Description
This paper cxamincs the rclationshlp bctwccn auditors’ pctccptlons of client organizations’ growth/
dccllnc status and the audltors’ asscssmcnts of cllcnt managers’ competence and lntcgrity. It Is hypothcsized
that perceived growth/decline status will have an invcrtcd-U rclatlonshlp with pcrcclved managcmcnt
competence and integrity. If client organizations arc pcrccivcd by auditors as rapidly declining or
rapidly growing, the auditors’ evaluations of thclr managers’ competence and integrity will bc lower than
lf the organizations are perceived as stable
accounting, organlzatfoonr and Sodety, Vol. 21, No. 2/3, PP. 193-213, 19%
copyri@lt 0 1994 Blscvier Science Ltd
Prkitcd in Great Britain. All rights rcscrved
0361~36fW96 $15.00+0.00
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS: THE STIGMA OF DECLINE AND
THE STIGMA OF GROWTH*
WILLIAM MCKINLEY
Southern I llinois University at Carbondale
LAWRENCE A. PONEMON
Binghamton University
and
ALLEN G. SCHICK
Morgan State University
This paper cxamincs the rclationshlp bctwccn auditors’ pctccptlons of client organizations’ growth/
dccllnc status and the audltors’ asscssmcnts of cllcnt managers’ competence and lntcgrity. It Is hypothc-
sized that perceived growth/decline status will have an invcrtcd-U rclatlonshlp with pcrcclved managc-
mcnt competence and integrity. If client organizations arc pcrccivcd by auditors as rapidly declining or
rapidly growing, the auditors’ evaluations of thclr managers’ competence and integrity will bc lower than
lf the organizations are perceived as stable. Results from a study of auditors’ perceptions of 123 actual
client organiaations arc pa&ally supportive of the hypotheses. WC conclude that rapid organlzatlonal
decline may bc stlgmatlzing in the eyes of auditors because it raises qucstlons about management
competence. Rapid organizational growth also may bc stigmatizing, but for a different reason: it creates
auditor doubts about management integrity. The results of the study arc dhcusscd from the pcrspcctivcs
of organization studies and auditing research aI& which suggestions for future investigation are made.
Copyright 0 1996 Elscvlcr Science Ltd.
Beyond the clouds lie the stars. Beyond the stars llcs the
Great Absurd. aohn Argcntl, Corporate Co&apse, 1976)
in the number of organizational employees
(Ford, 1980), maladaptation to the environment
In the current organization studies literature,
(Greenhalgh, 1983), a downturn in organization
research on organizational decline is expand-
size or performance (McKinley, 1987) and a
ing rapidly. Some of this literature has
decrease in an organization’s resource base
attempted to develop and operationalize defini-
(Cameron et al., 1987a), among many other defi-
tions of organizational decline. For example,
nitions. Since researchers are beginning to exhi-
organizational decline has been defined as stag- bit a degree of consensus on the use of the last
nation or cutback (Whetten, 19801, a decrease detinition, it is the one adopted in this study.
l An carllcr version of this paper was presented at the rcscarch conference of the Accounting, Behavior and Organlmtions
Scctlon, Amcrlcan Accounting Association, San Antonio, Texas, 11-12 March 1994. The authors would llkc to thank
Douglas D. Baker, E. Michael Eiambcr, Pamela R. Haunschlld, Anthony G. Hopwood, James Ring, Mark A. Mont, Gycwan
Moon, Reed E. Nelson, Andrcas Nicolaou, Carol M. Sanchez, Robert B. WcIkcr and the anonymous AOS revicwcrs for their
helpful comments.
I93
194 W. MCKINLEY et al.
In addition to defining organizational
decline, scholars have articulated large-scale
theoretical models that describe the impact of
decline on organizations and their members
(Harrigan, 1980; Sutton, 1990; Sutton &
D’Aunno, 1989; Weitzel & Jonsson, 1989; Zam-
muto & Cameron, 1985). Empirical research
also has been conducted to investigate the
effects of organizational decline on structural
and performance outcomes (e.g. Baker & Cul-
len, 1993; Cameron et al., 1987b; Cullen et al.,
1986; D’Aveni, 1989a; Hambrick & D’Aveni,
1988; Ludwig, 1993).
The extensive work on organizational decline
has been accompanied by research in a number
of closely related areas. For example, an organi-
zation studies literature on downsizing is now
beginning to develop (Cameron et al., 1991;
Dewitt, 1993; Freeman & Cameron, 1993;
Kozlwski et al., 1993; McKinley et al., 1995).
Correspondingly, there is a robust stream of
work on scarcity and organizational responses
to it (Bozeman & Slusher, 1979; Castriogio-
vanni, 1991; McKinley et al., 1986; Salancik &
Pfeffer, 1974; Schick, 1985; Whetten, 1981;
Yasai-Ardekani, 1989). In experimental, case
and survey studies, layoffs also have been an
important subject of investigation (e.g. Brock-
ner, 1988, 1992; Brockner et al., 1985, 1992,
1987; Cornfield, 1983; McKinley et al., 1993;
Worrell et al., 1991). Finally, bankruptcy, orga-
nizational death, and organizational turnaround
have received increasing attention from organi-
zational scholars, leading to a greater under-
standing of these decline-related phenomena
(Barker & Mone, 1994; Castrogiovanni et al.,
1992; D’Aveni 1989b, 1990; Grinyer et al.,
1988; Hambrick & Schecter, 1983; Harris & Sut-
ton, 1986; Robbins & Pearce II, 1992; Sutton,
1987; Sutton & Callahan, 1987). Comprehen-
sive reviews of the organizational decline litera-
ture and the research domains identified above
can be found in Cameron et al. (1988), Castro-
giovanni (1991), Weitzel & Jonsson (1989)
Whetten (1980) and Whetten (1987).
With some exceptions (Ford, 1985; Ford &
Baucus, 1987; Nottenburg & Fedor, 1983; Pone-
mon & Schick, 1991; Schick & Ponemon, 1993;
Sutton & Callahan, 1987) most decline research
has treated organizational decline as an objec-
tive construct. Relatively few empirical studies
have examined stakeholders’ perceptions of
organizational decline and how those percep-
tions influence the stakeholders’ assessments
of organizational or managerial characteristics.
This study helps to fill that gap by analyzing
auditors’ perceptions of the growth/decline sta-
tus of client lirms and the effects of those per-
ceptions on the auditors’ evaluations of client
managers’ competence and integrity. Based on
the organization studies literature, we argue
that auditors who perceive a client organiza-
tion as rapidly declining will question the com-
petence of that organization’s managers.
However, we also propose that auditors’ per-
ceptions of rapid organizational growth will
lead to similar questions, since rapid growth
carries some of the same stigma as rapid
decline. A parallel argument is made for the
relationship of perceived rapid decline and per-
ceived rapid growth to auditors’ assessments of
management integrity. These theoretical argu-
ments are summarized in the form of research
hypotheses, which are then tested with data
collected on audit team perceptions of 123
client organizations. The results are discussed
in terms of their implications for the organiza-
tion studies literature, as well as the literature
on auditors’ judgments of client managers’ traits
(e.g. Anderson & Marchant, 1989; Reekers et
al., 1992; Waller, 1989).
