Q&A: Investor perspective prompts auditors to rate CEO misconduct as more significant

Q&A: Investor perspective prompts auditors to rate CEO misconduct as more significant Swati Mestri Scientific Editor Andrew Zinin Chief Editor When thinking like investors, auditors are significantly more likely to rate corporate leaders' crimes as material concerns for the investing public, according to new Poole research. In their professional capacities, the study finds, auditors tend to rate executive lapses as less material to their firms' financial performance. That finding is indicative of an "expectation gap" between the way auditors define their work and the public's assumptions about them, said Eileen Taylor, professor of accounting and co-author of the paper. According to professional auditing standards (set by the Public Company Accounting Oversight Board, or PCAOB), information is material if there is a "substantial likelihood" that it "significantly alters the 'total mix' of information made available" in the eyes of a "reasonable investor." In "The Relevance and Materiality of Illegal Acts: Examining Auditor and Investor Judgments," published in the Journal of Business Ethics, Taylor and her co-author sought to quantify the expectation gap. To do so, they surveyed a group of 163 people. Roughly two-thirds of respondents were current or former audit professionals. The pool was split into groups, with one assigned the "auditor" role and the other assigned the "investor" role. Those in the auditor group were more likely to see leaders' illegal acts as largely irrelevant to their firms' financial statements, "while investors believe there is a strong connection between a CEO's illegal behavior and the company's performance," the paper states. Traditionally, auditors haven't looked beyond a company's financial records and statements in searching for material issues. But the industry is under growing pressure from the public to take things like management conduct into consideration, Taylor said. "There's fear that if we have to know all kinds of other laws and rules, we're going to be held responsible for this person's bad behavior if we don't report it," said Taylor, who is also a certified public accountant. "But if we report it, we're imperiling our relationship with the client. That's the tension, and it all comes back to the initial setup of how auditors are paid by their clients." She recently discussed her findings, possible remedies for the expectation gap and where her research is headed next. Q: How might the auditing profession address this expectation gap? One of our suggestions was to get a focus group of investors and ask them if they think this is a problem. Psychologically, once people are in that auditor role, I don't know if they can really take themselves out of it. They're trained as auditors, so they think a certain way. With anything, when you're in a group, you have that in-group bias. Getting someone from outside the group to look at it could help. Q: What made this topic interesting to you? The profession has always had this expectation gap between what the public wants auditors to do and what the profession thinks they're capable of and are willing to do. And you have a built-in conflict of interest because the company being audited is the one paying the auditor. It's hard to step back and not have that conflict. So it's a built-in independence issue. Q: How receptive is the audit profession to that critique? There's a traditional perspective that auditors are not experts in illegal acts. The personal illegal acts of a CEO are not their business as the auditor. So there's that norm. It's not the auditors' fault that they're immersed in financial statement numbers. There was a paper about why the Enron fraud wasn't material because it was such a big company and millions of dollars wasn't material from an auditor's perspective, if you look at it as a quantitative percentage of the business. But investors think it matters because it speaks to how well they can trust management. If a CEO has an affair, an auditor might say that's his personal business and it's somehow separate from his professional role. But we know that investors don't think that's the case. The investing public cares about what management does. Q: Are there other questions you're looking at in this line of inquiry? We have another paper looking at environmental, social and governance (ESG) reporting. There was a car company that wasn't honest about battery life, and we looked at whether there was a difference in how auditors, investors and customers thought about the integrity of that disclosure. We're looking at the same concept (as this paper), but in the context of ESG and sustainability reporting, which has less governance around it than financial statement reporting. Publication details Eileen Z. Taylor et al, The Relevance and Materiality of Illegal Acts: Examining Auditor and Investor Judgments, Journal of Business Ethics (2026). DOI: 10.1007/s10551-026-06477-4 Journal information: Journal of Business Ethics Provided by North Carolina State University