Principal provides capital and hires agent to manage resources.
Information asymmetry and conflicts of interest lead to information risk
for the principal.
Agent is accountable to principal; provides financial reports. Agent hires auditor
to report on the fairness of agent’s
financial reports. Agent pays auditor
to reduce principal’s information risk.
Auditor
Agent (Manager)
Principal (Absentee Owner)
Practice I N S I G H T
At the heart of a capital-market economy is the flow of reliable information, which investors, credi- tors, and regulators use to make informed decisions. Chief Justice Warren Burger gave his view of the significance of the audit function in a 1984 Supreme Court decision:
By certifying the public reports that collectively depict a corporation’s financial status, the indepen- dent auditor assumes a public responsibility transcending any employment relationship with the cli- ent. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public.
More than 30 years later, the message is the same—users of financial statements rely on the external auditor to act with honor and integrity in protecting the public interest.