Auditing firms have always known that an individual partner could be dominated by a large client and might defer excessively to such a client in a manner that could inflict liability on the firm. Thus, early on, they developed systems of internal monitoring that were far more elaborate than anything that law firms have yet attempted. But within the auditing firm, this internal monitoring function is not all-powerful. After all, it is not itself a profit center. With the addition of consulting services as a significant profit center, a natural coalition developed between the individual audit partner and the consulting divisions; each had a common interest in checking and overruling the firm's internal audit division when the latter's prudential decisions would prove costly to them. Cementing this marriage was the use of incentive fees. If those providing software consulting services for an audit firm were willing to offer the principal audit partner for a client a cost of one percent, or so, of any contract sold to the partner's audit client, few others within the firm might see any reason to object. If software consulting contracts (hypothetically, for $50 million) were then sold to the client, the audit partner might now receive more compensation from incentive fees for cross-selling than from auditing and thus had more significant reason to value the client's satisfaction above his interest in the firm's reputational capital. More importantly, the audit partner now also had an ally in the consultants who similarly would want to keep their mutual client satisfied, and together they would form a coalition potentially able to override the protests of their firm's internal audit unit (if it felt that an overly aggressive policy was being followed). While case histories exactly matching this pattern cannot yet be identified, abundant evidence does exist for the thesis that incentive fees can bias audit decision-making.

Question

1. Summarize in a paragraph or two the problem that the author sees in this regard.

2. Explain in a paragraph or two how this pertains to agency law.

Answer rating: 100% (QA)

Answer 1 The author sees a potential problem with audit firms crossselling software consulting contr... View the full answer