read the both 2 files and answer question 1 and 2 on page 63 from Chapter 6 file with good answer
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International Journal of Auditing
Int. J. Audit. 8: 1–19 (2004)
A Grounded Theory Model of
Auditor-Client Negotiations
Vivien Beattie,1 Stella Fearnley2 and Richard Brandt2
1
Department of Accounting and Finance, University of Glasgow
Department of Accounting and Management Science, University of
Portsmouth
2
The central research question addressed in this paper is ‘How
do companies and their auditors resolve important audit
issues?’ In-depth interviews are conducted with the audit
partners and finance directors of a varied group of six major
UK listed companies who had recently experienced audit
interactions involving 22 significant accounting issues. A
grounded theory model is developed of the negotiation process
and the factors that influence the nature of the outcome of
interactions. This model identifies, as principal analytical
categories, a range of general relationship factors and specific
accounting issue factors that influence aspects of the
negotiation process. These aspects include the parties
involved, the strategies adopted, the quality of the financial
reporting outcome and the ease with which it is achieved. A
secondary outcome of the research is that distinct categories of
audit engagement partner are identified, termed the crusader,
the safe pair of hands, the accommodator and the truster.
Key words: Auditor-client interactions, audit conflict, audit
negotiations, grounded theory, negotiation strategy.
SUMMARY
Companies’ aggressiveness in financial reporting,
and the role of auditors in constraining this, are
important contemporary topics (Levitt, 1998;
APB, 2001). Very few studies, however, examine
the process of negotiation between auditors and
directors. Although generic negotiation models
capture many aspects of this process (e.g.,
exchange of information, appeal to norms,
strategies and tactics adopted), such models (e.g.,
Gulliver, 1979) are under-theorised given the
Correspondence to: Department of Accounting and Finance,
University of Glasgow, 65-73 Southpark Avenue, Glasgow G12
8LE. Email: V.Beattie@accfin.gla.ac.uk
complexity of the auditor-client relationship and
require further development. To date, the only
behavioural study to adopt a qualitative, case
study based approach using real audit negotiations
is Beattie et al. (2001), reported in a book titled
Behind Closed Doors: What Company Audit is Really
About. A grounded theory model of the negotiation
process was developed and the purpose of this
paper is to summarise the findings of that study,
making it accessible through the scholarly journal
literature.
Matched interviews were conducted with
the finance directors (FDs) and audit engagement
partners (AEPs) of six major UK listed companies
who had recently engaged in significant
discussions and negotiations. Interviewees were
asked to ‘tell the story’ of these interactions. The
ISSN 1090–6738
Received December 2002
© Blackwell Publishing Ltd 2004. Published by Blackwell Publishing, 9600 Garsington Accepted December 2002
Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
2
analytical procedures followed enable concepts to
be identified and grouped into categories. The
interaction itself is the core category of the
grounded theory analysis. It is a process involving
events, strategies, outcome and consequences. The
nature of the interaction is influenced by the specific
context of the interaction: the issue, the objectives
of the individual parties, key third parties and
other factors. This specific context in turn
moderates powerful general contextual factors:
the quality of the primary relationship, company
circumstances, audit firm circumstances and
company buyer type. The external economic and
regulatory setting has a significant but more
peripheral impact.
The primary contextual factors affecting the
strategy adopted by each party and the nature of
the outcome appeared to be general, rather than
specific. High AEP integrity ensured an outcome
quality above a certain threshold, although the
ease of agreement depended upon other factors.
A quality hierarchy of six seller types is
hypothesised. The quality of the primary
relationship impacted directly upon both the
quality of the outcome and the ease of agreement.
Other critical general factors were: company type
and situation (e.g., conservative or aggressive, the
possibility of a bid); the effectiveness of corporate
governance arrangements in the company (e.g.,
powerful, dominant chairman); the clarity of the
accounting rules relating to the interaction issue;
and the support and quality control procedures
of the audit firm. The strategy adopted by the
AEP was an intervening variable: assertiveness,
reasoning, coalition and sanction strategies were
associated with good outcomes and ingratiation
and conditional acceptance were associated with
poor outcomes.
A secondary outcome of the study was the
identification of a hierarchy of six seller types (i.e.