Studying auditors’ evaluations of client man-
agers’ competence and integrity, and how such
evaluations are associated with the auditors’
perceptions of organizational decline and
growth, is important. Anderson & Marchant
(1989) Bemardi (1994) and Waller (1989)
have emphasized that assessments of client
managers’ competence and integrity are a cri-
tical component of the audit process. Such
judgments are used by the auditor to deter-
mine the level of audit risk, which can be
defined as “the likelihood that unintentional
mistakes and/or intentional distortions, misre-
presentations and misdeeds may cause large-
scale (material) misstatements in a client’s
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 195
financial statements” (Schick & Ponemon,
1993, p. 93). In addition, a number of state-
ments issued by the American Institute of Cer-
tified Public Accountants specifically direct
auditors to evaluate client managers’ compe-
tence and integrity (AICPA, 1985, para.
320.36; AICPA, 1988; AICPA, 1979). More gen-
erally, the Committee of Sponsoring Organiza-
tions of the Treadway Commission has pointed
out that internal control in an organization “is
only as effective as the integrity and compe-
tence of the people who develop, administer
and monitor the controls” (COSO, 1991, p. 6).
This Committee, which was formed to study
the auditing profession, defines competence
as reflecting “the knowledge and skilIs needed
to accomplish the tasks that define the indivi-
dual’s job” (COSO, 1991, p. 60). Integrity is
defined as “the quality or state of being of
sound moral principle; uprightness, honesty,
and sincerity” (COSO, 1991, p. 59). WhiIe judg-
ments about client managers’ competence and
integrity are clearly germane to an effective
audit, recent research (Bernardi, 1994; Pone-
mon, 1993) suggests that not aII auditors are
equaIly sensitive to these client traits. Differen-
tial assessments of competence and integrity by
auditors indicate that additional research is
needed to determine the predictors of variance
in these assessments.
Correspondingly, auditors’ evaluations of a
client organization’s growth/decline status are
important, because such evaluations can be a
clue to the level of audit risk. Schick and Pone-
mon (1993) showed that firm-assigned audit
risk varied as a function of auditors’ percep
tions of the client’s position on a continuum
ranging from rapid growth to rapid decline.
Client companies that were perceived as
rapidly growing or rapidly dechning were
assigned higher audit risk scores than compa-
nies perceived as stable. In that study, as weII
as this one, the deIinition of organizational
growth and decline is the one on which agree-
ment is beginning to develop in the organiza-
tion studies literature. Hence, growth is defmed
as an increase in an organization’s resource
base. Conversely, decline is defined as a
decrease in an organization’s resource base
(see Cameron et al., 1987a).
Besides contributing to a better understand-
ing of the audit process and auditors’ assess-
ments of client managers’ integrity and
competence, this paper makes several contri-
butions to the organization studies literature.
First, it expands the models that examine the
responses of external stakeholders to organiza-
tional decline and bankruptcy (D’Aveni, 1989b,
1990; Neu & Wright, 1992; Sutton & CaIIahan,
1987). Auditors are important stakeholders
whose financial opinions infIuence the deci-
sion making of other external exchange part-
ners, such as investors and government
agencies (Schick & Ponemon, 1993). There-
fore, auditors’ responses to perceived decline
are useful in understanding the overall message
of stigma that decline may transmit to members
of an organization’s task environment. Second,
this study moves beyond the models of stake-
holder reactions to organizational decline by
analyzing stakeholers’ (auditors’) reactions to
perceived organizationaI growth. Third, this
research adds to the growing organization stu-
dies literature on causal attributions and man-
agerial interpretations (Bettman & Weitz, 1983;
Chen & Meindl, 1991; Cram & Bateman, 1993;
Dutton & Jackson, 1987; Ford, 1985; Ford &
Baucus, 1987; Martinko & Gardner, 1987;
MeindI & EhrIich, 1987; MeindI et al ., 1985;
MiIliken, 1990; SaIancik & Meindl, 1984; Staw
et al ., 1983; Weiner, 1986). Our results are
consistent with this research because they
can be explained from an attributional perspec-
tive. Fourth, there is now a significant stream of
organization studies literature that focuses on
accountants and financial reporting practices as
subjects for investigation (e.g. Chatman, 1991;
LevittthaI & Fichman, 1988; Mezias, 1990; Mor-
rison, 1993; Seabright et al ., 1992; Sheridan,
1992). This paper adds to that research
stream, reafhrming the importance of account-
ing firm personnel and auditors to our under-
standing of organizational behavior.
196 W. MCKINLEY et al.
THEORETICAL BACKGROUND
Competence
There are a number of reasons why percep
tions of rapid organizational decline might lead
an auditor to question the competence of a
client Iii-m’s managers. First, organizational
decline carries a stigma (Cameron et al .,
1988; Sutton 1990; Sutton & Callahan, 1987).
This stigma extends to the managers of de&n-
ing or bankrupt firms and causes observers to
question the ability of those individuals (Sutton
& Callahan, 1987). It is generally assumed, par-
ticularly in American society, that leaders are in
control of their organizations and that they
have a significant impact on organizational per-
formance (Meindl et al ., 1985; Salancik &
Meindl, 1984). Therefore, when perfomance
is declining, observers tend to attribute this
outcome to lack of competence on the part
of the organization’s managers, regardless of
the managers’ “ true” causal Impact on perfor-
mance (Staw, 1975). This attributional effect is
so powerful that observers (e.g. the business
press) often revise their descriptions of organi-
zational leaders to be consistent with down-
turns in organizational performance (Chen &
Meindl, 1991). Assuming that auditors behave
similarly to other external judges of organiza-
tional performance, we would expect that audi-
tors who perceive client firms as rapidly
declining wiII rate the competence of those
firms’ managers as relatively low.
A second reason for anticipating a negative
effect of perceived decline on auditors’ assess-
ments of management competence is the phe-
nomenon of managerial succession and
turnover. A large body of research has sug-
gested that poor organizational performance
is a major cause of managerial succession
(AIIen & Panian, 1982; AIlen et al ., 1979;
Brown, 1982; Schwartz & Menon, 1985a), man-
agerial dismissal (Boeker, 1992; Fredrickson et
al ., 1988) and management turnover (AIexan-
der et al ., 1993; Lam et al ., 1992; Puffer &
Weintrop, 1991). A review of this literature
indicates that these finding are among the
most consistent in contemporary organiza-
tional research. Management succession and
turnover may have a positive or negative
impact on subsequent organizational perfor-
mance, thus the sign of this relationship is stiII
in doubt (Alexander et al ., 1993; Fredrickson et
al ., 1988; Mentzer, 1993). Nevertheless, regard-
less of the objective performance outcomes of
succession and turnover, we argue that these
events wiII be a negative signal to auditors. This
is because management succession and turn-
over project an image that the Iirrn is not fully
under control. For example, D’Aveni (1990)
posited that the “baiiout” of prestigious man-
agers in the years preceding bankruptcy sent a
message of stigma to external stakeholders of
declining firms. The result, D’Aveni (1990) sug-
gested, was the withdrawal of stakeholder sup
port and the hastening of the decline process.
