional independence standards, then conventional reasoning members are likely to assign zero points. However, if the norms emphasize the maintenance of client relations, then the conventional reasoning auditor is more likely to acquiesce to the demands of client management (Ponemon & Gabhart, 1993, p. 27). These results suggest that the relationship between independence and firm size is not linear or necessarily driven by economic factors. Rather, the ethical culture of the firm, which may be differentiated by firm size, interacts with the moral development of the auditor in enhancing or diminishing the client independence relationship.

RESEARCH IMPLICATIONS AND DISCUSSION

150,

L

i Firm

~*

MIdsize Large

High

Medium P GrouD

Fig. 1. Interaction

Size

Small

of P Group with audit firm size.

The results of this study indicate that the independence behavior of auditors is affected by their level of cognitive moral development. Consistent with moral development theory, the higher an auditor’s level of development, the less likely he or she is to resolve an independence dilemma by referring solely to technical standards. Despite the absence of any overt economic incentive, a high percentage (64%) of subjects’ responses to the case dilemma exhibited at least some degree of nonindependence (NONZERO point group).i2 The significantly lower mean P score of the ZERO point group versus the NONZERO point group provided evidence consistent with the notion that an auditor’s level of moral development influences his or her sensitivity to the contextual ethical issues present in workrelated ethical dilemmas. This finding is also consistent with our hypothesis that moral development affects auditor independence judgments. Primary support, however, for the

‘a Of the 312 subjects in the NONZERO point group, 45 (14%) assigned more than 500 Points to category A, indicating they approved of the hypothetical auditor’s lack of independence and infidelity to professional auditing standards.

that

COGNITIVE

MORAL DEVELOPMENT

moral development-independence relationship was supplied by our ANOVA tests. Audit firm size interacted with moral development level in affecting subjects’ independence judgment, although the direction of the relationship is unclear. This result provides evidence consistent with the proposition (Ponemon, 1990, 1992a, 1994) that the moral atmosphere of an audit firm influences an auditor’s consideration of client issues. Perhaps as a partial response to spiraling litigation costs, audit firms have invested increasingly greater resources in programs designed to foster ethical auditor behavior. The results of this study and those of other researchers (Ponemon, 1992b, 1994; Windsor & Ashkanasy, 1995) strongly suggest that the moral reasoning ability of auditors and accountants affects their resolution of work-related ethical dilemmas. Furthermore, whether conventional or postconventional auditors are more likely to comply with professional standards may be context specific and at least partially dependent upon the ethical values promoted by the referent audit firm. If the auditing profession equates ethical behavior with strict adherence to professional standards, then the results of this research have important implications for audit firms in understanding the relationship between moral development and ethical behavior. Auditors whose moral development was primarily conventional in nature were more likely to comply absolutely with professional independence standards and were more affected by potential penalties for noncompliance than postconventional auditors. For those subjects who did not comply absolutely, however, the response of conventional auditors deviated the most from independence standards, particularly in midsize and large firms. These results suggest that for conventional reasoning auditors, strong firm norms for independence and the presence of penalties for nonindependent behavior are effective mechanisms for promoting behavior consistent with professional standards. Postconventional auditors were more likely to consider contextual factors beyond the

AND AUDITOR

INDEPENDENCE

349

scope of professional standards when forming their independence judgments and were unaffected by the presence of potential penalties for nonindependence. These results, combined with the finding of Windsor and Ashkanasy (1995) that high moral reasoning auditors are unaffected by client economic pressure, that the independence behavior suggest of postconventional auditors is motivated by concerns other than self-interest. Given the increasing competition and declining margins in the audit industry, firms which are heavily dependent upon audit revenues may incorporate into their culture or value systems an emphasis on client relations and retention. These values may then be consciously or unconsciously inculcated in the ethical schema of the firm members, particularly those who reason at a conventional level, and subsequently influence their responses to ethical dilemmas. Audit firms can promote ethical behavior by emphasizing adherence to professional codes of conduct and high ethical standards above all other competing values. The results of this study suggest several areas for future research. First, research on factors which enhance or repress the ethical sensitivity of auditors will contribute to our understanding of this component of ethical behavior. Secondly, the connection between ethical sensitivity and moral development in affecting ethical behavior presents opportunities for future exploration. Finally, the influence of moral atmosphere in affecting ethical behavior is an area of research which presents an excellent opportunity for furthering our understanding of the socializing influence of the audit firm. There are some limitations to the study that should be discussed. First, the auditors in our sample came only from public accounting firm offices in the Midwest and were not randomly selected. Generalization of the results of this study are valid only to the extent that public accountants in the Midwest are similar to their counterparts in other regions of the country. The inclusion of auditors at all positional ranks from thirteen different office locations, representing eight different public accounting firms

350

J. T. SWEENEY and R. W. ROBERTS

and three different firm size categories mitigates potential biases due to nonrandom selection. Finally, auditor independence is a state of mind and therefore unobservable. The use of hypothetical cases to measure auditor independence is subject to several criticisms inherent in

this type of research: (1) cases may lack realism and the richness found in an actual audit setting, (2) participants may not answer truthfully, and (3) the auditor’s actual independence behavior may be affected by variables not represented in the case.

