371
CAN OVERSIGHT MITIGATE AUDITOR’S 
MOTIVATED REASONING?
AN EXPERIMENTAL STUDY* 
SERGEJA SLAPNIČAR
1
 Received: 18 June 2015
IGOR LONČARSKI 
2
 Accepted: 4 September 2015
MAJA ZAMAN GROFF 
3
     
ABSTRACT: Evidence of auditors’ failure to provide an independent opinion has reopened 
debates on measures to ensure auditor independence. We examine the effectiveness of oversight 
on two prominent determinants of auditor’s biased opinion – financial incentives and a 
personal relationship with the client. We conduct a between-subject experiment involving an 
accounting choice task. We find a significant effect of a personal relationship on the auditor’s 
choice after controlling for financial incentives. Oversight has a significant negative effect on 
auditor’s choice arising from financial incentives, whereas a personal relationship significantly 
reduces the effectiveness of oversight. Our results show that, in addition to oversight, other 
solutions that break up personal ties are needed to ensure auditor independence. 
Keywords: auditing, bias, financial incentives, motivated reasoning, oversight, personal relationship
JEL Classification: M48, M42
DOI: 10.15458/85451.7
1. INTRODUCTION
The recent global financial crisis has shaken users’ confidence in financial statements (Sik-
ka, 2009; Richard, 2008). Sikka (2009) reports that many distressed financial institutions 
in different countries received unqualified audit opinions on their financial statements 
just prior to publicly declaring financial distress. Prior to the financial crisis, the account-
ing profession underwent a profound regulatory reform in the U.S. (Sarbanes-Oxley Act 
of 2002) as well as in the EU (Directive 2006/43/EC). One of the most radical measures of 
the reforms was the introduction of public oversight. It was expected that effective pub-
lic oversight would mitigate the negative effects of auditor dependence. Recent evidence 
shows that the quality of auditing and the quality of financial reporting have improved 
* We would like to thank Allen Blay, Kathryn Kadous, Don Moore, as well as discussants and participants at 
European Accounting Association Meeting 2012, American Accounting Association conference 2012, and 
Infiniti 2014 conference for valuable comments and suggestions.
1 University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia, e- mail: Sergeja.slapnicar@ef.uni-lj.si
2 University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia, e- mail: Igor.loncarski@ef.uni-lj.si
3 University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia, e- mail: Maja.zaman@ef.uni-lj.si
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since the Sarbanes-Oxley Act was passed (DeFond & Lennox, 2011; Carcello et al., 2011; 
Chambers & Payne, 2011). 
In spite of these positive developments, new regulatory debates have been initiated due to a 
continuing concern that the last regulatory changes did not succeed in effectively enforcing 
auditor independence and mitigating the vital drivers of an auditor’s conflict of interest. The 
issue of audit tenure was revisited by the European Commission Green Paper (2010: 11), 
where the Commission recognised that “situations where a company has appointed the same 
audit firm for decades seem incompatible with desirable standards of independence”.
The reason that audit firm rotation debates have regained relevance lies in the essence of the 
threat to auditor’s independence. Although several studies provide evidence of a positive 
relationship between audit firm tenure and audit quality (Myers et al., 2003; Johnson et al., 
2002; Geiger & Raghunandan, 2002; Carcello & Nagy, 2004; Ruiz-Barbadillo et al., 2009), 
explaining it with the learning process, a number of other studies point out that auditors 
are inclined to serve their client’s interests, in particular in long-lasting relationships with 
ambiguous accounting choices (Hackenbrack & Nelson 1996; Kadous et al., 2003; Shafer et 
al., 2004; Blay, 2005; Kadous et al., 2008; Moore et al., 2010, Chu et al., 2011). As argued by 
Callao and Jarne (2010), the scope for ambiguity has increased with the adoption of IFRS in 
Europe. A biased judgment arises from an interpersonal auditor-client relationship which 
makes an auditor hesitant to act with professional rigor in order not to impair the relation-
ship with the client (Johnstone et al., 2001). Some scholars believe that in order to restore the 
integrity of the audit function audit firms (not just lead auditors) should work on a contract 
for a fixed number of years (Bazerman & Moore 2011: 310)
4
.
The aim of our study is to shed more light on the intentionality of auditor bias.  Financial 
incentives and a personal relationship create so-called directional goals that elicit motivated 
reasoning (Kunda, 1990). These goals drive individuals to process information in a biased 
manner, seemingly achieving objective support for the desired goal (Kunda, 1990; Blay, 
2005). One of the controversies of motivated reasoning lies in the question of whether it oc-
curs intentionally (consciously) or unintentionally (i.e. without awareness). As stressed by 
Bazerman et al. (2006), the distinction of the intentionality of the bias is key to regulatory 
intervention not only because such a distinction offers an insight into the effectiveness of 
various prevention measures, but also because it is only intentionality that gives grounds for 
legal charges.
While Kunda (1990) and Nelson (2005) propose that people are not aware that their informa-
tion processing is biased by their goals, empirical evidence in accounting settings suggests 
that professionals are sensitive to high practice risks (Farmer et al., 1987; Lord, 1992; Blay, 
2005; Kadous et al., 2008). Such sensitivity implies that this bias is, at least to some extent, 
deliberate. As biases are hard to observe with standard research methodology, the studies do 
4 In April 2014, after four years of discussions, the EU adopted mandatory audit firm rotation for public-interest 
entities. This calls for a mandatory audit firm rotation after 10 years of audit firm engagement with an option of 
prolongation for another 10 years when specific criteria are met (Regulation 537/2014 of the European Parlia-
ment and of the Council on specific requirements regarding statutory audit of public-interest entities).