Assuming that auditors are aware of such
dynamics, their view that decIining Iirms are
out of control wiII be reinforced. This raises
additional doubts about the competence of
managers whose firms are perceived as de&n-
ing.
A third reason that auditors may question the
competence of client managers whose firms
are perceived as rapidly declining has to do
with the issue of risk. A number of empirical
studies (e.g. Bowman, 1982; Fiegenbaum &
Thomas, 1988; Jegers, 1991; Singh, 1986)
have suggested that poor organizational perfor-
mance is associated with risk taking. Like the
findings on the relationship between poor per-
formance and succession or turnover, these
results are remarkably consistent from study
to study. The theoretical foundation for this
stream of research is prospect theory (Kahne-
man & Tversky, 1979), which argues that deci-
sion makers are risk seeking in the domain of
losses. Other investigations also have raised the
possibility that risk taking feeds back to accel-
erate the low performance that gives rise to it
(Bromiley, 1991; Hambrick & D’Aveni, 1988).
Furthermore, Fombrun and Shanley (1990)
have shown that performance-adjusted risk is
negatively related to corporate reputation,
contrary to the popular stereotype that risk
taking is valued by corporate stakeholders.
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 197
This suggests that risk taking will be viewed
negatively by auditors. In addition, we believe
this response will be reinforced by the empha-
sis placed on internal control in the auditing
profession (COSO, 1991). Thus, if the fIndings
of organization studies are consistent with the
day-today observations of auditors, risk taking
will give them one more reason to question the
competence of managers whose firms are per-
ceived as rapidly declining.
While the preceding discussion has argued
that perceptions of rapid decline will raise
doubts about the competence of client man-
agers, we also make the same argument about
perceptions of rapid growth. This is based on
our assumption that rapid organizational
decline and rapid organizational growth share
some of the same characteristics, at least in the
eyes of auditors. For one thing, both rapid
decline and rapid growth are likely to be seen
as risky situations. Argenti (1976) has pointed
out that maintaining organizational growth
often requires substantial borrowing, because
internahy generated cash flows are not enough
to fund the desired growth rate. This creates a
danger of “overtrading” or “overgearing”: that
is, excessive debt and high interest payments.
If sales encounter a period of stagnation, as can
take place in recessions or in many other cir-
cumstances, the firm is at risk of becoming
unprofitable. Argenti’s (1976) Type 2 failure
trajectory depicts the type of organizational
failure that occurs as a result of too-rapid
growth. Hambrick (1985) also discussed the
hazards of growth, including management
overoptimism and resulting investments
whose lixed costs cannot be covered by future
revenues. Consistent with these perspectives,
Haveman (1993) recently reported a positive
effect of organizational growth on organiza-
tional mortality.
We expect that such growth-related pro-
blems will have particular salience for external
stakeholders, because of the drama that often
attends corporate collapse through excessively
rapid growth (Argenti, 1976). Also, rapid
growth may violate norms of consistency
(Staw, 1981) because such norms value
steady, incremental increases in profit mar-
gins, rather than spectacular gains whose
future maintenance is uncertain. We anticipate
that auditors will adhere to norms of consis
tency, and thus will attribute higher compe-
tence to managers of stable firms than those
that are perceived as rapidly growing.
These arguments suggest the following
hypothesis:
Hypothesis 1: Auditors’ perceptions of the growth/
decline status of client organizations will have an
inverted-U relationship with their perceptions of man-
agement competence. Specitically, if client organiza-
dons are perceived by auditors as rapidly declining or
rapidly growing, management competence assessments
will be lower than if the client organizations are per-
ceived as stable.
htegrfty
In the previous section an inverted-U rela-
tionship was posited between auditors’ percep
tions of a client’s growth/decline status and
their evaluations of how competent the cli-
ent’s managers are. We predict a similar pat-
tern for auditors’ assessments of management
integrity, but for different reasons than those
articulated above. A number of studies in the
accounting and management literature have
suggested that organizational decline and fail-
ure are associated with “creative account-
ing”. For example, Argenti described many
instances of this practice, and stated: “I have
come to believe that [creative accounting] is
almost invariably associated with failure”
(1976, p. 143). Argenti (1976) also emphasized
that creative accounting is designed to deceive
stakeholders about the true state of a lirm’s
financial health, but ends up promoting man-
agerial self-deception. Correspondingly, Star-
buck et al., (1978) and Whetten (1980) called
attention to the existence of dubious account-
ing practices, such as distortion of accounting
data and juggling of operating results, in firms
facing organizational decline or crisis. Hop
wood et al., (1989), Kinney and McDaniel
(1989), and Schwartz and Menon (1985b) all
indicated that financially distressed firms tend
198 W. MCKINLEY et al.
to engage in creative accounting. Summarizing
the conclusions of this literature, Schick and
Ponemon (1993, p. 95) stated that “misrepre-
sentation, hiding, juggling or distorting fman-
cial data, financial condition or accounting
reports are prevalent during periods of
decline.” Such activities should be particularly
salient for auditors, because they are required
to certify that the financial statements of client
organizations are free from material misrepre-
sentations. We believe that the well-known ten-
dency toward accounting distortions during
decline will raise doubts among auditors about
the integrity of client managers whose lirms are
perceived as rapidly declining.
In addition to the technical issues raised by
the occurrence of creative accounting, Sutton
and Callahan’s (1987) research suggests that
decline and bankruptcy may be characterized
by a more general orientation toward stake-
holder deception. Sutton and Callahan (1987)
reported that the managers of some of the
bankrupt computer Iirms in their sample tried
to conceal the fact of bankruptcy from stake-
holders. The concealment strategies included
both evasion and outright lying. While such
blatant deception may not occur in every case
of rapid decline or bankruptcy, even occasional
instances that become public knowledge will
color auditors’ perceptions of management
behavior under such conditions. Sutton and
Callahan (1987) described the anger and loss
of trust experienced by stakeholders when
they discovered that managers were trying to
hide a Iirm’s true financial condition. Added to
concerns about technical accounting misrepre-
sentation, cases of more general deception will
reinforce auditors’ doubts about management
integrity when rapid decline is perceived to
be occurring.
Ironically, there is evidence to suggest that
rapid organizational growth will cause auditors
to have similar qualms about management
integrity. Again, this is consistent with our per-
spective that rapid organizational decline and
rapid organizational growth share some simila-
rities, at least in the view of auditors. Based on
a review of SEC enforcement actions and law-
suits, the National Commission on Fraudulent
Financial Reporting (1987, pp. 23-24) listed
several growth-related conditions that provide
opportunities and incentives for managers to
misrepresent operating results. These condi-
tions include the overloading of internal
accounting controls by a rapid expansion of
sales and pressure to meet investor expecta-
tions for increases in stock price. In describing
his Type 2 trajectory, Argenti (1976) also
emphasized the important role of stakeholder
expectations and how they can be stimulated
by rapid organizational growth. Initial rapid
growth created expectations for similar perfor-
mance in the future. Those expectations
become particularly strong when the firm is
promoted by the popular business press. To
maintain the growth rate and the tirm’s
image, managers may begin to overstate the
value of assets or the size of their inventories.
