The Audit Expectations Gap: Mitigating Information Asymmetries and Corporate Social Responsibility as a Signaling Device

Introduction

As highlighted through this volume, Corporate Social Responsibility necessitates effective engagement of stakeholders and investors – both at local and international levels. Where Corporate Social Responsibilities are fulfilled, and responsibilities and goals within the sphere of Carroll’s pyramid of Corporate Social Responsibility are realized, such that the engagement of stakeholders is facilitated primarily through legal and ethical responsibilities, and ultimately through economic and philanthropic responsibilities then Foreign Direct Investment is expected to yield the benefits which accrue to the economy as well those which should materialize through formidable corporate social responsibility reporting.

The issue of “audit expectation gap (AEG)” has been very significant to the accounting profession since the mid-1970s and continues to be debated on until today. In the 1970s and 1980s, massive corporate failures resulted in the accounting profession being severely criticized by the public. For example, in 1973, Equity Funding – an insurance firm based in Los Angeles - collapsed when computer-based fraud was discovered. In May 1982, Drysdale Government Securities collapsed followed by Penn Square Bank two months later. In 1985, the $340 million fraud in ESM Government Securities became the largest securities fraud case ever to come before a US federal court at that time. Auditors were then forced to battle with legal suits taken against them. Meanwhile, the mounting list of corporate failures and abuses, alleged audit failures, and lawsuits against prominent accounting firms generated concern outside the profession which subsequently prompted/resulted in the House Subcommittee on Oversight and Investigations of the Committee on Energy and Commerce conducting a hearing or congressional investigation of the profession, which was chaired by John Dingell, (“Management Accounting”, 1985). In defense, the profession defined the concept of AEG and focused public criticism on that concept.

The AEG refers to the difference between what the public and other financial statement users perceive auditors’ responsibilities to be and what auditors believe their responsibilities to entail (Marteens & McEnroe, 2001). It is assumed that auditors and users of financial statements have a different perception of the term “external audit” (De Beelde et al., n.d.). Reiter and Williams (n.d) are of the view that the expectations gap refers to the public’s expectation that companies with “unqualified” audit opinion, hence a true and fair view of the financial statements, should be free of financial fraud and short-term risks of business failure. These misconceptions of the public feed the legal liability crisis facing the accounting profession (Maccarone, 1993 as cited by Koh & Woo, 1998). Power (1993) called it an institutional process/ referred to it as institutional processes of “blame allocation”. Litigation, press comments, internal inquiries are among the methods of allocating the blame.