BIBLIOGRAPHY American Institute of Certified Public Accountants (AICPA). (1988). The Code of Professional Conduct of the American Institute of Certified Public Accountants. New York: AICPA. Antle, R. (1984). Auditor independence. Journal of Accounting Research, Spring, l-20. Arnold, D. F., & Ponemon, L. A. (1991). Internal auditors’ perceptions of whistle-blowing and the influence of moral reasoning: an experiment. Auditing: A Journal of Practice and Theory, 1- 15. Bernardi, R. A. (1994). Fraud detection: the effect of client integrity and competence and auditor cognitive style. Auditing: A Journal of Practice and Theory (Supplement), 68-84. Bebeau, M. J., Rest, J. R., & Yamoor, C. M. (1985). Measuring dental students ethical sensitivity. Journal of Dental Education, 225-235. Colby, A., & Kohlberg, L. (1987). The Measurement of MoralJudgment. New York: Cambridge University Press. Cushing, B. E. (1990). Discussion of “Auditor Independence Judgments: A Cognitive Developmental Model and Experimental Evidence”. Contemporary Accounting Research. 252-260. DeAngelo, L. E. (1981a). Auditor Size and Auditor Quality. Journal of Accounting and Economics (August), 183- 199. DeAngelo, 1.. E. (198lb). Auditor independence, ‘low balling,’ and disclosure regulation. Journal of Accounting and Economics, August, 113-127. Farmer, T. A., Rittenberg L. E., & Trompeter G M. (1987). An investigation of the impact of economic and organizational factors on auditor independence. Auditing: A Journal of Theory and Practice, Fall, l-14. Fogarty, T. (1992). Organizational socialization in accounting firms: a theoretical framework and agenda for future research. Accounting, Organizations and Society, 129- 149. Gaa, J. C. (1992). The auditor’s role: the philosophy and psychology of independence and objectivity. Proceedings of the 1992 Deloitte and Touche/University of Kansas Symposium on Auditing Problems, pp. 7-43. IJniversity of Kansas, School of Business. Gaa, J. C. (1994). me Ethical Foundations of Public Accounting. Research Monograph Number 22. Vancouver, British Columbia: CGA-Canada Research Foundation. Kohlberg, L. (1969). Stage and sequence: the cognitive developmental approach to socialization. In D. A. Goslin (Ed.), Handbook of Socialization Theory and Research (pp. 347-480). Chicago: Rand McNally. Iampe, J. C., & Finn, D. W. (1992). A model of auditors’ ethical decision processes. Auditing: A Journal of Practice and Tbeoly (Supplement), 33-59. Loeb, S. E. (1971). A survey of ethical behavior in the accounting profession. Journal of Accounting Research, 287-306. Magee. R. P., & Tseng, M. (1990). Audit pricing and independence. The Accounting Review, April, 315-336. Palmrose, 2. V. (1988). An analysis of auditor litigation and audit service quality. The Accounting Review, January, 55-73. Ponemon, L. A. (1990). Ethical judgments in accounting: a cognitive developmental perspective. Critical Perspectives 071Accounting, 191-215. Ponemon, L. A. (1992a). Auditor underreporting and moral reasoning: an experimental-lab study. Contemporary Accounting Research, 169-189. Ponemon, L. A. (1992b). Ethical reasoning and selection-socialization in accounting. Accounting, Organizations and Society, 239-258. Ponemon, L. A. (1993). The influence of ethical reasoning on auditors’ perceptions of management’s integrity and competence. Adzlances in Accounting, l-29. Ponemon, L. A. (1994). Whistle-blowing as an internal control mechanism: individual and organizational considerations. Auditing: A Journal of Practice and Theory, 118-130.