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not distinguish which of the two conditions – financial incentives or personal relationship – 
accounts for each type of bias. Most studies investigate either financial incentives (Farmer et 
al., 1987; Lord, 1992) or personal relationships (Blay, 2005; Bamber & Iyer, 2007), whereby 
the motives arising from a personal relationship may also be trimmed down to financial 
dependence. Although biases arising from a personal relationship have been investigated in 
(social) psychology (Milgram, 1974; Neuberg & Fiske, 1987; Kunda, 1990), corporate govern-
ance (Morck, 2008) and auditing (Bamber & Iyer, 2007; Moore et al., 2010), they are much 
less understood. To the best of our knowledge, the only study to simultaneously analyse the 
effects of financial incentives and a personal relationship on auditor choice is by Moore et al. 
(2010). The authors suggest that a personal relationship elicits non-conscious bias. Although 
the results of their experimental study do not confirm such a hypothesis, they show that 
auditors are inclined to serve their client and that they cannot entirely de-bias their actions. 
Without neurological analysis it is difficult to discern conscious bias from non-conscious 
bias. To some extent, however, their presence may be observed behaviourally by varying the 
auditor’s practice risk. The auditor’s tendency to serve the client’s preferences decreases with 
increasing practice risk such as a loss of reputation, litigation costs or licence withdrawal 
(Bauwhede & Willekens, 2004; Hope & Langli, 2010). The absence of practice risk is a limi-
tation of the Moore et al. (2010) study. Our study advances their analysis by proxying for 
practice risk in the form of public oversight. Assuming that individuals are not aware of non-
conscious bias, public oversight is expected to only mitigate conscious bias, while non-con-
scious bias should remain largely unaffected. Our results largely confirm our hypotheses. We 
find that a personal relationship affects the subject’s actions beyond financial incentives. The 
relevance of a personal relationship becomes evident in the interaction with the exposure of 
subjects to the oversight. A personal relationship significantly offsets the mitigating effect of 
oversight on auditor’s support for a client’s preference. 
The paper provides the following contributions to the literature. First, it adds to the theory of 
motivated reasoning and the relatively scarce empirical evidence of bias that arises in a per-
sonal relationship after controlling for financial incentives. Second, by studying the simulta-
neous effects of financial incentives, a personal relationship and the oversight risk, it advances 
previous findings and allows for a differentiation between biases that can or cannot be miti-
gated by the introduction of oversight. Finally, the finding that a personal relationship sig-
nificantly diminishes the effect of oversight may hold important implications for the debate 
on audit firm rotation, as well as corporate governance in general. Despite the fact that after 
four years of debates the EU regulation (Regulation 537/2014) has not introduced any form 
of effective audit firm rotation, our findings suggest that mechanisms to counter familiarity 
remain important. Their enforcement continues to lie in the hands of the decision-makers 
involved in the auditor appointment process (audit committees and boards of directors).
2. THEORETICAL BACKGROUND AND HYPOTHESES DEVELOPMENT
Auditor independence is considered a vital determinant of the integrity of financial re-
porting (Spira, 1999). Lee and Gu (1998: 534) define it as “the absence of collusion between 

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the auditor and the manager of the client firm”. Although the auditors are expected to sub-
ordinate their self-interest in favour of the public interest, different threats to auditor inde-
pendence and their impact on earnings management have been thoroughly investigated in 
the accounting and auditing literature. While agency theory stresses intentional distortions, 
behavioural literature points out that auditor bias arises from the cognitive limitations of 
individuals (Blay, 2005; Kadous et al., 2008). 
Kadous et al. (2003) explain the mechanisms of auditor decision-making with emotion-based 
motivated reasoning. When a person perceives that his or her outcome depends in some way 
on the actions taken by another person, such outcome dependency creates a directional goal. 
A directional goal, in turn, influences the cognitive process of reasoning by affecting the type 
of information that someone will consider, its evaluation and interpretation. As Kunda, the 
author of the motivated reasoning account, explains, the confusing fact is that a person is able 
to provide evidence to support his or her (biased) decision without realising the bias: “The 
objectivity of this justification construction process is illusory because people do not realize that 
the process is biased by their goals, ... they might even be capable of justifying opposite conclu-
sions on different occasions” (Kunda, 1990: 486). In the audit setting, the more auditors aspire 
to benefit from their support for their client’s preferences, the more likely it is that they will 
find sufficient evidence and interpret it in a way that is aligned with the client’s preferences. 
A necessary condition for motivated reasoning is the ambiguity of the choice. If the preferred 
choice cannot be seemingly objectively justified, individuals will not take it, regardless of 
their commitment to a directional goal (Kunda, 1990). 
Two major conditions that create directional goals in auditing are contingent financial incen-
tives and a personal relationship with the client (Nelson, 2005, 2006; Blay, 2005; Moore et al., 
2010). The client’s ability to influence auditor reporting decisions is stronger if the incumbent 
auditor perceives the client as a source of perpetual annuity (Gul, 1991; Seabright et al.,1992; 
Acemoglu & Gietzmann, 1997; Ruiz-Barbadillo et al., 2009).
To promote independence and disconnect auditors from the interests of the management, 
auditors receive a fixed fee for their services. Nevertheless, their financial incentive is implic-
itly variable. The nature of the auditor-client relationship creates a variable fee structure in the 
sense that a long audit tenure increases labour productivity as the auditor is increasingly more 
familiar with the client’s business and lower audit engagement is needed to perform an audit.
Overall, the stronger the auditor’s support for the client’s preferences, the more likely is the 
extension of the contract to future years. Johnstone et al. (2001) suggest that contingent fees 
(i.e. an implicit promise of future rents dependent on the auditor’s support for the client) di-
rectly threaten auditor’s independence. Hence, we propose the following hypothesis:
H1: Financial incentives increase the probability of the auditor’s support for the client’s prefer-
ences.
An alternative and/or complementary venue that affects biased decision-making is the nature 
of the relationship between the auditor and the client. Existing literature suggests different 