As was true for Billie Sol Estes’ ammonia tanks,
the fraud sometimes reaches such proportions
as to become absurd. This led Argenti (1976,
p. 159) to make the statement quoted at the
beginning of this paper. As Argenti (1976)
noted, the visibility of failures due to rapid
growth, as well as the publicity given to the
fraud that is often associated with these cases,
are out of proportion to the frequency with
which such failures actually occur. We argue
that such prominent cases will lead auditors
to be suspicious of management integrity
when they believe that a client organization is
rapidly growing.
Additional support for this view is found in
the organization studies literature, as well as
articles reported in contemporary business
publications. In building a theoretical model
of lying and deceit in the workplace, Grover
(1993) assigned an important causal role to
performance expectations. He hypothesized
that high performance expectations (the kind
that are prevalent during rapid organizational
growth) are associated with a higher incidence
of lying. An illustration of this principle is con-
tained in Brannigan and Grossman’s (1992)
description of rapid growth and financial fraud
at Comptronix. The ability of the lirm to
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 199
exceed analysts’ performance expectations
pushed the stock price up, generating strong
pressures for the company to continue its
record of high profits. This was accomplished
by inflating the value of inventories and by a
complicated scheme of fake financial transac-
tions. Bet-ton (1992) reported similar financial
manipulations at Phar-Mor, which also appear
to be related to the company’s need to main-
taln its phenomenal growth. The Phar-Mor case
is certainly salient to the auditing profession,
because it has resulted in a lawsuit tiled by
Investors against Phar-Mor’s former auditor,
Coopers & Lybrand (Berton, 1992). The
increasing frequency of such cases reinforces
our argument that auditors take rapid growth
as a signal that management integrity may be
compromised.
In summary, our discussion suggests the fol-
lowing hypothesis:
Hypothesis 2: Auditors’ perceptions of the growth/
decline status of client organizations will have an
inverted-U relationship with their perceptions of man-
agement integrity. If client organhtions are perceived
by auditors as rapidly declining or rapidly growing,
management integrity assessments will be lower than
if the client organizations are perceived as stable.
METHOD
Sampl e and data col l ecti on
The two hypotheses stated above were
tested with data from a study of auditors’ per-
ceptions of client organizations and their man-
agers (Schick & Ponemon, 1993). The study
was conducted in the offices of two interna-
tional public accounting firms headquartered
in a large northeastern city. After obtaining
the cooperation of the managing partners in
each office, a stratified random sample of 417
client organizations (203 from tirm one and 2 14
from firm two) was drawn. An audit team con-
sisting of one audit partner and one audit man-
ager had audit responsibility for each of these
client organizations. An individual audit partner
or audit manager might be involved in simulta-
neous audits of several different clients. There-
fore, perceptual responses regarding different
client organizations might suffer from lack of
independence, if they originated with the
same auditor. To deal with this problem,
responses from the same audit partner or man-
ager were not used more than twice, and each
partner and manager team was unique. This
resulted in the elimination of 290 client organi-
zations from the sample. Four more organiza-
tions were dropped due to missing data on the
perceptual measures. The Iinal sample for the
analyses reported in this paper, therefore, was
123 client organizations, 60 from audit firm one
and 63 from audit firm two.
All the client organizations were for-profit
businesses. Sixty-eight of the clients were pub
licly held corporations, i.e., their stock was
traded on a major stock exchange or in the
over-thecounter market. The remaining client
organizations (55) were privately held, which
meant that their stock was not traded.
Perceptions of each client organization and
its managers were solicited from the audit part-
ner and audit manager (audit team) responsible
for that client organization’s audit. A structured
questionnaire was administered seperately to
each of the two team members to record their
perceptions of the client. The relevant pages of
this questionnaire are reproduced in the
Appendix. The administration of the question-
naire was done in person by an interviewer, so
that respondent queries could be answered.
Audit partners are senior management officials
of an audit firm, with voting rights, equity inter-
ests and responsibility for the completion of
the audit engagement. Audit managers are
one level below audit partners in the audit
Iirm hierarchy. Audit managers have no equity
interest in the audit Iirm and are charged with
determining the overall scope of the audit. Data
were collected from a total of 30 audit partners
and 36 audit managers in audit Firm one and 33
audit partners and 40 audit managers in audit
firm two. The audit partners included in this
study had an average of 16.7 years of auditing
experience, while the audit managers had an
average of 7.7 years of experience. For addi-
tional details regarding the sample and method
200 W. MCKINLEY et al.
of data collection, the reader is referred to
Schick and Ponemon (1993).
Measures
I ndependent variable. For each client organi-
zation, the audit partner and audit manager
were asked their perceptions of the client’s
growth/decline status. If a respondent believed
the client organization was declining, (s)he
was asked to evaluate the degree of decline
on a Likert-type scale. The response cate-
gories ranged from 1 (very rapid decline) to
6 (no decline-stable). Correspondingly, if the
respondent believed the client organization
was growing, perceptions about the degree of
growth were recorded on a second Likert-type
scale. Response categories on that scale ranged
from 1 (very rapid growth) to 6 (no growth-
stable). For purposes of analysis, these two
scales were combined, using reverse scoring
where necessary, to form an ll-category
scale, ranging from 1 (very rapid growth) to 6
(stability) to 11 (very rapid decline). In this
way, the various auditor perceptions about
the level of client growth or decline were cap
tured on one ordinal scale. Of the 123 compa-
nies studied, audit managers viewed 43 as
declining, 41 as stable and 39 as growing. Simi-
larly, audit partners viewed 41 as declining, 42
as stable and 40 as growing. Audit managers
and partners tended to hold consistent percep-
tions of decline, stability or growth, since in
120 cases the audit managers and partners
were within two rating points on the 1 l-point
ordinal scale. Consequently, the perceptual
scores for the audit partner and audit manager
were averaged, to obtain a single score for each
client organization. This is consistent with the
conclusion of past auditing researchers (e.g.
Schultz & Reekers, 1981; Solomon, 1987; Trot-
man et al., 1983) that critical auditing decisions
are based on the combined evaluations of two
or more members of an audit team.
