A growing number of high-profile companies have had to restate their earnings at substantially lower levels to correct the prior use of "aggressive" and even fraudulent accounting practices. Because the companies’ auditors approved the original reports, policymakers have questioned the capacity of public accounting firms to promote fair financial reporting. In response, recent legislation has instituted several reforms, including the creation of the Public Company Accounting Oversight Board, which together with the Securities and Exchange Commission will investigate alleged lapses in accounting practices. But how much oversight is really necessary? Jeffery Gunther and Robert Moore examine recent events in the light of research findings. Based on this analysis, they conclude that market forces have tended, over time, to shape the role of auditors to match or correspond to the needs of investors in monitoring individual companies’ performance. Despite current sentiment to the contrary, substantial government involvement in the business of auditing appears to be needed only when other types of government intervention, such as bank deposit insurance, have already disrupted market-based incentives for effective audits. In the more typical situation, both government and industry policymakers should avoid restrictive measures that unnecessarily increase audit costs, instead taking into account market forces’ successful track record in disciplining ineffective auditors and promoting an effective audit function.>