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drivers of a personal relationship on decision choice. Rennie et al. (2010) indicate that con-
tinuity of the auditor–client relationship results in a closeness between auditors and their 
clients and that it is positively related to the auditor’s trust in a client. Bamber and Iyer (2007) 
report that auditors who identify more closely with a client are more likely to consent to the 
client-preferred position. Similarly, Nelson (2009) and Johnstone et al. (2001) report that 
identification with a client leads to a low professional scepticism Neuberg and Fiske (1987) 
report that outcome dependency enhances the probability of a target person (i.e. a client) be-
ing liked. Liking somebody introduces emotions into the decision-making process that is no 
longer based purely on rational behaviour. 
An alternative explanation of the influence of a personal relationship on choice can be drawn 
from the field of social psychology, in particular from the work of Milgram (1974). He ar-
gues that humans have an instinctive predisposition for loyalty, an impulse to obey authority. 
Building on the work of Milgram (1974), Morck (2008) points out the predisposition of indi-
viduals for excessive loyalty (obedience) to the principal in the field of corporate governance. 
Excessive loyalty depends on the nature of the personal relationship between the agent and 
the principal. Applied to the lasting relationship between non-executive directors and execu-
tive managers, Morck (2008) spotlights the phenomenon of a so-called agentic shift accord-
ing to which non-executive directors become excessively subservient to executive managers 
due to a different effective distribution of power than what is formally defined. Parallels can 
be drawn to the relationship between the auditor and executive manager who may be seen 
by an auditor as a principal (authority). Shafer et al. (2004), for example, provide evidence 
that auditors consider it perfectly appropriate to align their judgment regarding choices of 
accounting principles with that of their clients.
Related to the effects of a personal relationship on a subject’s choice, we hypothesise that: 
H2: A personal relationship increases the probability of the auditor’s support for the client’s pref-
erences.
The two drivers inducing auditor bias are, however, essentially different. The preferences in-
fluence decision-making in various ways, some of which the decision-maker (auditor) may 
have some insight into, but for many he does not. A cue to bias awareness may be obtained 
by varying auditor practice risk and by simultaneously estimating how it interacts with both 
drivers of bias. A regulatory measure in the form of public oversight of auditors is supposed 
to represent such a practice risk. The oversight may result in litigation costs, licence with-
drawal and negative reputation effects (all leading to the loss of future business). Prior experi-
mental studies unanimously show that, while serving their clients, auditors and tax advisors 
are sensitive to the variation of risks that might threaten their own interests (Farmer et al., 
1987; Lord, 1992; Hackenbrack & Nelson, 1996; Cloyd & Spilker, 1999; Kadous et al., 2003; 
Shafer et al., 2004; Blay, 2005; Kadous et al., 2008). However, the susceptibility of auditors to 
different drivers of bias is not explicitly addressed. This distinction is important as the over-
sight is more likely to reduce the bias that an individual is aware of, but less likely to mitigate 
the bias of which an individual is unaware of. 
A closer examination of manipulation conditions in previous research shows that a per-
sonal relationship only captures the financial incentive dimension, rather than the affec-

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tive processes innate in long-lasting relationships. None of the studies has attempted to 
separate the financial and affective underpinnings of a personal relationship. Consequent-
ly, the finding that an auditor’s support for a client’s preferences could be effectively miti-
gated by introducing high practice risk may be attributable to the fact that the bias arose 
from financial incentives alone. However, the affective component of bias that arises from 
a personal relationship may be more resistant to oversight. We propose that oversight has 
a weaker impact on bias arising from a personal relationship (after controlling for finan-
cial incentive) because the auditor is not completely aware of that bias. 
In sum, based on prior findings we conjecture that oversight has a significant mitigating 
effect on choices arising from financial incentives. We suggest that this effect occurs be-
cause financial incentives are predominantly conscious. In line with the literature on per-
sonal relationships, developing affection for a person may be largely non-conscious. We 
therefore predict that bias arising from a personal relationship is less effectively mitigated 
by oversight. In other words, it reduces the effectiveness of oversight. 
Hence, we propose the following hypothesis: 
H3: The mitigating effect of oversight on auditor’s choice is more pronounced when that 
choice is motivated by financial incentives and less pronounced when the choice is affected by 
a personal relationship. 
3. EXPERIMENTAL SETTING
Participants. We analysed the hypotheses experimentally with a two-by-two-by-two, be-
tween-subjects design that involved a choice task. For this purpose, we recruited 312 students 
of the Faculty of Economics, University of Ljubljana. Subjects assumed the roles of auditors 
(217 students) or clients, i.e. Chief Financial Officers (95 students). Subjects playing the role 
of clients were used to create the atmosphere of auditor-client familiarity. To motivate the 
participants, we set up a compensation scheme in which they could earn between EUR 0 to 
EUR 6. Their expected compensation was EUR 3 for half an hour of activity, which rough-
ly represents the average hourly rate for student work. We recruited senior undergraduate 
(90%) and graduate (10%) accounting and finance students in order to assure that they were 
familiar with the task. Nevertheless, we had to exclude 12 subjects in the role of auditors from 
our final sample due to their answers provided in the manipulation checks. The final number 
of subjects in the role of auditors was 205 (44% female, average work experience 2.8 years). 
Procedure. The subjects in the role of auditors were either seated alone or matched in pairs 
with the subjects who assumed the role of the CEO of the client. The auditors were presented 
with the task of making a decision regarding the value of an asset on the company’s balance 
sheet. They could either approve the high valuation of the asset, as proposed by the client, or 
choose an alternative (lower) valuation, which was not in their client’s interest. Clients were 
given the same scenario with the task to persuade the auditor to approve the valuation in their 
interest. Two alternative values of the investment were measured with a valuation model. In 
the first model, a more realistic assumption about the growth of cash flows was used, which 

