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Auditing: A Journal of Practice & Theory Vol. 29, No. 1 May 2010 pp. 279-293 American Accounting Association DOI: 10.2308/aud.2010.29.1.279 Exploring Trust and the Auditor-Client Relationship: Factors Inuencing the Auditor's Trust of a Client Representative Morina D. Rennie, Lori S. Kopp, and W. Morley Lemon SUMMARY: This research examines nancial statement auditors' trust of members of client management in the context of a disagreement. In this descriptive eld study involving 48 partners and 23 managers of Canadian ofces of international accounting rms, we explore factors that can inuence an auditor's trust of client management. We nd that a client representative's openness of communication and demonstration of concern during an auditor-client disagreement are positively associated with the trust that an auditor feels for that individual. We also nd that aspects of the auditorclient relationship are associated with auditor trust. Responses to general questions about trust and auditing indicate that our auditors believe it is important to trust their clients and that they attempt to ensure that trust does not impede professional skepticism, primarily through a rigorous audit process and the adoption of an independent attitude. INTRODUCTION nancial statement audit cannot be conducted in the absence of the auditor's trust of members of client management. The auditor needs information provided by management and the cooperation of management to carry out the audit. Members of client management have a great deal more specic knowledge about their organization than does the auditor. Thus, the auditor has no option but to bestow some degree of trust upon members of client management. Yet if trust is allowed to become too strong, professional skepticism could be impaired. A Morina D. Rennie is a Professor at the University of Regina, Lori S. Kopp is an Associate Professor at the University of Lethbridge, and W. Morley Lemon is a Professor Emeritus at the University of Waterloo. We appreciate the helpful advice of Greg Berberich; Celeste Brotheridge; Ron Camp; Mike Gibbins; Kathy Hurtt; Jack Ito; Bill Kinney; Steve Salterio; Glenys Sylvestre; participants at workshops at the University of Regina, University of Waterloo, The University of Texas at Austin, University of Auckland, and Victoria University of Wellington; participants at the 2006 Canadian Academic Association Annual Conference and the 2007 American Accounting Association Auditing Section Midyear Conference; anonymous reviewers; and the editor. The authors gratefully acknowledge the nancial support of the Canadian Institute of Chartered Accountants/Canadian Academic Accounting Association Research Grant Program. Professor Lemon acknowledges the nancial support provided by the PricewaterhouseCoopers Auditing Professorship. Editor's note: Accepted by Ken Trotman. Submitted: June 2007 Accepted: July 2009 Published Online: April 2010 279 280 Rennie, Kopp, and Lemon The purpose of this descriptive, exploratory study is to shed light on auditors' trust of client management. We use the context of an auditor-client disagreement to learn about client behaviors in particular, openness of communication and demonstration of concern and aspects of the auditor-client relationship in particular, length of association and frequency of past disagreements that may inuence the auditor's trust of a client representative. We also gather opinions from the auditors in our study relating to the importance of trust and managing the balance between trust and professional skepticism. Evidence about the trust that an auditor feels for members of client management is important because this trust has the potential to affect an auditor's judgment. Trust acts as a lens through which the actions of a trusted individual are interpreted Jones 1996. Interpersonal trust accumulates through repeated encounters between individuals Dasgupta 1988; Lines et al. 2005 and can affect the behavior and judgment of the trustor Konovsky and Pugh 1994; Morgan and Hunt 1994; Williams 2001. Trust can result in reduced levels of monitoring of the trusted individual's behavior Gargiulo and Ertug 2006, 170; Williams 2001 and in the extreme may even create a desire to obey the trusted individual Bijlsma-Frankema et al. 2005. In previous research, it has been found that auditors with greater trust are less likely to attend to evidence of aggressive reporting than are less trusting auditors Rose 2007 and that students playing auditor-like roles choose less rigorous \"audits\" in cases where trust-attracting behavior is exhibited by client management King 2002. It has also been observed that skepticism/suspicion affects the assessment of evidence for audit-context evidence, see Rose 2007, Nelson 2009, and Quadackers et al. 2009; for evidence in other contexts, see Schul 1993, Schul et al. 1996, and Hilton et al. 1993. Ethical disposition, experience, past history with the client, auditor position, and situational factors have been found to be associated with auditor suspicion1 Shaub 1996; Shaub and Lawrence 1996, 1999. Bell et al. 2005 indicate a need for research that sheds light on issues around professional skepticism. Because of the negative relationship between trust and skepticism, an exploration of auditor trust of client management is important. In a eld study involving 71 auditors at the partner or manager level, we nd that a client representative's openness of communication during the course of a disagreement is positively associated with the auditor's trust of that client representative. A client representative's demonstration of concern toward the auditor also appears to be trust-relevant. The frequency of disagreements with the client representative is negatively associated with the auditor's trust of the client representative, while the length of the auditor-client relationship is positively associated with the auditor's trust. We also nd that auditors believe it is important to trust their clients and that auditors cite a variety of strategies for trying to ensure