As is apparent from page 2 of the question-
naire contained in the Appendix, we did not
define “growth” and “decline” for the intervie-
wees. This decision was based on our desire to
measure growth/decline as a perceptual con-
struct, which would then be related to percep
tions of client management competence and
integrity. However, the interrater reliability of
this growth/decline measure was assessed by
Schick and Ponemon (1993, p. 99). They
found a strong positive correlation (r = 0.81,
p
This paper cxamincs the rclationshlp bctwccn auditors’ pctccptlons of client organizations’ growth/
dccllnc status and the audltors’ asscssmcnts of cllcnt managers’ competence and lntcgrity. It Is hypothcsized
that perceived growth/decline status will have an invcrtcd-U rclatlonshlp with pcrcclved managcmcnt
competence and integrity. If client organizations arc pcrccivcd by auditors as rapidly declining or
rapidly growing, the auditors’ evaluations of thclr managers’ competence and integrity will bc lower than
lf the organizations are perceived as stable
accounting, organlzatfoonr and Sodety, Vol. 21, No. 2/3, PP. 193-213, 19%
copyri@lt 0 1994 Blscvier Science Ltd
Prkitcd in Great Britain. All rights rcscrved
0361~36fW96 $15.00+0.00
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS: THE STIGMA OF DECLINE AND
THE STIGMA OF GROWTH*
WILLIAM MCKINLEY
Southern I llinois University at Carbondale
LAWRENCE A. PONEMON
Binghamton University
and
ALLEN G. SCHICK
Morgan State University
This paper cxamincs the rclationshlp bctwccn auditors’ pctccptlons of client organizations’ growth/
dccllnc status and the audltors’ asscssmcnts of cllcnt managers’ competence and lntcgrity. It Is hypothc-
sized that perceived growth/decline status will have an invcrtcd-U rclatlonshlp with pcrcclved managc-
mcnt competence and integrity. If client organizations arc pcrccivcd by auditors as rapidly declining or
rapidly growing, the auditors’ evaluations of thclr managers’ competence and integrity will bc lower than
lf the organizations are perceived as stable. Results from a study of auditors’ perceptions of 123 actual
client organiaations arc pa&ally supportive of the hypotheses. WC conclude that rapid organlzatlonal
decline may bc stlgmatlzing in the eyes of auditors because it raises qucstlons about management
competence. Rapid organizational growth also may bc stigmatizing, but for a different reason: it creates
auditor doubts about management integrity. The results of the study arc dhcusscd from the pcrspcctivcs
of organization studies and auditing research aI& which suggestions for future investigation are made.
Copyright 0 1996 Elscvlcr Science Ltd.
Beyond the clouds lie the stars. Beyond the stars llcs the
Great Absurd. aohn Argcntl, Corporate Co&apse, 1976)
in the number of organizational employees
(Ford, 1980), maladaptation to the environment
In the current organization studies literature,
(Greenhalgh, 1983), a downturn in organization
research on organizational decline is expand-
size or performance (McKinley, 1987) and a
ing rapidly. Some of this literature has
decrease in an organization’s resource base
attempted to develop and operationalize defini-
(Cameron et al., 1987a), among many other defi-
tions of organizational decline. For example,
nitions. Since researchers are beginning to exhi-
organizational decline has been defined as stag- bit a degree of consensus on the use of the last
nation or cutback (Whetten, 19801, a decrease detinition, it is the one adopted in this study.
l An carllcr version of this paper was presented at the rcscarch conference of the Accounting, Behavior and Organlmtions
Scctlon, Amcrlcan Accounting Association, San Antonio, Texas, 11-12 March 1994. The authors would llkc to thank
Douglas D. Baker, E. Michael Eiambcr, Pamela R. Haunschlld, Anthony G. Hopwood, James Ring, Mark A. Mont, Gycwan
Moon, Reed E. Nelson, Andrcas Nicolaou, Carol M. Sanchez, Robert B. WcIkcr and the anonymous AOS revicwcrs for their
helpful comments.
I93
194 W. MCKINLEY et al.
In addition to defining organizational
decline, scholars have articulated large-scale
theoretical models that describe the impact of
decline on organizations and their members
(Harrigan, 1980; Sutton, 1990; Sutton &
D’Aunno, 1989; Weitzel & Jonsson, 1989; Zam-
muto & Cameron, 1985). Empirical research
also has been conducted to investigate the
effects of organizational decline on structural
and performance outcomes (e.g. Baker & Cul-
len, 1993; Cameron et al., 1987b; Cullen et al.,
1986; D’Aveni, 1989a; Hambrick & D’Aveni,
1988; Ludwig, 1993).
The extensive work on organizational decline
has been accompanied by research in a number
of closely related areas. For example, an organi-
zation studies literature on downsizing is now
beginning to develop (Cameron et al., 1991;
Dewitt, 1993; Freeman & Cameron, 1993;
Kozlwski et al., 1993; McKinley et al., 1995).
Correspondingly, there is a robust stream of
work on scarcity and organizational responses
to it (Bozeman & Slusher, 1979; Castriogio-
vanni, 1991; McKinley et al., 1986; Salancik &
Pfeffer, 1974; Schick, 1985; Whetten, 1981;
Yasai-Ardekani, 1989). In experimental, case
and survey studies, layoffs also have been an
important subject of investigation (e.g. Brock-
ner, 1988, 1992; Brockner et al., 1985, 1992,
1987; Cornfield, 1983; McKinley et al., 1993;
Worrell et al., 1991). Finally, bankruptcy, orga-
nizational death, and organizational turnaround
have received increasing attention from organi-
zational scholars, leading to a greater under-
standing of these decline-related phenomena
(Barker & Mone, 1994; Castrogiovanni et al.,
1992; D’Aveni 1989b, 1990; Grinyer et al.,
1988; Hambrick & Schecter, 1983; Harris & Sut-
ton, 1986; Robbins & Pearce II, 1992; Sutton,
1987; Sutton & Callahan, 1987). Comprehen-
sive reviews of the organizational decline litera-
ture and the research domains identified above
can be found in Cameron et al. (1988), Castro-
giovanni (1991), Weitzel & Jonsson (1989)
Whetten (1980) and Whetten (1987).
With some exceptions (Ford, 1985; Ford &
Baucus, 1987; Nottenburg & Fedor, 1983; Pone-
mon & Schick, 1991; Schick & Ponemon, 1993;
Sutton & Callahan, 1987) most decline research
has treated organizational decline as an objec-
tive construct. Relatively few empirical studies
have examined stakeholders’ perceptions of
organizational decline and how those percep-
tions influence the stakeholders’ assessments
of organizational or managerial characteristics.
This study helps to fill that gap by analyzing
auditors’ perceptions of the growth/decline sta-
tus of client lirms and the effects of those per-
ceptions on the auditors’ evaluations of client
managers’ competence and integrity. Based on
the organization studies literature, we argue
that auditors who perceive a client organiza-
tion as rapidly declining will question the com-
petence of that organization’s managers.
However, we also propose that auditors’ per-
ceptions of rapid organizational growth will
lead to similar questions, since rapid growth
carries some of the same stigma as rapid
decline. A parallel argument is made for the
relationship of perceived rapid decline and per-
ceived rapid growth to auditors’ assessments of
management integrity. These theoretical argu-
ments are summarized in the form of research
hypotheses, which are then tested with data
collected on audit team perceptions of 123
client organizations. The results are discussed
in terms of their implications for the organiza-
tion studies literature, as well as the literature
on auditors’ judgments of client managers’ traits
(e.g. Anderson & Marchant, 1989; Reekers et
al., 1992; Waller, 1989).