AEP types) to complement the taxonomy of buyer
types that already exists in the literature. This
taxonomy reflects an AEP’s level of professional
and personal integrity, their level of technical
competence and other personal characteristics
(such as predisposition towards self-reliance,
confrontation and scepticism).
INTRODUCTION
Companies’ aggressiveness in financial reporting
is an important contemporary topic. In a now
famous speech titled The Numbers Game, a former
© Blackwell Publishing Ltd 2004
V. Beattie et al.
Chairman of the SEC lambasted companies for
manipulating accounting numbers and thereby
eroding the quality of financial reporting (Levitt,
1998). The fundamental importance of this issue
has, since the Enron affair, become more widely
recognised. Debate has focused upon the general
regulatory environment and factors specific to the
auditor-client relationship (i.e. client company,
audit firm and individual auditor factors).
The general regulatory environment reflects the
particular regulatory control strategy adopted, a
choice often characterised as the ‘principles versus
rules’ debate. ‘Formalism’ implies a narrow
approach to control, that is, the use of clearly
defined, highly administrable rules, which carries
the danger of ‘creative compliance’ (i.e. the use of
rules to escape control without actually violating
those rules). An anti-formalism strategy involves
stressing the overriding purpose of financial
accounting in terms of the true and fair view
override (in the UK), the use of broad criteria and
the avoidance of tight definitions. It can be
criticised on the grounds of legitimacy (it being
argued that citizens have the right to know exactly
what is prohibited in advance of behaviour),
imprecision, and the possibility of outrageous
results (McBarnet & Whelan, 1991; 1992).1
McBarnet & Whelan (1999) conclude that
controlling creative accounting ultimately depends
on instilling a business ethic of compliance within
the spirit of the law.
The auditor-client relationship dimension of
the debate on aggressive financial reporting is
extremely complex. A key question is ‘How do
companies and their auditors resolve important
audit issues?’. In particular, what role do auditors
play in preventing overly aggressive financial
reporting? In the UK, the Auditing Practices Board
has issued a consultation paper that encourages
auditors to be more alert and responsive to the
risk of aggressive earnings management (APB,
2001). Specifically, auditors are encouraged to
understand better the pressures on directors and
management to deliver a specific level of earnings;
to act with even greater scepticism; to place greater
emphasis on the broader factors influencing
materiality; to take a more robust attitude with
directors; and to communicate openly and frankly
with those charged with governance.
The audit firm-client company relationship
(hereafter auditor-client relationship) has certain
distinguishing features. The audit team must
interact with the employees and management of
Int. J. Audit. 8: 1–19 (2004)
A Grounded Theory Model of Auditor-Client Negotiations
the client company, obtaining information and
explanations, with a view to preparing an audit
report for the company’s shareholders. Added to
this, senior company management have de facto
control over the appointment and remuneration
of the auditor. A company’s audited financial
statements emerge from the interactions that take
place between, primarily, the finance director and
the audit engagement partner. These interactions
can involve conflict, which leads in turn to
negotiations and perhaps bargaining.
Many empirical academic studies have
investigated the factors that influence (or are
perceived to influence) an auditor’s ability to resist
management pressure (e.g., Knapp, 1985; Gul,
1989; Beattie et al., 1999) and auditors’ response
to ethical dilemmas (e.g., Lord & DeZoort, 2001;
Shafer et al., 1999, 2001; Thorne & Hartwick,
2001). These studies use large-scale survey or
experimental methods. However, very few studies
examine the process of negotiation and (due to
access problems) virtually none uses evidence
drawn from real situations. It is only in recent years
that a new strand of empirical behavioural
research has emerged that possesses one or other
or both of these desirable characteristics (Gibbins
et al., 2001; Beattie et al., 2000; Goodwin, 2002).
To date, however, the only behavioural study to
adopt a qualitative, case study based approach
using real negotiations has been Beattie et al. (2001).