that trust of client management does not impede professional skepticism. Most often these strategies relate to controls within the audit process and/or to the auditor's attitude/mindset when conducting the audit. While this is an exploratory study that examines a limited set of variables, the results may have implications for the practice of auditing and for standard setting. The ndings provide evidence that auditors do hold a level of trust in client representatives and that the level of trust is associated with commonplace behaviors of client representatives that attract trust. The study also contributes to the literature on interpersonal trust by adding evidence from the auditor-client contexta context in which excessive trust could potentially harm large numbers of investors and other nancial statement users. The remainder of this paper is organized as follows: Hypotheses Development, Method, Results and Discussion, Limitations, and Conclusion. 1 Shaub 1996 treats suspicion as being synonymous with professional skepticism Shaub 1996, 156 and treats trust as being the complement of suspicion Shaub 1996, 155. Auditing: A Journal of Practice & Theory American Accounting Association May 2010 Exploring Trust and the Auditor-Client Relationship 281 HYPOTHESES DEVELOPMENT The level of interpersonal trust that an auditor has for a client representative is shaped by past experiences shared by these individuals. The social-psychological perspective on trust focuses on the interpersonal transactions between individuals that create or destroy trust Lewicki and Bunker 1995, 1996. The inventory of experiences shared by auditors and client representatives includes disagreements that occur during the course of a nancial statement audit. This study uses the context of a disagreement between an auditor and a client representative as a platform to help us learn about factors inuencing the trust that an auditor feels for a member of client management.2 Anchoring recall on a particular incident a concrete event has been found to enhance recall relative to situations in which no anchor is used Levin et al. 2006. In this study we look at two behaviors by a client representative that have been identied in the trust literature as potentially inuencing interpersonal trust: openness of communication and demonstration of concern. We describe these as \"trust-attracting behaviors.\" Client representatives who are skilled at exhibiting trust-attracting behaviors may have several opportunities to demonstrate them to an auditor during the course of a disagreement. When a client representative shows high levels of openness of communication and/or demonstration of concern during a disagreement, we predict that the auditor will feel greater trust toward this individual as a result of the disagreement experience. Conversely, a client representative who is not able to communicate openly or demonstrate concern may not generate an improved feeling of trust by the auditor, and may even create distrust as a result of the disagreement. Both openness of communication and demonstration of concern as antecedents to trust are discussed by Whitener et al. 1998 and tested by Korsgaard et al. 2002 in a manager-employee context. Both behaviors have also been identied in the trust literature as potential antecedents to trust see Williams 2001; Gabarro 1978; McAllister 1995; Butler 1991; Mishra 1996. Beyond the particular disagreement described by our participants, a further aspect of the accumulated experience between the auditor and the client representative is all other disagreements shared by these two people. We wanted to know what inuence the frequency, over time, of disagreements between an auditor and a particular client representative would have on that auditor's trust of the client representative. We predict that the frequency of disagreements would tend to have a negative relationship with the trust that an auditor feels for the client representative involved in the disagreements. That is, the more frequently the auditor and client representative have disagreements, the lower the auditor's trust of this individual would be. Our reasoning is that an auditor-client history that includes frequent disagreements may be indicative of a client representative who tends to push the limits of GAAP or who attempts to inuence the audit process. A pattern of behavior that includes regular differences of opinion could even call into question the intentions of the client representative. Erosion of trust would result. It should also be noted that prior research outside the auditing context demonstrates that cooperation between the parties to a relationship is positively associated with trust see Anderson and Narus 1990; Morgan and Hunt 1994; so, inversely, lack of cooperation for example, frequent disagreements may be associated with less trust. Shaub 1996 found an inuence of past experience with the client on auditors' trust or suspicion of the client although not specically in the area of frequent disagreements. Another factor that may potentially inuence an auditor's trust is the length of the auditorclient association. This variable attempts to capture the quantity of past experiences in the relationship. Researchers in the trust literature generally agree that trust develops and builds over time 2 Individuals tend not to be aware of the parameters of their trust of another individual until they are in a circumstance that tests that trust Stickel and Gamroth 2006, 47. A disagreement between an auditor and a member of client management is such a circumstance. Auditing: A Journal of Practice & Theory May 2010 American Accounting Association 282 Rennie, Kopp, and Lemon Doney and Cannon 1997, 39. As a result, the length of a relationship should be associated with the level of trust. The tenure of the auditor-client relationship has long been suggested to be a factor that may cause closeness between auditors and their clients. For example, it has often been suggested to be a factor that can compromise independence see Kleinman et al. 1998 and Moore et al. 2006; for a dissenting