COGNITIVE

MORAL DEVELOPMENT AND AUDITOR INDEPENDENCE

Ponemon, L. A. (1995). The objectivity of accountants’ litigation support judgments. The Accounting Review, July, 467-488. Ponemon, L. A., & Gabhart, D. R. (1990). Auditor independence judgments: a cognitive developmental model and experimental evidence. Contempom y Accounting Research, 227-25 1. Ponemon, L. A., & Gabhart, D. R. (1993). Ethical reasoning in accounting and auditing. Research Monograph Number 21. Vancouver, British Columbia: CGA-Canada Research Foundation. Ponemon, L. A., & Gabhart, D. R. (1994). Ethical reasoning research in the accounting and auditing professions. In J. R. Rest and D. Narvaez (Eds), Moral Development in theprofessions:psycholo~ and upplied ethics (pp. 101-l 19). Hillsdale, New Jersey: Laurence Erlbaum Associates. Pratt, J., & Belieau P. (1992). Organizational culture in public accounting: size, technology, rank, and functional area. Accounting, Organizations and Society, 667-684. Public Oversight Board (POB) of the American Institute of Public Accountants (1993). In the public interest. Stamford, Conn: AICPA. Public Oversight Board (POB) Advisory Panel on Auditor Independence (1994). Strengthening the professionalism of the independent auditor. Stamford, Conn: AICPA. Randall, D. M., & Fernandes, M. F. (1991). The social desirability response in ethics research.Journul of Business Ethics, 805-817. Rest, J. R. (1986). Moral development: advances in research and theory. New York: Prager Press. Rest, J. R. (1979). Development injudging Moral Issues. Minneapolis, MN: University of Minnesota Press. Rest, J. R. (1993). Guidefor the Defining Issues Test. Version 1.3. Minneapolis, MN: lrniversity of Minnesota Rest, J. R. (1994). Background: theory and research. In J. R. Rest and D. NaITdeZ (Eds), Moral devefopment in the professions: psychology and applied ethics (pp. I-26). Hillsdale, NJ: Laurence Erlbaum Associates. Rest, J. R., & Thoma, S. (1985). Relation of moral judgment development to formal education. Derjelopmental Psychology, 709-7 14. Securities & Exchange Commission (SEC), Office of the Chief Accountant (1994). Stuff report on auditor independence Shaub. M. K. (1989). An empirical examination of the determinants of auditors’ ethical sensitivity. Doctoral dissertation. Lincoln, NE: University of Nebraska. Shaub, M. K. (1994). An analysis of the association of traditional demographic variables with the moral reasoning of auditing students and auditors. Journal of Accounting Education. Winter, l-26 Sweeney, J. T. (1995). The moral expertise of auditors. an exploratory analysis. Research on Accounting Ethics, 213-234. Thoma, S. J. (1986). Estimating gender differences in the comprehension and preference of moral issues. Detrelopmental Review, 165- 180. Trevino, L. (1986). Ethical decision making in organizations: a person-situational interactionist model. Academy of Management Review, 601-617. Trevino, L. (1992). Moral reasoning and business ethics: implications for research, education, and management. Journal of Business Ethics, 445-459. Tsui, J. S. L., & GUI, F A. (1996) Auditors’ behavior in an audit conflict situation: a research note on the role of locus of control and ethical reasoning. Accounting, Organizations and Society, 4 l-5 1. Windsor, C. A., & Ashkanasy, N. M. (1995). The effect of client management bargaining power, moral reasoning development, and belief in a just world on auditor independence. Accounting, Organizutions and Society, 20, 701-720. Watts, R. L., & Zimmerman, J. L. (1986). Positiue accounting theory. New York: Prentice Hall, Inc.

351

352

J. T. SWEENEY and R. W. ROBERTS

APPENDIX Instructions: 1. Please read the case very carefully. 2. Using your judgment, please allocate 1000 points to the following two categories: (a) You agree with the decision of the auditor. (b) You do not agree with the decision of the auditor. Unless you are in absolute agreement with the auditor’s decision, do not allocate 1000 points to any single category. For example, if you are about 80% in agreement with the auditor’s decision, allocate 800 points to category A and 200 points to category B. Case Study I: Chris Gibson has been employed by the public accounting firm of RS and T for the past four years and is the senior in-charge of the Greenwood Manufacturing Company audit. Greenwood is a manufacturer of household furniture and a division of a large, publicly traded corporation. With annual sales of approximately $40 million, Greenwood is in good financial health and the corporation has received unqualified audit opinions in recent years. While visually inspecting the accounting records of Greenwood in a search for unusual appearing transactions, Chris discovered an uncoded cash disbursement of $25,000. Chris decided to discuss the situation with the controller, Ed Johnson. Ed Johnson first worked for Greenwood Manufacturing when it began operations in 1970. Mr. Johnson has held the controllers’ position for eight years and is generally regarded as one of the most competent and highly respected executives at Greenwood. Mr. Johnson has always been cooperative and professional during the course of the audit. Ed Johnson was alone in his office when Chris Gibson entered and referred to the

$25,000 disbursement. Mr. Johnson asked Chris to close the door, pulled a file from his desk, and then began the following conversation: “I expected you might be dropping by to discuss that withdrawal. The disbursement is my personal responsibility, and I repaid it the next day. You can verify the receipt by examining the bank statement. I have copies of all supporting documents in this file. “I withdrew those funds from the company account after receiving a phone call that afternoon from my son, a student at the university. At the time, I was unaware he had developed a severe gambling problem. He told me that he had substantial losses which he was unable to pay. Furthermore, he had been threatened with bodily harm if he didn’t pay $25,000 in gambling debts by that night. The only way I could obtain that much cash in a matter of hours was to access company funds. I repaid the amount the following day with personal funds. My son has since obtained counseling and treatment for his gambling problem. “You’re the only person I’ve confided in: you must realize I will lose my job if this matter becomes public.” Chris confirmed that the support from Mr. Johnson’s file was consistent with his explanation. As the corporate internal audit staff has yet to complete its annual audit of the Greenwood Manufacturing division, Chris is aware that the disbursement may be subsequently examined. Chris decides not to disclose the information obtained concerning the disbursement. A: Chris should Points:------

not have disclosed

(not to exceed

B: Chris should have disclosed Points:------

the disbursement. 1000)

the disbursement.

(not to exceed

1000)

(Remember, the combined points assigned to category A and B must equal 1000.)