Matched, in-depth interviews were conducted
with the audit partners and finance directors of
six major UK listed companies who had recently
experienced
audit
interactions
involving
significant accounting issues. A grounded theory
model was developed of the negotiation process
and the factors that influenced the nature of the
outcome of interactions. The study is reported in a
book titled Behind Closed Doors: What Company
Audit is Really About. Within this book, a chapter is
devoted to presenting the interview evidence from
each of the six case studies, and the process of
development of the grounded theory is set out in
detail. This permits the ‘huge chasm’ that often
separates data from conclusions to be bridged
(Eisenhardt, 1989, p. 539).
In this paper, the grounded theory model of the
auditor-client negotiation process that emerged
from the case study analysis is presented. This
makes the findings accessible through the journal
literature. In writing this summary paper, the
opportunity is taken to update the review of
related literature.
© Blackwell Publishing Ltd 2004
3
The remainder of this paper is structured as
follows. The next section, a review of relevant
literature, begins by examining negotiation,
conflict and strategies in non-audit settings. It then
reviews the limited prior and contemporaneous
literature in audit settings that either examines the
process of negotiation or collects real-life data on
actual negotiations. Methods are briefly outlined in
the third section. The fourth section of the paper
presents the grounded theory model of auditorclient interactions. A final section summarises and
concludes.
RELEVANT LITERATURE
Negotiation, conflict and strategies in
non-audit settings
The generic process of negotiation (and related
concepts) has been the subject of detailed analysis
in the social sciences. ‘Negotiation’ is defined as
‘processes of interaction between disputing
parties whereby, without compulsion by a thirdparty adjudicator, they endeavour to come to
an interdependent, joint decision concerning the
terms of agreement on the issues between them’
(Gulliver, 1979, p. 79, emphasis in original).
Negotiation encompasses ‘bargaining’, which
‘consists of the presentation and exchange of
more or less specific proposals for the terms
of agreement on particular issues’ (Gulliver,
1979, p. 71).
The problem faced by negotiators is that of
‘being interdependent while having interests
which are in contrast to those of the other
party’ (Mastenbroek, 1989, p. 56). In addition,
‘negotiating presumes a certain symmetry in the
balance of power’ (Mastenbroek, 1989, p. 63).
‘Power’ can be defined as ‘the ability of one actor
to overcome resistance in achieving a desired
result’ (Brass & Burkhardt, 1993). ‘Conflict’ can
be defined as ‘the interaction of interdependent
people who perceive the opposition of goals, aims,
and/or values, and who see the other party as
potentially interfering with the realization of
these goals (aims, or values)’ (quoted in Nicotera,
1993).
Gulliver (1979) develops, from actual cases
spanning a wide range of contexts, an analytical
framework that captures the economic, social, and
psychological aspects of the negotiation process. It
is a non-game model that recognises two general
processes in negotiation that create and sustain
Int. J. Audit. 8: 1–19 (2004)
4
the internal dynamics: a cyclical process and a
developmental process.
The cyclical process involves the ongoing
exchange of information between the parties
(perhaps incorporating information from third
parties). The kind of information exchanged
depends on the current phase of negotiation, and
may include information about procedural rules,
appeals to norms, factual information, threats and
promises. When a party receives information, they
assess it, adjust their own preference set and their
expectations of the other party, and revise their
overall strategy. They then make a tactical decision
about what information to pass to the other party.
Typical tactics are: to concentrate on obtaining
further information; to change the subject matter of
the information exchange when a current issue
seems threatening; to focus on the affective tone of
the relationship; to match the behaviour of the
other party, for example offer antagonism for
antagonism; to offer opposing behaviour to that of
the other party; and to make concessions.
The developmental process occurs through
successive iterations of this cycle, as they drive the
negotiation through a number of overlapping
phases. The causes of convergence and the nature
of the outcome can often be explained in terms of
appeals to norms and other sources of power. It is
the conversion of potential power into effective
persuasive strength (not actual power) which is
important.
Negotiation strategies and tactics are examined
by Kipnis et al. (1980), who undertake an empirical
study of managerial use of influence within
organisations. They first asked managers to
describe actual incidents and from this constructed
a questionnaire containing 58 influence tactics.
Responses to this questionnaire were factor
analysed to reveal seven dimensions of influence.