view, see Nelson 2006. Bamber and Iyer 2007 nd that audit tenure is positively associated with auditor identication with the client. It is possible that both independence issues and identication with the client are inuenced by interpersonal trust between auditors and members of client management. Research in other elds demonstrates a positive relationship between length of association and trust. For example, Coulter and Coulter 2002 found that length of the relationship is a moderating variable in assessments of trust in a service provider. In an auditing context, Shaub 1996 did not observe a signicant relationship between length of association and the auditor's suspicion/trust of the client in hypothetical scenarios. However, the effects of long-term association are difcult to capture in hypothetical situations that have not actually been experienced by a study's participants, so we do not necessarily expect that Shaub's result would be observed in the context of actual auditor-client relationships. Figure 1 provides an overview of the factors examined in this study and the hypotheses. The illustration shows that the trust an auditor feels for a client representative may inuence the auditor's judgment, although the impact of trust on judgment is beyond the scope of the current study. We hypothesize that: H1: A client representative's degree of openness of communication during a disagreement is positively related to the auditor's trust of that individual. FIGURE 1 Factors Potentially Inuencing an Auditor's Trust of a Client Representative A specific auditor-client disagreement Client representatives openness of communication during disagreement Client representatives demonstration of concern during disagreement Other factors, including the auditors satisfaction with the outcome of disagreement (control variable). H1 and H2 + H3 Auditors trust of client representative Auditors future judgments All other disagreements with this client representative and factors associated with those disagreements. H4 + Frequency of disagreements Auditing: A Journal of Practice & Theory American Accounting Association Length of Association Other factors that may influence trust, including the auditors predisposition to trust (control variable) May 2010 Exploring Trust and the Auditor-Client Relationship 283 H2: A client representative's degree of demonstration of concern during a disagreement is positively related to the auditor's trust of that individual. H3: The frequency of disagreements with a client representative is negatively related to the auditor's trust of that individual. H4: The length of the auditor-client relationship is positively related to the auditor's trust of a client representative. Control Variables We identify two control variables. The rst is the auditor's satisfaction with the outcome of the disagreement. Specically, participants were asked, \"Were you satised with the outcome?\" Any impact of specic client behaviors on trust would need to have an inuence over and above the auditor's satisfaction. The second control variable is the auditor's predisposition to trust. This control variable is included to ensure that tests of our hypothesized relationships are considered over and above any inuence of the auditor's predisposition to trust. We also looked at the correlation of our dependent variable with the other items on our instrument that could conceptually be justied as control variables and found no other candidates. METHOD Participants The participants in the study were 71 experienced auditors 48 partners, including two principals; 20 senior managers; and three managers from across Canada. Participants were from international accounting rms and had an average of 17.5 years of experience since becoming a Chartered Accountant range: four to 38 years. Including articling time of two to three years, we estimate that our least experienced participants had a minimum of six years of total auditing experience. We believe this level of experience is more than sufcient to perform the tasks of describing a disagreement incident and answering questions relating to that incident. See Table 1 for demographic information. Materials and Procedures The instrument was carefully developed so as to elicit meaningful and considered responses from our participants. The instrument was developed to allow us to collect both qualitative and quantitative data. Wherever possible we used or adapted measures that had been employed in other published research. As part of the instrument development process, feedback was obtained at research seminars at several universities in Canada, the United States, and New Zealand, as well as from other researchers in the eld. The instrument was pilot tested with three experienced Chartered Accountants who were not included in the subject pool. The instrument was distributed to partners and managers from Canadian ofces of international accounting rms. A partner from each of six international accounting rms was contacted by one of the researchers. The nature and purpose of the study were explained to the partners, who, upon their indicating a willingness for their rm to participate, were asked if they would distribute our cover letter and instrument to up to 20 individuals at the manager level and above in their rms. In order to preserve the anonymity of the subjects, neither the name of the subject nor that of the rm or ofce was requested. The materials were distributed to the contact person at each of the rms, and the completed materials were returned to one of the researchers. While we did not ask the distributors to tabulate the number of instruments distributed, we do know that there was a maximum of 120 distributed. Therefore the response rate is no less than 59 percent. Auditing: A Journal of Practice & Theory May 2010 American Accounting Association 284 Rennie, Kopp, and Lemon TABLE 1 Participants and Incidents Number Participants in Study Partners including two principals Senior Managers Managers Total Experience since becoming a Chartered Accountant years Approximate Percentage of Time Spent on