Studying auditors’ evaluations of client man-
agers’ competence and integrity, and how such
evaluations are associated with the auditors’
perceptions of organizational decline and
growth, is important. Anderson & Marchant
(1989) Bemardi (1994) and Waller (1989)
have emphasized that assessments of client
managers’ competence and integrity are a cri-
tical component of the audit process. Such
judgments are used by the auditor to deter-
mine the level of audit risk, which can be
defined as “the likelihood that unintentional
mistakes and/or intentional distortions, misre-
presentations and misdeeds may cause large-
scale (material) misstatements in a client’s
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 195
financial statements” (Schick & Ponemon,
1993, p. 93). In addition, a number of state-
ments issued by the American Institute of Cer-
tified Public Accountants specifically direct
auditors to evaluate client managers’ compe-
tence and integrity (AICPA, 1985, para.
320.36; AICPA, 1988; AICPA, 1979). More gen-
erally, the Committee of Sponsoring Organiza-
tions of the Treadway Commission has pointed
out that internal control in an organization “is
only as effective as the integrity and compe-
tence of the people who develop, administer
and monitor the controls” (COSO, 1991, p. 6).
This Committee, which was formed to study
the auditing profession, defines competence
as reflecting “the knowledge and skilIs needed
to accomplish the tasks that define the indivi-
dual’s job” (COSO, 1991, p. 60). Integrity is
defined as “the quality or state of being of
sound moral principle; uprightness, honesty,
and sincerity” (COSO, 1991, p. 59). WhiIe judg-
ments about client managers’ competence and
integrity are clearly germane to an effective
audit, recent research (Bernardi, 1994; Pone-
mon, 1993) suggests that not aII auditors are
equaIly sensitive to these client traits. Differen-
tial assessments of competence and integrity by
auditors indicate that additional research is
needed to determine the predictors of variance
in these assessments.
Correspondingly, auditors’ evaluations of a
client organization’s growth/decline status are
important, because such evaluations can be a
clue to the level of audit risk. Schick and Pone-
mon (1993) showed that firm-assigned audit
risk varied as a function of auditors’ percep
tions of the client’s position on a continuum
ranging from rapid growth to rapid decline.
Client companies that were perceived as
rapidly growing or rapidly dechning were
assigned higher audit risk scores than compa-
nies perceived as stable. In that study, as weII
as this one, the deIinition of organizational
growth and decline is the one on which agree-
ment is beginning to develop in the organiza-
tion studies literature. Hence, growth is defmed
as an increase in an organization’s resource
base. Conversely, decline is defined as a
decrease in an organization’s resource base
(see Cameron et al., 1987a).
Besides contributing to a better understand-
ing of the audit process and auditors’ assess-
ments of client managers’ integrity and
competence, this paper makes several contri-
butions to the organization studies literature.
First, it expands the models that examine the
responses of external stakeholders to organiza-
tional decline and bankruptcy (D’Aveni, 1989b,
1990; Neu & Wright, 1992; Sutton & CaIIahan,
1987). Auditors are important stakeholders
whose financial opinions infIuence the deci-
sion making of other external exchange part-
ners, such as investors and government
agencies (Schick & Ponemon, 1993). There-
fore, auditors’ responses to perceived decline
are useful in understanding the overall message
of stigma that decline may transmit to members
of an organization’s task environment. Second,
this study moves beyond the models of stake-
holder reactions to organizational decline by
analyzing stakeholers’ (auditors’) reactions to
perceived organizationaI growth. Third, this
research adds to the growing organization stu-
dies literature on causal attributions and man-
agerial interpretations (Bettman & Weitz, 1983;
Chen & Meindl, 1991; Cram & Bateman, 1993;
Dutton & Jackson, 1987; Ford, 1985; Ford &
Baucus, 1987; Martinko & Gardner, 1987;
MeindI & EhrIich, 1987; MeindI et al ., 1985;
MiIliken, 1990; SaIancik & Meindl, 1984; Staw
et al ., 1983; Weiner, 1986). Our results are
consistent with this research because they
can be explained from an attributional perspec-
tive. Fourth, there is now a significant stream of
organization studies literature that focuses on
accountants and financial reporting practices as
subjects for investigation (e.g. Chatman, 1991;
LevittthaI & Fichman, 1988; Mezias, 1990; Mor-
rison, 1993; Seabright et al ., 1992; Sheridan,
1992). This paper adds to that research
stream, reafhrming the importance of account-
ing firm personnel and auditors to our under-
standing of organizational behavior.
196 W. MCKINLEY et al.
THEORETICAL BACKGROUND
Competence
There are a number of reasons why percep
tions of rapid organizational decline might lead
an auditor to question the competence of a
client Iii-m’s managers. First, organizational
decline carries a stigma (Cameron et al .,
1988; Sutton 1990; Sutton & Callahan, 1987).
This stigma extends to the managers of de&n-
ing or bankrupt firms and causes observers to
question the ability of those individuals (Sutton
& Callahan, 1987). It is generally assumed, par-
ticularly in American society, that leaders are in
control of their organizations and that they
have a significant impact on organizational per-
formance (Meindl et al ., 1985; Salancik &
Meindl, 1984). Therefore, when perfomance
is declining, observers tend to attribute this
outcome to lack of competence on the part
of the organization’s managers, regardless of
the managers’ “ true” causal Impact on perfor-
mance (Staw, 1975). This attributional effect is
so powerful that observers (e.g. the business
press) often revise their descriptions of organi-
zational leaders to be consistent with down-
turns in organizational performance (Chen &
Meindl, 1991). Assuming that auditors behave
similarly to other external judges of organiza-
tional performance, we would expect that audi-
tors who perceive client firms as rapidly
declining wiII rate the competence of those
firms’ managers as relatively low.
A second reason for anticipating a negative
effect of perceived decline on auditors’ assess-
ments of management competence is the phe-
nomenon of managerial succession and
turnover. A large body of research has sug-
gested that poor organizational performance
is a major cause of managerial succession
(AIIen & Panian, 1982; AIlen et al ., 1979;
Brown, 1982; Schwartz & Menon, 1985a), man-
agerial dismissal (Boeker, 1992; Fredrickson et
al ., 1988) and management turnover (AIexan-
der et al ., 1993; Lam et al ., 1992; Puffer &
Weintrop, 1991). A review of this literature
indicates that these finding are among the
most consistent in contemporary organiza-
tional research. Management succession and
turnover may have a positive or negative
impact on subsequent organizational perfor-
mance, thus the sign of this relationship is stiII
in doubt (Alexander et al ., 1993; Fredrickson et
al ., 1988; Mentzer, 1993). Nevertheless, regard-
less of the objective performance outcomes of
succession and turnover, we argue that these
events wiII be a negative signal to auditors. This
is because management succession and turn-
over project an image that the Iirrn is not fully
under control. For example, D’Aveni (1990)
posited that the “baiiout” of prestigious man-
agers in the years preceding bankruptcy sent a
message of stigma to external stakeholders of
declining firms. The result, D’Aveni (1990) sug-
gested, was the withdrawal of stakeholder sup
port and the hastening of the decline process.