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produced a lower value of the investment. In the second model, a very aggressive assumption 
about the future growth of cash flows was incorporated, yielding a higher value of the asset 
in favour of the client. In the first five minutes of the experiment, the auditor-client pairs 
were instructed to discuss personal matters in order to create an atmosphere of familiarity. 
They then read the case and learned their task. In the next ten minutes they were asked to 
discuss the valuation and the auditor’s decision. After the discussions the auditors indicated 
their decision. The client’s reward was calculated on the basis of the auditor’s response. In the 
subgroup without the presence of the client the auditors took their decisions without any cli-
ent interaction. Finally, following the experimental task, the participants completed an exit 
questionnaire with manipulation checks and demographic questions. 
As a robustness check, we measured the difference in decision-making with a question in 
which the task was repeated, but where the role of the participants was changed from auditors 
to investment advisors (adopted from Moore et al., 2010). According to Lord et al. (1984), 
subjects are unable to de-bias their choice even if they are told to be objective. A person can 
effectively undo the bias only if asked to consider the choice from another perspective or 
another personal role. 
Design. The experiment had a two (personal relationship: anonymous vs. personal) by two 
(financial incentive: fixed fee vs. ‘variable’ fee) by two (oversight: 50% probability of oversight, 
no probability of oversight) between-subjects factorial design. Subjects in the role of auditors 
were randomly assigned to eight groups. We manipulated the experimental conditions in 
following ways. In the condition of an anonymous client, auditors received instructions and 
completed their decision individually in the absence of any interaction with other partici-
pants. In the condition of a personal relationship with the client, we set out to match auditors 
and clients. We asked participants to pair with those people they know best. 
In the fixed fee condition, the auditors were paid a fixed fee of EUR 2 regardless of their deci-
sion. In the ‘variable’ fee condition, the auditors received a EUR 2 fixed fee if they supported 
the valuation which was not in the interest of their client, but based on more realistic assump-
tions. In addition, they could earn another euro as the present value of future business with 
the company if they supported the valuation the client preferred. In total, they could receive 
EUR 3 for this decision. Clients received EUR 2 in compensation if the auditor disagreed 
with their valuation and EUR 3 if the auditor agreed to the valuation based on the aggressive 
assumption of growth. The extra compensation for the clients was based on the bonus they 
were set to receive if the profits of their company were above a certain threshold. In order 
to achieve that, an auditor had to agree to the higher valuation of the asset on the audited 
company’ s balance sheet. The compensation scheme for clients was therefore designed to cor-
respond to the compensation scheme for auditors and to make them eager to convince agents 
to support the valuation in their interest. 
Oversight was manipulated in the following way: subjects in the no-oversight condition were 
assured that no oversight would take place. Those in the oversight condition were told that 
it was possible that their audit would be subject to regulatory oversight. The probability that 
the oversight would take place was 50%. If they had approved the lower value of the asset, the 
oversight authority would not have opposed their opinion. If they had approved the higher 

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value of the investment, it is certain that the oversight authority would have disagreed with 
their decision and the penalty would have been applied. 
The financial incentives in the future business condition and the oversight condition were 
composed of a EUR 2 fixed fee and an additional EUR 4 if approving the higher value of the 
investment. Under both incentive schemes – fixed fee and future business – the compensation 
would be zero if the auditor supported the client’s choice and the oversight took place. In the 
future business condition, the expected value of the total compensation in the oversight condi-
tion was kept equal to the expected value of the compensation in the no-oversight condition. 
As soon as the auditors made a choice in the oversight condition, a random number drawn 
by a computer mimicked whether the oversight had taken place or not. This determined the 
value of the auditor’s compensation given their valuation choice. Clients were paid based on 
the valuation choice and were not penalised if the oversight had disapproved of the auditor’s 
decision. The auditor payoffs under the different schemes are presented in Table 1. 
Table 1: Auditor payoff under all schemes
Variable 
No oversight
Fixed 
No oversight
Variable
Oversight
Fixed
Oversight
2+1 2 2+4 (50%), 0 (50%) 2 (50%), 0 (50%)
4. RESULTS
We first analysed the mean values of the choices made by the subjects across subgroups by 
computing the predicted means. In Table 2 we present the proportions of decisions for a 
high valuation under the different incentive, relationship and oversight conditions.
Table 2: Decision by two-by-two-by-two groups. Numbers represent proportion of high 
valuations. 
Difference represents t-test of proportion differences. n=205
Incentive Relation
No oversight Oversight
Difference
Anonymous Personal Anonymous Personal
1 2 3 4
3-1   4-2
Fixed
mean 35.5% 55.0% 11.1% 48.3% -24.4% ** -6.7%
std. dev. 48.6% 51.0% 32.0% 50.9%
n 31 20 27 29      
Variable
mean 64.0% 72.2% 18.5% 71.4% -45.5% *** -0.8%
std. dev. 49.0% 46.1% 39.6% 46.0%
n 25 18 27 28
***  denotes significance at the level below 0.01, ** denotes significance at the level below 0.05