Financial Statement Audits Males Females Participants Working with Big 4 Firms Incidents Clients Involved in Incidents: Public Companies Non-Traded Subsidiaries of Public Companies Private Companies Other Types of Organizations Total Importance of Disagreement 0 \"only of minor importance\" to 10 \"extremely important\" Age of Disagreement years Percent 48 20 3 67.6 28.2 4.2 71 Mean (Standard Deviation) 100.0 17.5 9.2 71.9 22.5 54 17 41 76.1 23.9 57.7 34 6 16 9 52.3 9.2 24.6 13.9 65 100.0 7.8 2.0 2.4 3.07 The rst question of the instrument anchored each participant on an experience from his or her past which would be the basis for the majority of other responses in the instrument: Think of a time, since you were at least at the manager rank, when you had a disagreement with a member of client management during the course of a nancial statement audit. The disagreement could be either serious or minor. Briey describe this disagreement including the issue causing the disagreement. Our approach was similar to the experiential questionnaire approach see Gibbins and Qu 2005 employed in the Gibbins et al. 2001 and Gibbins et al. 2005, 2007 auditor-client negotiation studies, and by Nelson et al. 2002 in an earnings management context, in that it was based on situations that respondents had experienced. Korsgaard et al. 2002 used a similar approach in a management-employee trust context, as did Lind et al. 1997 in a procedural justice context. Participants who had never had such a disagreement were asked to skip the questions relating to the auditor-client disagreement. Four participants did so. One participant described disagreements in general rather than a specic disagreement, and another participant provided a disagreement from a time before he/she was at the manager level, so those responses were not included in analyses relating to specic disagreements. The 65 participants who described a specic disagreement went on to answer questions about their experience and their level of satisfaction with the outcome; the effect of the disagreement on trust; the extent of prior disagreements; behaviors of Auditing: A Journal of Practice & Theory American Accounting Association May 2010 Exploring Trust and the Auditor-Client Relationship 285 the client representative during the disagreement; trust of the client representative; tenure with the client; and other information about the disagreement, the client, the rm, and the respondent. Participants also answered questions about their general trust in people and in clients. Finally, all 71 participants answered questions about the importance of trust in the audit and the strategies they use to ensure that trust in the client does not impede professional skepticism. These questions were not tied to the specic disagreement that the participants had described earlier in the instrument. RESULTS AND DISCUSSION The descriptive statistics for our variables can be found in Table 2. It was important, in this study, to establish that a disagreement incident would be relevant to an auditor's trust of a client representative. We found that participants reported a wide range of inuence that the disagreement had exerted on their trust of the client representative involved in the disagreement, with responses covering the entire range of: 0 \"Signicantly weakened trust\" to 10 \"Signicantly strengthened trust\" mean 4.94; standard deviation 2.29. Of a total of 65 respondents recalling a disagreement, 24 36.9 percent indicated that their trust of the client representative had been weakened by the disagreement, 24 36.9 percent had not changed their TABLE 2 Descriptive Statistics Dependent, Independent, and Control Variables (n )56 Theoretical Response Standard Range Range Mean Deviation Dependent Variable Auditor's trust of client representative anchors: 0 Do not trust this individual; 10 Trust this individual completely Independent Variables Client representative's openness of communication during a disagreement anchors: extent to which client representative displayed: 0 Not at all; 10 A great deal Client representative's demonstration of concern during a disagreement anchors: extent to which client representative displayed: 0 Not at all; 10 A great deal Frequency of disagreements with client representative anchors: 0 Never; 5 Occasionally; 10 Frequently Length of Association years Control Variables Auditor's satisfaction with outcome anchors: 0 Not at all satised; 5 Satised; 10 Very satised Auditor's predisposition to trust. Level of agreement/ disagreement with the following two items: \"Trustworthy clients are the norm\" and \"Most people are honest in their dealings with others\" anchors: 0 Strongly disagree; 10 Strongly agree. Auditing: A Journal of Practice & Theory 0-10 0-10 6.02 2.37 0-10 0-10 6.69 2.66 0-10 0-10 4.66 2.71 0-10 0-8 3.57 2.40 0.5-20 4.11 3.58 0-10 3-10 7.95 1.95 0-20 4-20 14.22 2.96 May 2010 American Accounting Association 286 Rennie, Kopp, and Lemon level of trust as a result of the agreement, and 17 26.2 percent believed that the disagreement had strengthened their trust of the client representative. This result provides evidence that the experience we used to get insight into trusta disagreementwas trust-relevant. Participants also reported a full range of auditor trust of client representatives involved in the disagreement the question was, \"Based on your past and present experience, how would you characterize the level of trust you have in the client representative with whom you had this disagreement?\". All points on the scale were represented in the responses, ranging from: 0 \"Do not trust this individual\" to 10 \"Trust this individual completely.