Assuming that auditors are aware of such
dynamics, their view that decIining Iirms are
out of control wiII be reinforced. This raises
additional doubts about the competence of
managers whose firms are perceived as de&n-
ing.
A third reason that auditors may question the
competence of client managers whose firms
are perceived as rapidly declining has to do
with the issue of risk. A number of empirical
studies (e.g. Bowman, 1982; Fiegenbaum &
Thomas, 1988; Jegers, 1991; Singh, 1986)
have suggested that poor organizational perfor-
mance is associated with risk taking. Like the
findings on the relationship between poor per-
formance and succession or turnover, these
results are remarkably consistent from study
to study. The theoretical foundation for this
stream of research is prospect theory (Kahne-
man & Tversky, 1979), which argues that deci-
sion makers are risk seeking in the domain of
losses. Other investigations also have raised the
possibility that risk taking feeds back to accel-
erate the low performance that gives rise to it
(Bromiley, 1991; Hambrick & D’Aveni, 1988).
Furthermore, Fombrun and Shanley (1990)
have shown that performance-adjusted risk is
negatively related to corporate reputation,
contrary to the popular stereotype that risk
taking is valued by corporate stakeholders.
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 197
This suggests that risk taking will be viewed
negatively by auditors. In addition, we believe
this response will be reinforced by the empha-
sis placed on internal control in the auditing
profession (COSO, 1991). Thus, if the fIndings
of organization studies are consistent with the
day-today observations of auditors, risk taking
will give them one more reason to question the
competence of managers whose firms are per-
ceived as rapidly declining.
While the preceding discussion has argued
that perceptions of rapid decline will raise
doubts about the competence of client man-
agers, we also make the same argument about
perceptions of rapid growth. This is based on
our assumption that rapid organizational
decline and rapid organizational growth share
some of the same characteristics, at least in the
eyes of auditors. For one thing, both rapid
decline and rapid growth are likely to be seen
as risky situations. Argenti (1976) has pointed
out that maintaining organizational growth
often requires substantial borrowing, because
internahy generated cash flows are not enough
to fund the desired growth rate. This creates a
danger of “overtrading” or “overgearing”: that
is, excessive debt and high interest payments.
If sales encounter a period of stagnation, as can
take place in recessions or in many other cir-
cumstances, the firm is at risk of becoming
unprofitable. Argenti’s (1976) Type 2 failure
trajectory depicts the type of organizational
failure that occurs as a result of too-rapid
growth. Hambrick (1985) also discussed the
hazards of growth, including management
overoptimism and resulting investments
whose lixed costs cannot be covered by future
revenues. Consistent with these perspectives,
Haveman (1993) recently reported a positive
effect of organizational growth on organiza-
tional mortality.
We expect that such growth-related pro-
blems will have particular salience for external
stakeholders, because of the drama that often
attends corporate collapse through excessively
rapid growth (Argenti, 1976). Also, rapid
growth may violate norms of consistency
(Staw, 1981) because such norms value
steady, incremental increases in profit mar-
gins, rather than spectacular gains whose
future maintenance is uncertain. We anticipate
that auditors will adhere to norms of consis
tency, and thus will attribute higher compe-
tence to managers of stable firms than those
that are perceived as rapidly growing.
These arguments suggest the following
hypothesis:
Hypothesis 1: Auditors’ perceptions of the growth/
decline status of client organizations will have an
inverted-U relationship with their perceptions of man-
agement competence. Specitically, if client organiza-
dons are perceived by auditors as rapidly declining or
rapidly growing, management competence assessments
will be lower than if the client organizations are per-
ceived as stable.
htegrfty
In the previous section an inverted-U rela-
tionship was posited between auditors’ percep
tions of a client’s growth/decline status and
their evaluations of how competent the cli-
ent’s managers are. We predict a similar pat-
tern for auditors’ assessments of management
integrity, but for different reasons than those
articulated above. A number of studies in the
accounting and management literature have
suggested that organizational decline and fail-
ure are associated with “creative account-
ing”. For example, Argenti described many
instances of this practice, and stated: “I have
come to believe that [creative accounting] is
almost invariably associated with failure”
(1976, p. 143). Argenti (1976) also emphasized
that creative accounting is designed to deceive
stakeholders about the true state of a lirm’s
financial health, but ends up promoting man-
agerial self-deception. Correspondingly, Star-
buck et al., (1978) and Whetten (1980) called
attention to the existence of dubious account-
ing practices, such as distortion of accounting
data and juggling of operating results, in firms
facing organizational decline or crisis. Hop
wood et al., (1989), Kinney and McDaniel
(1989), and Schwartz and Menon (1985b) all
indicated that financially distressed firms tend
198 W. MCKINLEY et al.
to engage in creative accounting. Summarizing
the conclusions of this literature, Schick and
Ponemon (1993, p. 95) stated that “misrepre-
sentation, hiding, juggling or distorting fman-
cial data, financial condition or accounting
reports are prevalent during periods of
decline.” Such activities should be particularly
salient for auditors, because they are required
to certify that the financial statements of client
organizations are free from material misrepre-
sentations. We believe that the well-known ten-
dency toward accounting distortions during
decline will raise doubts among auditors about
the integrity of client managers whose lirms are
perceived as rapidly declining.
In addition to the technical issues raised by
the occurrence of creative accounting, Sutton
and Callahan’s (1987) research suggests that
decline and bankruptcy may be characterized
by a more general orientation toward stake-
holder deception. Sutton and Callahan (1987)
reported that the managers of some of the
bankrupt computer Iirms in their sample tried
to conceal the fact of bankruptcy from stake-
holders. The concealment strategies included
both evasion and outright lying. While such
blatant deception may not occur in every case
of rapid decline or bankruptcy, even occasional
instances that become public knowledge will
color auditors’ perceptions of management
behavior under such conditions. Sutton and
Callahan (1987) described the anger and loss
of trust experienced by stakeholders when
they discovered that managers were trying to
hide a Iirm’s true financial condition. Added to
concerns about technical accounting misrepre-
sentation, cases of more general deception will
reinforce auditors’ doubts about management
integrity when rapid decline is perceived to
be occurring.
Ironically, there is evidence to suggest that
rapid organizational growth will cause auditors
to have similar qualms about management
integrity. Again, this is consistent with our per-
spective that rapid organizational decline and
rapid organizational growth share some simila-
rities, at least in the view of auditors. Based on
a review of SEC enforcement actions and law-
suits, the National Commission on Fraudulent
Financial Reporting (1987, pp. 23-24) listed
several growth-related conditions that provide
opportunities and incentives for managers to
misrepresent operating results. These condi-
tions include the overloading of internal
accounting controls by a rapid expansion of
sales and pressure to meet investor expecta-
tions for increases in stock price. In describing
his Type 2 trajectory, Argenti (1976) also
emphasized the important role of stakeholder
expectations and how they can be stimulated
by rapid organizational growth. Initial rapid
growth created expectations for similar perfor-
mance in the future. Those expectations
become particularly strong when the firm is
promoted by the popular business press. To
maintain the growth rate and the tirm’s
image, managers may begin to overstate the
value of assets or the size of their inventories.
