The Effect Of Auditor Independence On International Capital Markets For eCommerce Firms

Abstract

According to the efficient market hypothesis, the market for securities can be described as efficient if the market reflects all available information and reacts quickly to new information (Schroeder and Clark 1998). Investors depend on financial statements to help them judge opportunities, risks, and investment alternatives (Revsine, Collins and Johnson 1999). This information must be verified by independent sources such as auditors. The relationship between auditor and stockholder is based on agency theory (Schroeder and Clark 1998), where the agent (auditor) has a fiduciary relationship with the principle (stockholders). Any loss of faith in auditor independence by investors will seriously affect the information value of financial statements.

Auditor independence rules must be easy to understand and rigorously enforced or the public's confidence in financial statements will erode. This paper will specifically assess the difficulties encountered by large accounting firms such as PriceWaterhouseCoopers (PWC) and Arthur Andersen in their efforts to remain independent with respect to their e-commerce clients. Many e-commerce companies have innovative and untested business models as well as inexperienced and untraditional business managers. Some auditors fail to measure the risk associated with these intangible, knowledge-based attributes. In addition, auditor independence may be blurred by the promise of lucrative consulting contracts. According to Arthur Levitt, the Chair of the SEC in 1999:

“The dynamic nature of today’s capital markets creates issues that increasingly move beyond the bright line of black and white. New industries, spurred by new services and new technologies, are creating new questions and challenges that must be addressed. Today, we are witnessing a broad shift from an industrial economy to a more service based one; a shift from bricks and mortar to technology and knowledge.” (Levitt 1999)

The objective of this paper is to review current independence rules, assess the difficulty in maintaining independence in the current e-commerce environment, and to make suggestions for improving independence rules. In addition, investigations conducted by the Securities and Exchange Commission (SEC) and new legislation such as the Sarbanes-Oxley Act will be reviewed as possible solutions to the problem.