Logic would suggest that if you want better audits, give auditors a bonus for high-quality work – a pay incentive is bound to work. But that’s not quite what researchers found when they looked at the way bonuses affect auditors.
What they unearthed was a complex picture in which some auditors up their game when offered a bonus, while others, notably Big Four auditors, see their work undermined. Coming at a time of intense focus on audit quality, the findings may have big implications for the way firms understand how to motivate and incentivise auditors.
Academics Herman van Brenk and Barbara Majoor of the Nyenrode Business University in the Netherlands came to their conclusions after conducting an experiment involving 420 Dutch audit professionals ranging from those described as ‘audit staff’ to ‘audit managers’. The experiment asked them to consider a plc company in need of a €3m accounting adjustment and which of five additional audit procedures they would carry out considering performance materiality for the organisation is €4.8m.
An expert panel was convened to score the participants on the quality of their audit plans based on a scale of 1 (not very effective) to 7 (very effective). The scenario was further modified by either including, or excluding, the offer of a bonus and by modifying external pressures, such as budget constraints or regulatory pressure for quality. The researchers call this ‘cost-quality’ pressure.
The experiment’s findings may surprise those who assume monetary incentives are an easy route to higher-quality work
Participants were also categorised by three types of motivation: intrinsic drive, reward responsiveness and fun seeking.
The experiment’s findings may surprise those who assume monetary incentives are an easy route to higher-quality work. Bonuses increased the quality of work from auditors with ‘lower’ intrinsic drive levels, but decreased the quality of work from auditors with higher levels of intrinsic drive. Bonuses seemed to make no difference to auditors motivated by ‘reward responsiveness’ or ‘fun seeking’ impulses.
In an audit with high cost-quality pressures, bonuses make little difference to auditors with any of the three forms of motivation. However, bonuses seemed to stimulate ‘audit managers’ while undermining the work of ‘audit staff’.
Impact on Big Four
But the headline news is the effect bonuses may have on Big Four auditors. The researchers found that the ‘effects of an audit quality bonus are weaker for Big Four participants than for non-Big Four participants’.
Bonuses have become an increasing feature of audit work and the search for higher-quality audits. Van Brenk and Majoor report that the Big Four have been using bonuses for non-partner employees since 2015. They say even regulators have emphasised that an audit firm’s compensation plan is a signal of their ‘commitment’ to audit quality.
And quality has been a concern of policy makers and regulators alike. The latest research findings come as the UK awaits major reforms of the audit sector following several high-profile scandals.
'Effects of an audit quality bonus are weaker for Big Four participants than for non-Big Four participants’
Government proposals based on a white paper, Restoring trust in audit and corporate governance, pointedly address audit quality concerns. Measures in the white paper to reform audit committees, the role of shareholders and the supervision of audit firms are all aimed at improving quality.
In April, the Financial Reporting Council, the UK’s audit regulator, launched a consultation on taking over registration and approval for the auditors of listed companies, a move also aimed at improving the quality of audit work.
Cognitive evaluation theory
But how can van Brenk and Majoor’s findings that bonuses work for some and not others be explained? One approach is to look at the work of psychologists and something known as ‘cognitive evaluation theory’, first described in 1975, which attempts to portray the way intrinsic motivation is affected by both personal qualities and externalities.
The theory says financial rewards could damage the motivation of individuals with a high level of intrinsic drive because they feel it ‘undermines feelings of autonomy and self-determination’, or even their competency. Bonuses shift attention from being ‘intrinsically motivated’ to ‘motivated by money’, a change dubbed the ‘over justification’ or the ‘crowding out’ effect.
Other researchers have made findings that chime with the theory. A 2020 study by US researcher Daniel Zhou found that auditors are more focused on the ‘enjoyment’ of their work than ‘extrinsic incentives’. This ‘intrinsic’ motivation can, Zhou claims, mitigate the ‘distorting influence’ of other motivations (some of them no doubt less desirable).
It’s these factors that van Brenk and Majoor believe may be at play among auditors when presented with the possibility of a bonus for their work.
The writers conclude that, yes, a bonus may improve the quality of audit work, but the effect may only apply to auditors with lower levels of intrinsic motivation, and then when they are under low levels of engagement pressure.
‘This is an important finding,’ van Brenk and Majoor write, ‘because audit tasks are primarily qualified as quality-type tasks and auditing engagements are likely to be conducted under high time, budget and compliance pressures, indicating that the impact of an audit quality bonus is limited, at least in the context of our study.
‘Thus, when considering the implementation or continuation of audit quality rewards, it is important to acknowledge the typical audit environment in terms of cost-quality conflicts and the auditor’s level of drive, both of which can constrain effectiveness of those rewards.’
The quest for improvements to audit and audit quality is a major preoccupation for policy-makers around the world. While most focus on regulatory structures, van Brenk and Majoor shine a light on the way personal incentives might be used. It may not provide the full story, but it is a place to start.
The results of the study, Evidence on the Effects of an Audit Quality Bonus, are published in European Accounting Review