As was true for Billie Sol Estes’ ammonia tanks,
the fraud sometimes reaches such proportions
as to become absurd. This led Argenti (1976,
p. 159) to make the statement quoted at the
beginning of this paper. As Argenti (1976)
noted, the visibility of failures due to rapid
growth, as well as the publicity given to the
fraud that is often associated with these cases,
are out of proportion to the frequency with
which such failures actually occur. We argue
that such prominent cases will lead auditors
to be suspicious of management integrity
when they believe that a client organization is
rapidly growing.
Additional support for this view is found in
the organization studies literature, as well as
articles reported in contemporary business
publications. In building a theoretical model
of lying and deceit in the workplace, Grover
(1993) assigned an important causal role to
performance expectations. He hypothesized
that high performance expectations (the kind
that are prevalent during rapid organizational
growth) are associated with a higher incidence
of lying. An illustration of this principle is con-
tained in Brannigan and Grossman’s (1992)
description of rapid growth and financial fraud
at Comptronix. The ability of the lirm to
AUDITORS’ PERCEPTIONS OF CLIENT FIRMS 199
exceed analysts’ performance expectations
pushed the stock price up, generating strong
pressures for the company to continue its
record of high profits. This was accomplished
by inflating the value of inventories and by a
complicated scheme of fake financial transac-
tions. Bet-ton (1992) reported similar financial
manipulations at Phar-Mor, which also appear
to be related to the company’s need to main-
taln its phenomenal growth. The Phar-Mor case
is certainly salient to the auditing profession,
because it has resulted in a lawsuit tiled by
Investors against Phar-Mor’s former auditor,
Coopers & Lybrand (Berton, 1992). The
increasing frequency of such cases reinforces
our argument that auditors take rapid growth
as a signal that management integrity may be
compromised.
In summary, our discussion suggests the fol-
lowing hypothesis:
Hypothesis 2: Auditors’ perceptions of the growth/
decline status of client organizations will have an
inverted-U relationship with their perceptions of man-
agement integrity. If client organhtions are perceived
by auditors as rapidly declining or rapidly growing,
management integrity assessments will be lower than
if the client organizations are perceived as stable.
METHOD
Sampl e and data col l ecti on
The two hypotheses stated above were
tested with data from a study of auditors’ per-
ceptions of client organizations and their man-
agers (Schick & Ponemon, 1993). The study
was conducted in the offices of two interna-
tional public accounting firms headquartered
in a large northeastern city. After obtaining
the cooperation of the managing partners in
each office, a stratified random sample of 417
client organizations (203 from tirm one and 2 14
from firm two) was drawn. An audit team con-
sisting of one audit partner and one audit man-
ager had audit responsibility for each of these
client organizations. An individual audit partner
or audit manager might be involved in simulta-
neous audits of several different clients. There-
fore, perceptual responses regarding different
client organizations might suffer from lack of
independence, if they originated with the
same auditor. To deal with this problem,
responses from the same audit partner or man-
ager were not used more than twice, and each
partner and manager team was unique. This
resulted in the elimination of 290 client organi-
zations from the sample. Four more organiza-
tions were dropped due to missing data on the
perceptual measures. The Iinal sample for the
analyses reported in this paper, therefore, was
123 client organizations, 60 from audit firm one
and 63 from audit firm two.
All the client organizations were for-profit
businesses. Sixty-eight of the clients were pub
licly held corporations, i.e., their stock was
traded on a major stock exchange or in the
over-thecounter market. The remaining client
organizations (55) were privately held, which
meant that their stock was not traded.
Perceptions of each client organization and
its managers were solicited from the audit part-
ner and audit manager (audit team) responsible
for that client organization’s audit. A structured
questionnaire was administered seperately to
each of the two team members to record their
perceptions of the client. The relevant pages of
this questionnaire are reproduced in the
Appendix. The administration of the question-
naire was done in person by an interviewer, so
that respondent queries could be answered.
Audit partners are senior management officials
of an audit firm, with voting rights, equity inter-
ests and responsibility for the completion of
the audit engagement. Audit managers are
one level below audit partners in the audit
Iirm hierarchy. Audit managers have no equity
interest in the audit Iirm and are charged with
determining the overall scope of the audit. Data
were collected from a total of 30 audit partners
and 36 audit managers in audit Firm one and 33
audit partners and 40 audit managers in audit
firm two. The audit partners included in this
study had an average of 16.7 years of auditing
experience, while the audit managers had an
average of 7.7 years of experience. For addi-
tional details regarding the sample and method
200 W. MCKINLEY et al.
of data collection, the reader is referred to
Schick and Ponemon (1993).
Measures
I ndependent variable. For each client organi-
zation, the audit partner and audit manager
were asked their perceptions of the client’s
growth/decline status. If a respondent believed
the client organization was declining, (s)he
was asked to evaluate the degree of decline
on a Likert-type scale. The response cate-
gories ranged from 1 (very rapid decline) to
6 (no decline-stable). Correspondingly, if the
respondent believed the client organization
was growing, perceptions about the degree of
growth were recorded on a second Likert-type
scale. Response categories on that scale ranged
from 1 (very rapid growth) to 6 (no growth-
stable). For purposes of analysis, these two
scales were combined, using reverse scoring
where necessary, to form an ll-category
scale, ranging from 1 (very rapid growth) to 6
(stability) to 11 (very rapid decline). In this
way, the various auditor perceptions about
the level of client growth or decline were cap
tured on one ordinal scale. Of the 123 compa-
nies studied, audit managers viewed 43 as
declining, 41 as stable and 39 as growing. Simi-
larly, audit partners viewed 41 as declining, 42
as stable and 40 as growing. Audit managers
and partners tended to hold consistent percep-
tions of decline, stability or growth, since in
120 cases the audit managers and partners
were within two rating points on the 1 l-point
ordinal scale. Consequently, the perceptual
scores for the audit partner and audit manager
were averaged, to obtain a single score for each
client organization. This is consistent with the
conclusion of past auditing researchers (e.g.
Schultz & Reekers, 1981; Solomon, 1987; Trot-
man et al., 1983) that critical auditing decisions
are based on the combined evaluations of two
or more members of an audit team.
As is apparent from page 2 of the question-
naire contained in the Appendix, we did not
define “growth” and “decline” for the intervie-
wees. This decision was based on our desire to
measure growth/decline as a perceptual con-
struct, which would then be related to percep
tions of client management competence and
integrity. However, the interrater reliability of
this growth/decline measure was assessed by
Schick and Ponemon (1993, p. 99). They
found a strong positive correlation (r = 0.81,
p