\" The mean response standard deviation was 6.02 2.37. Thus, these auditors have varying levels of trust in client representatives. The descriptive statistics show that the auditor's length of association with the client ranged from 0.5 years to 20 years, with a mean of just over four years.3 For the remaining independent variables, which were measured using response scales, the participants provided a good range of responses, representing nearly all points on the response scales. None of the disagreements that are the basis of this study were considered to be of a trivial nature.4 Pearson correlations for the variables utilized in this study show that at, the univariate level, the client representative's openness of communication and the client representative's demonstration of concern during a past disagreement are both signicantly associated with participants' assessments of their trust of that client representative p 0.01. The frequency of disagreements with that client representative is signicantly negatively associated with the auditor's trust p 0.05, and the length of association is positively associated with trust p 0.10. The client representative's openness of communication during a past disagreement is positively associated with demonstration of concern p 0.01 and is negatively associated with the frequency of disagreements with that client representative p 0.05. Hypothesis Tests The hypotheses were tested using hierarchical regression, with the auditor's trust of the client representative as the dependent variable.5 Hierarchical regression was used because we had two different types of independent variablesone set relating to a specic disagreement and the other set going beyond that disagreement. The rst block of independent variables model 1 tested H1 3 4 5 We were able to obtain this large range of association because auditor rotation rules in Canada came into effect later than in the U.S. Our data were collected during the transition period associated with the Canadian independence rules which allowed existing associations to continue until December 31, 2005 instruments distributed November-December 2004. The question about the importance of the disagreement was answered on a 0 to 10 response scale, anchored at 0 \"Only of minor importance,\" 5 \"Important,\" and 10 \"Extremely important.\" Only two participants assessed importance at less than 5 both at 3. A regression including issue importance as an independent variable showed that it was not signicant t 0.009; p 0.993. The regression diagnostics showed that collinearity was not an issue, with tolerances ranging between 0.743 and 0.975, and variance ination factors well below 10. There was no evidence of violation of underlying assumptions. To assess the robustness of the results, we did a supplementary analysis of the relationship between the variables associated with the disagreement and auditors' assessments of the impact of the specic recalled disagreement on trust. We found that client openness of communication and demonstration of concern were both signicantly positively related to this variable t 2.708; p 0.005 and t 1.953; p 0.028, which is consistent with our reasoning relating to H1 and H2. Auditing: A Journal of Practice & Theory American Accounting Association May 2010 Exploring Trust and the Auditor-Client Relationship 287 and H2 and were those relating specically to the disagreement described by the auditor.6 Building on those variables, in model 2, were those variables relating to the entire auditor-client relationship rather than solely to this disagreement: frequency of disagreements with the client H3; length of association with the client H4; and the control variable, the auditor's predisposition to trust. Because all hypotheses specied a direction, one-tailed tests were used however, two-tailed tests were used for control variables. The regression results are shown in Table 3. The R2 for the overall regression was 0.504, with the rst block of variables contributing 0.397 and the second block contributing 0.107. The adjusted R2 was 0.453. There was a positive relationship between the openness of communication of the client representative during a disagreement and the auditor's trust of the client representative H1: p 0.001; and there was also a positive relationship between the client representative's demonstration of concern and the auditor's trust H2: p 0.05. Model 2 shows that an auditor's trust of a client representative may also be affected by aspects of the relationship between auditor and client. We found that the frequency of disagreements with the client representative was negatively associated with the level of auditor trust H3: p 0.05 and that length of association was positively related to the auditor's trust H4: p 0.05.7 The results of the hypothesis tests suggesting that the trust an auditor feels for a client representative at any point in time may be inuenced by the behaviors of client representatives during disagreements are consistent with the ndings by Korsgaard et al. 2002 in a study on employees' trust of management. Here we show that behaviors that would cause an employee to trust management can also inuence trust in a context outside a superior-subordinate relationship. We found that the control variable \"satisfaction with the outcome\" was positively associated with trust p 0.05, as expected. A negative relationship between the control variable \"auditor's predisposition to trust\" and the auditor's trust of the client representative was observed p 0.05. This result may seem, on the face of it, to be at odds with some prior research particularly with Rose 2007, and it is curious that, at the univariate level, the auditor's predisposition to trust was not signicantly associated with the auditor's trust of this client representative. However, some researchers in the trust literature have found that the relationship between trusting predispositions and trust in a specic situation can be complex see Brockner et al. 1992; Chrobot-Mason 2003. This may be an issue that is worth exploring further. 6 7 Measurements of the independent variables relating to H1 and H2 were obtained through this question: \"Following are possible behaviours that individuals in disagreements sometimes have. Please indicate, on the appropriate scale, the extent to which the client representative displayed each of the following behaviours during this disagreement.\" Below this instruction, ve behaviors were listed, with a 0 to 10 responses scale for each, anchored by 0 \"Not at all\" and 10 \"A great deal.