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We first look at the results without the presence of oversight (columns 1 and 2 in Table 
2). The results show that 35.5% of the subjects in the fixed fee condition and an anony-
mous relationship decided to approve the valuation in favour of the client, whereas in the 
variable fee condition and an anonymous relationship this proportion increased to 64.0%. 
Further, 55.0% of the subjects chose the valuation in favour of the client in the personal 
relationship and fixed fee condition, while the percentage rose to 72.2% in the combined 
condition of a personal relationship and variable fee. The results show that the effect of the 
type of relationship on the decision is stronger in the absence of contingent compensation 
– i.e. in the condition of fixed pay. The proportion of decisions favourable to the client in-
creases by roughly 20 percentage points (55.0%–35.5%) in the case of fixed pay compared 
to an increase of around 8 percentage points in the case of variable pay (72.2%–64.0%). 
Next, we look at the results in the presence of oversight (columns 3 and 4 in Table 2). The 
share of subjects who chose the valuation in favour of the client in the fixed fee condi-
tion without oversight amounted to 35.5%, whereas in the oversight condition it was just 
11.1%. The difference of 24.4 percentage points is statistically significant. In the variable 
fee condition without oversight, 64.0% of subjects chose the higher valuation, while in the 
same condition with the presence of oversight the proportion dropped to 18.5%. Again, 
the difference of 45.5 percentage points is statistically significant.
Contrary to these results, the effect of oversight is much less pronounced in the case of 
a personal relationship. The share of subjects who selected the valuation in favour of the 
client was somewhat smaller in the fixed pay and personal relationship conditions in the 
presence of oversight, but the difference of 6.7 percentage points is not statistically signifi-
cant. Interestingly, oversight had no effect in the condition of a personal relationship and 
variable pay.
The results clearly show that the oversight affects the decisions made by the subjects. How-
ever, the effect of the oversight has only a significant impact on the decision in the anony-
mous relationship condition, which leads us to believe that the oversight is able to mitigate 
the effect of financial incentives, but has little or no effect when it comes to a personal 
relationship.
In Figures 1 and 2 we illustrate the effect of oversight on decisions made by the subjects in 
the financial and relationship conditions by estimating marginal effects of the introduc-
tion of the oversight. By doing so, we further investigate the channel through which the 
effect of oversight takes place.

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Figure 1: Financial Incentive by Oversight plot for Decision (High Valuation=1) with and 
without Oversight.
 
The oversight should have a minimum effect in the fixed fee condition as this condition 
does not give any incentive to support the client’s preferences. However, the results pre-
sented in Figure 1 surprisingly demonstrate a large impact of the oversight in both fi-
nancial conditions: with the fixed fee the share of subjects choosing the higher valuation 
amounts to 44.5% in the no-oversight condition compared to 28.3% in the oversight con-
dition. With the variable fee in the no-oversight condition, this share amounts to 67.8% 
compared to 43.0% in the oversight condition. In the figure we also show 95% confidence 
interval of the linear prediction and, as observed, albeit the mentioned difference seems 
large, it is not statistically significant. Note that the effect of joint conditions when estimat-
ing predictive margins or marginal effects (fixed and variable) in the personal relationship 
is presented such that the reported means are not directly comparable to those shown in 
Table 2. The results suggest that subjects who supported the client preference did so not 
only due to the financial incentives but also due to incentives arising from the personal 
relationship.

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Figure 2: Personal Relationship by Oversight plot for Decision (High Valuation=1) with 
and without Oversight.
 
In Figure 2 we present the effect of the oversight on decision incentives arising from a per-
sonal relationship. Like before, we observe a large difference in the percentage of subjects 
choosing the higher valuation in the condition of an anonymous relationship: the share 
of higher valuation choices amounts to 49.1% in the no-oversight condition and 14.7% in 
the oversight condition (note that here the difference is also statistically significant). In 
the personal relationship condition, the presence of oversight makes almost no difference: 
the share of auditors choosing the higher valuation is 63.2% in the no-oversight condition 
compared to 59.3% in the oversight condition. 
In line with the predictions in Hypothesis 3, oversight seems to influence the subjects’ 
decision mostly through its effect on financial incentives, while its effect seems to be much 
weaker in the personal relationship condition. 
To confirm the bivariate results we perform logistic regressions where a dependent vari-
able is a decision. The results are presented in Table 3.

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Table 3: Logistic Regression. Dependent Variable: Decision (High Valuation=1). n=205
Dependent 
Variable 
Decision Coef. Mfx SE Sig.   Coef. Mfx SE Sig.  
incentive 0.898 0.219 0.313 0.004 *** 1.010 0.244 0.438 0.021 **
relation 1.429 0.341 0.322 0.000 *** 0.620 0.151 0.447 0.165
oversight -0.981 -0.239 0.324 0.002 *** -1.718 -0.401 0.607 0.005 ***
incentive*oversight     -0.152 -0.037 0.637 0.811
relation*oversight     1.610 0.382 0.663 0.015 ***
intercept -0.778 N/A 0.296 0.009 *** -0.525 N/A 0.337 0.120
***  denotes significance at the level below 0.01, ** denotes significance at the level below 0.05; Mfx stands for 
marginal effects and SE for robust standard errors.
The financial incentive condition takes the value of 0 for a fixed fee and the value of 1 for 
a variable fee. The personal relationship condition takes the value of 0 for an anonymous 
relationship and the value of 1 for a personal relationship. Similarly, oversight takes the 
value of 0 in the no-oversight condition and the value of 1 in the oversight condition. We 
present two separate specifications. In the first specification, we do not include interaction 
terms between the main conditions and the oversight, while in the second specification we 
add the two interaction terms.
The results of the basic model are in line with our expectations in Hypotheses 1 and 2. 
Financial incentive significantly positively affects the probability of choosing the higher 
valuation (i.e. the one in the client’s interest) (a coefficient of 0.898 and marginal effect 
of 0.219
5
). Personal relationship also has a significant positive effect on the probability of 
choosing the higher valuation (coefficient of 1.429 and marginal effect of 0.341). Over -
sight has a significant negative effect on the probability of choosing the higher valuation 
(coefficient of -0.981 and marginal effect of -0.239). 
However, as implied by the bivariate results, oversight seems to have a differential impact 
on the two drivers that we regard as proxies for conscious and non-conscious bias. To 
analyse its impact (Hypothesis 3), we add two interaction terms (incentive*oversight and 
relation*oversight) to the basic specification. The results of the extended model show that 
the significant positive effect of the financial incentive on the probability of choosing the 
higher valuation persists (a coefficient of 1.010 and a marginal effect of 0.244). The same 
holds for the negative effect of the oversight – i.e. a reduced probability of choosing the 
higher valuation (a coefficient of -1.718 and a marginal effect of -0.401). However, we now 
find no significant effect of a personal relationship on the decision. Moreover, the interac-
tion term between a relationship and the oversight has a significant positive effect (a coef-
ficient of 1.610 and marginal effect of 0.382) that almost entirely offsets the negative effect 
5 Marginal effect is the change in probability of choosing a high valuation as opposed to a low valuation 
when the value of a binomial independent variable (incentive, relation and/or oversight, as well as interaction 
terms) changes from 0 to 1.

