Andersen and the market for lemons in audit reports

Previous accounting ethics research berates auditors for ethical lapses that contribute to the failure of Andersen (e.g., Duska, R.: 2005, Journal of Business Ethics 57, 17-29; Staubus, G.: 2005, Journal of Business Ethics 57, 5-15; however, some of the blame must also fall on regulatory and professional bodies that exist to mitigate auditors' ethical lapses. In this paper, we consider the ethical and economic context that existed and facilitated Andersen's failure. Our analysis is grounded in Akerlof's (1970, Quarterly Journal of Economics August, 488-500) Theory of the Market for Lemons and we characterize the market for audit reports as a market for lemons. Consistent with Akerlof's model, we consider the appropriateness of the countervailing mechanisms that existed at the time of Andersen's demise that appeared to have effectively failed in counteracting Andersen's ethical shortcomings. Finally, we assess the appropriateness of the remedies proposed by the Sarbanes-Oxley Act of 2002 (SOA) to ensure that similar ethical lapses will not occur in the future. Our analysis indicates that the SOA regulatory reforms should counteract some of the necessary conditions of the Lemons Model, and thereby mitigate the likelihood of audit failures. However, we contend that the effectiveness of the SOA critically depends upon the focus and attention of the Public Companies Accounting Oversight Board (PCAOB) towards assessing the ethical climates of public accounting firms. Assessments by the PCAOB of public accounting firm's ethical climate are needed to sufficiently ensure that public accounting firms effectively promote and maintain audit quality in situations where unconscious bias or economic incentives may erode the public accounting firm's independence.