\" While all ve were realistic behaviors that could occur during the course of a disagreement, only two of these itemsthe second and fourthwere of interest for testing our hypotheses. The items of interest were: \"The client representative demonstrated openness of communication\" and \"The client representative showed concern about being fair to me.\" The rst, third, and fth behaviors on the list were ller items that were included to reduce the probability that participants would guess the hypotheses. Two of these ller items were ultimately found to be correlated with trust: \"The client representative tried to use his/her power over me to get what he/she wanted\" was negatively correlated with trust r 0.353; p 0.01, and \"The client representative seemed willing to compromise to nd an outcome that both of us would feel was acceptable\" was positively correlated with trust r 0.501; p 0.01. Because auditor rotation rules indicate ve years and seven years of association to be important benchmarks, we did comparisons of auditor trust based on those time periods as an additional test. The mean trust s.d. was 5.72 2.55 for associations of ve years or less and was 7.07 1.14 for those greater than ve years, with a marginally signicant difference between means F 3.70; p 0.06. The mean trust s.d. was 5.89 2.53 for associations of seven years or less and 6.70 1.06 for those greater than seven years. The difference between means was not signicant F 0.985; p 0.33. For both comparisons, there was an imbalance in group sizes and in standard deviations with more extreme imbalances in the seven-year test, so these results should be interpreted with caution. Auditing: A Journal of Practice & Theory May 2010 American Accounting Association 288 Rennie, Kopp, and Lemon TABLE 3 Dependent Variable \"Auditor's Trust of Client Representative\" (n )56 Variable Model 1: r2 = 0.367; change in r2 = 0.367; and change in F 13.410 Constant Client representative's openness of communication during disagreement Client representative's demonstration of concern during disagreement Auditor's satisfaction with outcome of disagreement control Model 2: r2 = 0.504; change in r2 = 0.107 and change in F 4.155 Constant Client representative's openness of communication during disagreement Client representative's demonstration of concern during disagreement Auditor's satisfaction with outcome of disagreement control Frequency of disagreements Length of association Auditor's trust predisposition control Hypothesized Direction Standardized Coefcients t p-value* 0.000 Positive 0.482 0.795 4.313 0.430 0.000 Positive 0.224 1.971 0.027 0.137 1.328 0.189 0.010 Positive 0.452 1.664 4.252 0.101 0.000 Positive 0.184 1.719 0.046 0.222 2.228 0.030 0.174 0.217 0.191 1.795 2.237 2.041 0.039 0.015 0.046 Negative Positive * p-values are one-tailed for hypothesized relationships all of which specify a direction and two-tailed for the control variables. The rst set of independent variables model 1 test H1 and H2 and are those relating specically to the disagreement described by the auditor together with the satisfaction of outcome control variable that relates to the disagreement described by the participant. Model 2 incorporates two additional variables that relate to the entire auditor-client relationship rather than solely to this disagreementfrequency of disagreements with the client H3, length of association with the client H4, and includes the control variable, the auditor's predisposition to trust. The Dependent Variable is the response to question: \"Based on your past and present experience, how would you characterize the level of trust you have in the client representative with whom you had this disagreement?\" Response scale ranges from 0 to 10, anchored at: 0 \"Do not trust this individual\" and 10 \"Trust this individual completely.\" Qualitative Results As part of this study, we wanted to nd out the auditors' views on the importance of trust in the audit, and on managing the balance between trust and professional skepticism. Their responses on these issues are summarized in the next two sections.8 Auditors' Views on the Importance of Trust to the Audit Participants were asked, \"In your experience, how important is it for auditors to trust their clients?\" The response scale ranged from 0 to 10, with anchors 0 \"Not at all important,\" 8 Explanation groupings rst were induced from participant responses by one of the authors. Responses then were categorized into groups independently by each of the two other authors. Inter-rater reliability Cohen's kappa was 0.985 for the question on the importance of independence and 0.884 for the question relating to strategies to ensure that trust did not get in the way of professional skepticism. In situations where individual categorizations differed, an agreement was arrived at for a nal decision. Auditing: A Journal of Practice & Theory American Accounting Association May 2010 Exploring Trust and the Auditor-Client Relationship 289 5 \"Important,\" and 10 \"Very important.\" The mean response to this question was 8.20 standard deviation 2.19, which suggests a relatively high level of importance attached to auditors' trust of the client. Participants were asked to explain their answers. Sixty-six of the 71 participants provided 89 comments in response. The responses can be grouped into three types of explanations. Forty-two percent of the explanations comment on the impact of trust on the auditor-client relationship itself. More specically, they comment that trust is a minimal requirement for accepting a company as an audit client. Examples of the participants' comments in this category are: \"Trust implies integrity, which is a basic requirement for client acceptance\" and \"Complete trust in clients is not acceptable. However, basic trust must be present. Otherwise the auditor must decline the engagement.\" Thirty-seven percent of the comments describe the importance of trust to the efcient/ effective performance of the audit. Examples include: \"It would not be feasible to audit a client where the trust was lacking\" and \"Where little or no trust exists, the cost of an effective audit is prohibitive.