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of the oversight on a stand-alone basis. This result corroborates our previous findings that 
the oversight impedes the financial incentive channel, but has very little if no effect on the 
relationship channel. We interpret this finding as providing evidence to support our third 
hypothesis about the stronger effect of oversight on financial incentives than on a personal 
relationship.
As a robustness test, we investigate the decisions taken by the subjects when playing a 
different role in the experiment. In one of the exit questions the subjects were asked to 
indicate the value of the investment if they were in the role of experts advising an investor. 
In other words, they were asked what they really thought the true value of the asset was.
Table 4: Difference in the decision taken in the role of auditor and expert with and without 
presence of the oversight (n=203, two missing values)
Number Percent Number Percent
  No oversight With oversight
No Bias
As auditor “60” , as expert “60” 33 35.5% 39 35.5%
As auditor “60” , as expert “50” 10 10.8% 22 20.0%
Conscious Bias
As auditor “80” , as expert “50” 17 18.3% 15 13.6%
As auditor “80” , as expert “60” 23 24.7% 12 10.9%
Non-conscious Bias
As auditor “80” , as expert “80” 10 10.8% 14 12.7%
Other
As auditor “60” , as expert “80” 0 0.0% 8 7.3%
Total 93 100.0% 110 100.0%
Note: 50, 60 and 80 refer to low or high valuation of the company in the scenario. 
In Table 4 we compare the responses given in the role of experts to the responses given in 
the role of auditors in both the conditions with and without the oversight. We denote the 
responses where the subjects as experts chose a lower value than they actually chose as 
auditors as ‘conscious bias’ . This indicates that the subjects were aware of a different value 
of the asset that they provided in a different role. We observe that 43% of the subjects 
provided a higher value as auditors in the no-oversight condition than they did as experts 
and only 24.5% of subjects did so in the oversight condition. In addition, we observe 
that 46.3% of the subjects do not seem to exhibit any bias in the no-oversight condition, 
while the percentage of no bias is 55.5% in the oversight condition. Finally, we characterise 
10.8% of the subjects as exhibiting ‘non-conscious bias’ in the no-oversight condition – 
these are the ones who chose the more aggressive valuation of the asset in both roles. This 
share amounts to 12.7% in the oversight condition.

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We define a new multiple response variable related to ‘bias’ . The variable “bias” takes the 
value of 1 for “conscious bias” (subjects who chose the higher valuation, but believed that 
the true value of the asset is lower and 0 otherwise), and the value of 2 for “non-conscious 
bias” (subjects who chose the higher valuation in which they truly believed). Note that we 
exclude eight subjects who selected higher values as experts compared to the decision they 
made in the role of auditors. These subjects were excluded since on one hand they cannot 
be regarded as ‘unbiased’ and, on the other hand, they do not exhibit any of the two ‘biases’ 
in which we are interested. This leaves us with 195 responses for which we performed a 
multinomial probit analysis to investigate the factors affecting the biases.
Table 5: Multinomial Probit Regression. Dependent Variable: No Bias=0, Conscious 
Bias=1, Non-conscious Bias=2 (n=195; excluded 8 observations that do not fit into these 
categories)
Dependent 
Variable Bias
Conscious Non-conscious
Coef.
Robust 
SE Sig.   Coef.
Robust 
SE Sig.  
incentive 0.697 0.384 0.069 * 1.133 0.557 0.042 **
relation 0.199 0.395 0.613   1.403 0.574 0.014 **
oversight -1.890 0.542 0.000 *** 0.409 0.773 0.597
incentive*oversight 0.237 0.577 0.681   -1.297 0.726 0.074 *
relation*oversight 1.793 0.592 0.002 *** 0.268 0.751 0.722
intercept -0.438 0.291 0.133   -2.387 0.625 0.000 ***
*** denotes significance at the level below 0.01, **denotes significance at the level below 0.05, * denotes signifi-
cance at the level below 0.1
The results shown in Table 5 demonstrate that financial incentives affect both conscious and 
non-conscious bias (coefficients of 0.697 and 1.133, respectively). Oversight is only effective 
in the case of conscious bias (a significantly negative coefficient of -1.890). However, in the 
personal relationship condition oversight fails to deliver (a significantly positive coefficient 
of the interaction effect between a relationship and oversight of 1.793 which almost entirely 
compensates for the negative stand-alone effect of oversight). Next to financial incentives, a 
personal relationship is a significant explanatory variable for non-conscious bias (a positive 
coefficient of 1.403), while oversight does not have any effect on a stand-alone basis. It can 
offset the effect of financial incentives (a significantly negative coefficient of -1.297), but it is 
not effective in mitigating the effect of a personal relationship.
Overall, our results confirm the first and second hypotheses about the main effect of finan-
cial incentives and a personal relationship, as well as the third hypothesis that the mitigating 
effect of oversight is stronger in the financial incentive condition than in the personal rela-
tionship condition. Oversight can only effectively unravel the effect of financial incentives. 
We conjecture that the ineffectiveness of oversight in a personal relationship is an indication 
of the presence of emotion-based decision-making that people are not entirely aware of. 

