Learning from others’ deficiencies: How group affiliation and election basis jointly affect auditors’ effective use of inspection feedback

Abstract

Both external and internal inspectors typically select audit engagements to inspect using a risk-based approach (i.e. they pick those they predict are more likely to have deficiencies). While reducing the amount of resources needed to find audit deficiencies, this approach can perversely influence the behavior of non-inspected auditors who read the inspection feedback. Using social identity theory and attribution theory, I predict that auditors’ effective use of inspection feedback depends on whose engagements are inspected (more vs. less closely affiliated auditors) and how the engagements are selected (risk vs. random basis). I predict and find that auditors identify more strongly with the inspected auditors when inspections are risk-based or pertain to more closely affiliated auditors (e.g., same office). This stronger identification triggers defensive attributions, decreasing the perceived value of the report, and reducing the degree to which they employ corrective action that addresses inspector feedback in their own audits. Random selection is more neutral in nature, reducing identification and improving incorporation of inspection feedback, but only when the feedback is for less closely affiliated auditors. Implications for auditors, audit firms, and regulators are discussed.