\" The third group of comments 18 percent suggest that professional skepticism is important or that there should not be too much trust during the process of conducting audit procedures. These are examples of the comments in this category: \"Given the nature of work, while we must always maintain professional skepticism, if you do not have the basic trust that your client is doing all the right things, then we should resign from the account;\" \"I think trust ... is extremely important; however, in our role as auditor we still need to ensure we have the appropriate amount of skepticism tooso there is more to it than just trust.\" What is striking about the comments of these auditors is the complexity of interpersonal trust that an auditor holds for members of client management. A basic level of trust is needed to enter into an auditor-client relationship and to be able to conduct an audit, but the auditor must also exercise professional skepticism. Our concern was whether this trust can or does reach such a level as to compromise professional skepticism. One of our participants put it this way: \"If there is no trust, auditor should not accept/reaccept client. Having said that, auditing requires external evidence to support management's assessments; therefore complete trust is dangerous/problematic to remaining continually skeptical.\" How Auditors Ensure That Auditor-Client Trust Does Not Impede Professional Skepticism We also wanted to know how auditors ensure that trust in client representatives does not impede the exercise of professional skepticism. The participants were asked, \"What strategies do you use to make sure the trust you have for a client does not get in the way of professional skepticism?\" Seventy of the 71 participants provided 91 comments in response. The comments can be grouped into two general themes. The comments relate either to the audit process 60 percent of the responses or to the auditor's attitude/mindset 40 percent of the responses when conducting the audit. Examples of responses that focus on a rigorous audit process are: \"Ensure that we have an appropriately planned audit that looks at all risk and signicant areas\" and \"Very rigorous/uncompromising internal standards for independence, training and audit le completion.\" Examples of responses focusing on specic process-related strategies include: \"Do necessary audit work and do not hesitate to push back,\" \"Communicate the auditor responsibilities in conducting an audit,\" and \"Have my decisions reviewed on a regular basis.\" The second major theme of the participants' responses relates to attitude or mindset. The areas discussed included exercising professional skepticism, maintaining an objective/independent attitude, putting trust aside when conducting the audit, understanding client motivation, developing a culture of quality in the accounting rm, keeping the perspective of the shareholder in mind, and Auditing: A Journal of Practice & Theory May 2010 American Accounting Association 290 Rennie, Kopp, and Lemon maintaining an attitude of professionalism. Illustrative responses include: \"Do not become a 'friend'\" and \"Our rst duty is to the shareholders to be their 'eyes' and report faithfully and truthfully no matter how difcult that is.\" LIMITATIONS A limitation of this study is that we rely on the recall of disagreement incidents by participants. This reliance brings with it the risk that the events were recalled inaccurately or in a biased manner. Moreover, the respondents recalled unique incidents which varied in recentness. Counterbalancing this issue is that anchoring recall on a particular incident a concrete event enhances recall relative to situations where no anchor is used Levin et al. 2006. A second major type of limitation is that this study examines a limited number of potentially important variables that may affect client trust. As a result, this is an exploratory study. We do not mean to suggest that other variables may not be important. Finally, the usual limitations of eld studies also apply to this study, and so results should be interpreted with this in mind. CONCLUSION Auditor trust of client management is essential to the efcient, effective conduct of an audit. Yet the auditor must also act with professional skepticism. In this study we explore factors that can affect auditor trust of client management. We nd that the degree of openness of communication and demonstration of concern displayed by a client representative during a disagreement are associated with the trust that an auditor has for that individual. We also nd that the frequency of disagreements and the length of association are associated with auditor trust. We believe this study, which is the rst to use actual auditor-client situations to examine auditor-client trust rather than trust assessed through experiments based on hypothetical scenarios, has contributed to two literatures. It adds to the edgling literature on auditor-client trust. The study also contributes to the literature on interpersonal trust and, in particular, trust in conict scenarios. Other work in this area Korsgaard et al. 2002 explored trust of a manager by an employee in the context of a disagreement about the employee's job and in relationship to the fairness of human resources policies. Until the current study, trust inuences associated with the behaviors of parties to a disagreement in a relationship other than an employer-employee relationship and the power disparity implied by that relationship had not been studied. We show that similar effects can be observed in a professional relationship that is not dened by a superiorsubordinate structure. Our study suggests some potential implications for audit practice and some fruitful areas for further research. In particular, the results suggest that it is desirable for auditors and auditing standard setters to be aware of factors that may lead to greater auditor trust of client management and to perhaps consider whether there