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5. DISCUSSION
Being provoked by high-impact audit failures during the recent global financial crisis, the 
aim of this study is to provide new evidence regarding the intentionality of auditor biases 
and add to the debates on how to resolve auditor conflicts of interest. As argued in moral 
seduction theory by Moore et al. (2006), the understanding of perceptual biases impor-
tantly indicates the effectiveness of regulatory measures. In particular, the study intends to 
contribute to the debates on whether oversight can effectively mitigate auditors’ biases and 
which alternative measures (if any) are additionally required. This might be particularly 
important to audit committees in the auditor appointment process. 
To analyse these questions, we looked separately at personal relationships and financial 
incentives that create directional goals according to theory of motivated reasoning. Re-
garding financial incentives, our results corroborate prior evidence that financial incen-
tives adversely influence auditor’s independence. Although audit fees are fixed in practice, 
the notion of variable financial incentives is based on the premise that the probability 
of auditor reappointment increases if an auditor delivers an affirmative audit opinion. 
Despite the evidence that the introduction of audit committees had a mitigating effect on 
earnings manipulation (Bedard et al., 2004; Baxter & Cotter, 2009) by interfering between 
auditor’s opinion and managers’ selection of the auditor, it would be naïve to expect that 
audit committees are perfectly informed about the negotiations that take place between 
managers and auditors (Gibbins et al., 2007). Their analysis of survey responses by CFOs 
shows that less than one-fifth of the solutions are adopted as originally proposed by the 
auditor; others are either adopted as proposed by the client or negotiated among them. 
This indicates that managers are able to exercise a subtle influence in the process of audi-
tor reappointments. 
Regarding a personal relationship we found that it significantly affects the choice of the 
auditor. The subjects who were in the personal relationship condition were more inclined 
to accept the less realistic assumptions put forward by clients. Further, our more detailed 
analysis suggests that a personal relationship significantly offsets the otherwise mitigating 
effect of oversight. 
We find that oversight effectively reduces the overall bias and its magnitude. Interesting-
ly, oversight decreases the bias related to the financial incentive condition of both those 
with a fixed fee and those with a variable fee. This suggests that the subjects with a fixed 
fee schedule also had intentional bias. Such bias could only arise from the personal rela-
tionship which half the subjects were exposed to in the fixed fee condition. But we also 
show that a personal relationship significantly offsets the mitigating effect of oversight. 
We interpret this finding as evidence of non-conscious, unintentional bias in a personal 
relationship. 
Based on our analyses and results, we argue that a combination of several measures is 
needed to efficiently address the issues of auditor bias. While oversight is efficient for 
mitigating conscious bias, our findings imply that only the termination of a personal rela-

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tionship would help eliminate biases arising from auditors’ allegiances. Although debates 
on mandatory audit firm rotation are currently off the regulatory agenda due to the adop-
tion of the new EU regulation (Regulation 537/2014), this mechanism should be consid-
ered as an important complementary control mechanism. As reported by W ang and T uttle 
(2009), auditors report fewer cooperative negotiation strategies with their clients in the 
case of mandatory auditor rotation. Milgram (1974) demonstrated that excessive loyalty 
can be substantially reduced by introducing a so-called ‘dissenting peer’ . Having the audi-
tor action challenged or reviewed by a different auditor would create such an effect. The 
public oversight that was introduced following the recent auditing regulatory reform to 
scrutinise audit quality beyond professional self-regulation can be regarded as an effective 
measure to improve audit quality. The only question is how far-reaching it is given that 
the public oversight authority cannot examine the entire market frequently enough. On 
the other hand, peer oversight – the crucial element of audit firm rotation – can extend 
to all market participants and could represent an effective complementary mechanism for 
mitigating auditor biases. 
6. LIMITATIONS AND FUTURE RESEARCH
The validity of our results is to be weighed up against the limitations of the study. Probably 
the greatest limitation is the fact that the experimental subjects were students. To some 
extent, we attempted to control for this limitation by inviting only senior accounting and 
finance students to participate. These students were most familiar with the auditing pro-
fession and regulation. Moreover, they had on average 2.8 years of work experience and 
many of them have worked as audit assistants in audit firms. An important argument in 
favour of the use of students is that when sensitive issues such as professional ethics are 
being investigated auditors relatively easily recognise politically appropriate answers to 
which students may be less susceptible (Randall & Fernandes, 1991). 
In some well-cited studies that use students to proxy auditors (i.e. Moore et al., 2010 Cur-
tis, 2006) a clear case is made that students are expected to behave in a similar way as 
auditors when it comes to making a choice in an experimental task on the condition that 
the experiment adequately addresses the auditor’s decision problem. Our experiment is 
essentially a game in which the financial rewards are explicit, while the relationship is im-
plicit. Accordingly, in our experimental conditions the students were better aware of the 
financial incentives than they were of the personal relationship and this may have driven 
the result whereby they reacted more to oversight under a financial incentive manipula-
tion. Our focus was, however, not on financial incentives as this effect has been robustly 
proven in a number of previous experimental studies which used practising auditors as 
experimental subjects. The contribution of this study lies in highlighting the role of a per-
sonal relationship that may create unintentional bias after controlling for the strong effect 
of financial incentives and in the additional robustness analysis.
In the robustness test a limitation may stem from our assumption (like in Moore et al., 
2010) that the subjects would be able to de-bias their choice when they changed their role. 