Kipnis & Schmidt (1982) developed a new scale to
measure these seven influence strategies: reason
– the use of facts and data to support the
development of a logical argument; coalition – the
mobilisation of other people in the organisation;
ingratiation – the use of impression management,
flattery and the creation of goodwill; bargaining –
the use of negotiation through the exchange of
benefits or favours; assertiveness – the use of a direct
and forceful approach; higher authority – gaining
the support of higher levels in the organisation
to back up requests; and sanctions – the use
of organisationally derived rewards and
punishments.
© Blackwell Publishing Ltd 2004
V. Beattie et al.
Negotiation in audit settings
Analytical models of auditor-client bargaining
have tended to be abstract, economic, gametheoretic models (e.g., Fellingham & Newman,
1985; Zhang, 1999). Over a decade ago, Murnighan
& Bazerman (1990) argued that more behavioural
research was needed if we were to further our
understanding of negotiation behaviour. Despite
this plea, limited work of this nature has been
undertaken.
Other, non-analytical models have been
developed. Kleinman & Palmon (2001) focus
broadly on auditor-client relationships, with a
particular emphasis on auditor independence.
They synthesise extant research on auditor-client
relationships and use this platform, together with
established theories from the field of social
psychology, to construct a multi-level model of
these relationships. The levels considered are
those of the individual, the audit firm (together
comprising the micro model) and the wider
environment (the macro model). The linkages
between the different elements of the model and
between the micro and macro levels are not really
addressed and, as a result, the model is essentially
a synthesising framework. Recognising some of
these limitations, the authors call for more
qualitative, case study research of auditor
behaviour (p. 135).
Gibbins & Salterio (2001) develop a cognitive
model of the auditor’s intended strategy in
auditor-client negotiations. They identify, from
the generic bargaining literature, two principal
strategies – distributive and integrative. Each has
an associated range of tactics. Distributive tactics
include concession-making and contending, while
integrative tactics include creative problem solving
and expanding the agenda. Three principal factors
influencing intended bargaining strategy are
defined: individual issue assessment, auditor
motivation and auditor relative bargaining power.
Each is presented, for simplicity of exposition, as a
dichotomy: overlap/non-overlap between auditor
and client acceptable ranges; toward-auditorfavoured outcomes versus toward-client-favoured
outcomes; strong versus weak, respectively.
Assuming cognitive economy (i.e., a simple
strategy is preferred to a complex one) and
manipulating auditor motivation and bargaining
power factors, predictions are made regarding
the general strategy and specific tactics that will
be employed.
Int. J. Audit. 8: 1–19 (2004)
A Grounded Theory Model of Auditor-Client Negotiations
Two quantitative, questionnaire studies of
interactions and negotiations have been
undertaken. Gibbins et al. (2001) survey ninetythree experienced Canadian public accounting
firm partners, who were asked to respond in
the context of a specific negotiation example
selected from their experience. They find that
agreement was reported to have been reached
somewhere between both parties’ original
positions in 41% of cases, on the auditor’s original
position in 32% of cases, and on the client’s
original position in 4% of cases. A new solution
was generated in 16% of cases. The two factors said
to be of most importance to the negotiation
were ‘accounting and disclosure standards’
and ‘audit firms’ accounting expertise’. They
conclude that negotiation is important, frequent
and context-sensitive. Client perceptions were
not surveyed and so no comparison can be made
between the responses of the different parties.
The questionnaire is structured using a threeelement accounting negotiation process model
based on the behavioural negotiation literature and
elaborated to include accounting contextual
features.
Beattie et al. (2000) survey 300 listed UK
company finance directors and 307 listed company
audit engagement partners (response rates were
51% and 80%, respectively). This survey
established the frequency with which, over a threeyear period, an extensive set of 46 audit and auditrelated issues was discussed, was negotiated, and
resulted in a change to either the accounting
numbers or disclosures. This large-scale survey
allows the extent, nature and outcome of
interactions to be assessed for the population
as a whole. Compliance issues are found to
dominate discussions, while accounting and fee
issues dominate negotiations. In aggregate,
auditor/auditee interactions have a significant
impact upon the content of financial reports, the
mean number of reported changes to the
accounting numbers (disclosures) being 1.3 (2.9)
and 3.4 (6.1) for the FD and AEP groups,
respectively.
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