1-3
Chapter Assignment 1: Review Question 1-2
Discuss why there is a demand for auditing services in a free-market economy. What
evidence suggests that auditing would be demanded even if it were not required by
government regulation?
There is a demand for auditing in a free-market economy because the agency relationship
between an absentee owner and a manager produces a natural conflict of interest due to the
information asymmetry that exists between the owner and manager. That is, the manager
generally has more information about the "true" financial position and results of operations of the
entity than the absentee owner does. If both parties seek to maximize their own self-interest, it is
likely that the manager will not act in the best interest the of owner. As a result, the agent agrees
to be monitored as part of his/her employment contract. Auditing appears to be the most costeffective form of monitoring. (Messier, 2011)
The empirical evidence suggests auditing was demanded prior to government regulation. In
1926, independent auditors audited 82 percent of the companies on the New York Stock
Exchange. Additionally, many private companies and municipalities not subject to government
regulations such as the Securities Act of 1933 and Securities Exchange Act of 1934 also demand
auditing. (Messier, 2011)
Reference:
Glover, Steven m., Messier, William F., & Prawitt, Douglas F., (September, 2011) Auditing and
Assurance Services: A Systematic Approach. The McGraw-Hill Companies, Inc., New
York, NY