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Some subjects might have been unaware that they were giving a biased answer when they 
made their initial judgments. Later, when asked to take on the role of an expert, they real-
ised that they had failed to consider the alternative point of view previously, and respond-
ed differently. However, this limitation in our approach does not inflate non-conscious 
bias, but rather underestimates it.
Although the only possible examination of non-conscious or conscious decision-making 
would entail the emerging neuroscientific methods, we believe we managed to shed some 
light on the cognitive effect of a personal relationship on non-conscious bias, which was 
(to the best of our knowledge) previously neglected in the literature. 
Overall, we consider the experiment a sufficiently powerful tool to reveal the effects of the 
studied variables. We believe that the question of conscious and non-conscious biases in 
auditors’ decision-making is worth pursuing further. Future research could complement 
our findings by refining the measurement methods of non-conscious bias and directly 
addressing the effectiveness of various measures when it comes to mitigating both types 
of bias.
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RESEARCH EXPERIMENT
Background
You work as an auditor for an established audit firm. Currently, you are auditing financial 
statements of a major public company A. As it seems, the company will report a modest op-
erating profit of 30 million EUR. Some years ago Company A bought shares of Company 
B, which operates in the food industry. At the time Company A paid 100 million EUR for 
this significant stake in Company B that provided Company A with the significant influence 
over Company B. Due to the financial crisis and the fact that cash flows of Company B are 
not meeting the expectations, Company A is faced with the issue of investment impairment 
due to the decrease in the fair value of its stake in Company B. The current market value of 
the mentioned financial investment is 50 million EUR. The Chief Financial Officer (CFO) of 
Company A believes that it is inappropriate to value their investments in Company B by using 
the market value, because of the extremely low liquidity in the market. Therefore, he proposed 
to value the investment with a valuation model. As the auditor you are currently reviewing the 
valuation model the CFO has proposed. In the model the CFO assumed a 5% growth of cash 
flows without any apparent capital expenditure to support this growth. The valuation based on 
this assumption gives the value of the investment into Company B of 80 million EUR. 

ECONOMIC AND BUSINESS REVIEW  |  VOL. 17  |  No.  3  |  2015 390
Historical patterns show that the growth in demand for products of Company B is closely 
related to the growth of the purchasing power of population. Generally, the purchasing 
power is reflected in the growth of the gross domestic product. According to forecasts 
GDP is expected to grow in the next years by 1% only. At the assumption of a 1% growth 
rate in the valuation model, the estimated value of the investment is 60 million EUR. 
If the investment value proposed by the CFO will be used in the financial statements, 
an impairment of 20 million EUR will have to be accounted for. If, on the other hand, 
the lower investment value will be recognized, an impairment of 40 million EUR will be 
needed. In this latter case the valuation of the investment will cause a net loss of Company 
A, while the valuation according to the assumption proposed by the CFO, would not.
SUMMARY 
Purchase price of the investment in Company B: 100 million, projected growth of GDP: 1%.
Valuation 
model
Mark-to-
model value
Assumption 
regarding 
growth of 
cash flows 
Impairment 
of the 
investment
Operating 
profit of 
Company 
A
Net profit / loss 
of Company 
A after 
impairment 
CFO’s 80 million 5% 20 million 30 million 10 million
Alternative 60 million 1% 40 million 30 million -10 million
As the auditor you are aware of the importance of your professional reputation and the 
fact that the auditor is primarily committed to serve public interest - namely, that the cred-
itors, shareholders and other users of financial information get the reliable information 
about fair presentation of the financial position and financial performance of Company A. 
 
FINANCIAL INCENTIVE CONDITION
Either:
FIXED CONDITION: Y our payment for auditing services is fixed, regardless which of 
the two valuation models you confirm. Y our payment is EUR 2.
Or:
FUTURE BUSINESS CONDITION: Your payment for auditing service is fixed and 
amounts to 2 EUR. If you require the recognition of the lower value of the investment, 
next year you will no longer be hired by Company A. If you approve the higher value of the 
investment, your contract with the Company A will be renewed in the next years. Present 
value of future business with Company A amounts to 1 EUR. Y our total compensation will 
hence amount to 3 EUR (2 EUR of fixed fee + 1 EUR of future business). 

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OVERSIGHT CONDITION
Either: NO OVERSIGHT: Your audit firm was inspected by the Agency for public over-
sight just last year. Therefore, no oversight will take place in your audit firm.  
Or: 
OVERSIGHT: There is a 50 % probability that your audit firm will be subject to public 
oversight this year. 
FINANCIAL INCENTIVE UNDER THE OVERSIGHT CONDITION 
Either:
FIXED CONDITION: Y our payment for auditing services is fixed, regardless which of the 
two valuation models you confirm. Y our payment is EUR 2.
Or:
FUTURE BUSINESS CONDITION: Your payment for auditing service is fixed and 
amounts to 2 EUR. Your payment for auditing service is fixed and amounts to 2 EUR. 
If you require the recognition of the lower value of the investment, next year you will no 
longer be hired by Company A. If you approve the higher value of the investment, your 
contract with the Company A will be renewed in the next years. Present value of future 
business with Company A amounts to 4 EUR. Y our total compensation will hence amount 
to 6 EUR (2 EUR of fixed fee + 4 EUR value of future business). 
If you approve the valuation model with a lower growth rate, the oversight will not disap-
prove of your audit.
If you approve the valuation model with a higher growth rate, oversight will disagree with 
your decision. Y ou will get fined and reprimanded. In this case your payment will be 0 EUR.
Your decision
Please specify which valuation model you will approve in the financial statements audit 
(tick the box). 
• the valuation model that takes into account the lower growth rate: Y ou request that 
the value of the investment is set at 60 million EUR and that the impairment of the 
investment amounts to 40 million EUR.  
• the valuation model that takes into account the higher growth rate: You approve 
the model that was prepared by the CFO with the value of the investment at 80 mil-
lion EUR. You agree that the impairment of the financial investment amounts to 20 
million EUR.