may be a potential for excessive trust to overwhelm the auditor's professional skepticism. Further research into auditor trust and professional skepticism may identify a need to augment existing guidance on professional skepticism to specically address the trust issue. At the same time, we wish to emphasize that we were not, in this study, able to determine whether the levels of trust that auditors had for the client representative were such that the auditor's judgment would be compromised. This renement can be a subject of future research. Another interesting area would be to explore whether there is a potential relationship between trust and independence, as trust may be relevant to the \"familiarity threat\" to independence. Prior research Bamber and Iyer 2007 nds that auditor tenure is positively related to the auditor's identication with the audit client and ultimately with the auditor's acquiescence to the client. As the current study nds that auditor trust of a client representative is also associated with tenure, Auditing: A Journal of Practice & Theory American Accounting Association May 2010 Exploring Trust and the Auditor-Client Relationship 291 there may be some benet in further research that explores whether trust may inuence an auditor's identication with an audit client. At the same time, several of our participants identied an independent attitude as a source of protection against the potential for trust to compromise skepticism, which suggests another interesting facet of a complex issue. The current study was exploratory and examined a limited set of variables. Future research could build on the evidence provided in this study that suggests that ordinary behaviors that could happen during any disagreement, and aspects that are part of every auditor-client relationship, may inuence the trust an auditor feels for a client representative. 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However, users may print, download, or email articles for individual use. \"On the Timing of CEO Stock Option Awards,\" by Erik Lie Purpose: Previous literature documents conflicting results for executive stock options. Some studies report that stock options are timed opportunistically, while others do not find evidence of this. Are stock option awards granted objectively, or are executives timing their stock option awards retroactively? Hypotheses: The author develops what he refers to as a \"novel\" hypothesis. Rather than just test whether the stock options are timed opportunistically, meaning that they are timed with insider knowledge of future events, the author hypothesizes that the options are backdated. In other words, stock option awards are granted as of a previous date when the stock price is low. Data: The data for the sample is from the period 1992 - 2006. The final sample includes 5,977 grants. The sample is made of 1,426 scheduled grants, granted annually, 1,668 unscheduled awards, and 2,883 unclassified awards. Unclassified means that the author was unable to determine if the award is scheduled or unscheduled, but he concludes that most of these unclassified awards are probably unscheduled. Methodology: The author compares the abnormal stock price before and after the stock option is granted to the executive. He uses Logistic Regression and compares to a control sample. The model predicts whether the abnormal returns identify the official grant, or one of the control observations. He also tests an earlier portion of the sample and compares it to a later portion of the sample to determine if the results have changed over time. Findings: There is a sharp reversal of the abnormal return immediately after the option pricing date. If the awards were not timed, the returns before and afterward would be normal. Instead, the author finds abnormally low returns before the award and abnormally high returns after the award is granted. The executives take advantage of an abnormally low option price on their award, which earns them more money. He finds that this result is stronger in later years, which indicates that the executives have increased this activity over time. This may explain why earlier studies did not find such strong evidence of the executives' activity. The most important finding is that it is statistically unlikely that option prices were determined according to a scheduled pricing date; they were most likely backdated. Implications: Although the author finds that firms are probably backdating options, he cautions that this may not be precluded by the official wording in the executives' contracts. Furthermore, even though the backdating is evident in this aggregate analysis, it is not possible from this study to determine specific firms or executives might have backdated their options. Investors in the market should be concerned that executives are receiving higher compensation by backdating options. Actually, this article sparked a wave of restatements. Short Explanation: CEO's are paid with stock options. In most cases, they are given shares of their firm's stock as a bonus, which they can sell later on for cash, say, 1,000 stock options. If the CEO gets the stock when the price is $50, and they sell later when the price goes up to $70, then the CEO get $20 for every stock option. The $50 is referred to as the \"strike price,\" and, of course, CEO's would like that price to be as low as possible so they will make more money selling the options in the future: buy low, sell high. What Erik Lie found was that some firms were making it easier for CEOs to have a lower strike price. Instead of taking the stock price on the day the options were to be given to the CEO, firms were looking into the past stock prices and making the option effective as of a day when the price was lowest. That way, the CEO would earn more money on the sale. My Opinion: This is a favorite article of mine because of the impact it had in the real world. It is also evidence of CEO Power over the board of directors as board members are willing to allow \"favors\" to the CEO as reciprocity for being elected or reelected as board members