Professional Independence and Attachment Bias: An Exploratory Study

Larelle Chapple School of Accounting and Business Information Systems, Australian National University, Australia Peter Crofts Barrister at law, Victoria, Australia Colin Ferguson Department of Accounting and Business Information Systems, The University of Melbourne, Australia Jane Hronsky Department of Accounting and Business Information Systems, The University of Melbourne, Australia Key words: professional independence; bias; attachment bias; moot court experiment ABSTRACT Policy makers have focused on auditor independence-related reforms to address the perceived loss of credibility in financial reporting that followed major accounting scandals from late 2001. Independence is generally agreed to comprise two components, independence in mind and independence in appearance (eg IFAC Code of Ethics). Objectivity is one of the fundamental principles and it requires that professional judgment not be compromised because of bias, conflict of interest or undue influence. We argue that bias is an inevitable component of the human psyche. This exploratory study examines the phenomenon of unconscious attachment bias. Such attachment bias is likely to arise in a professional services setting such as auditing. This paper describes an experiment where participants, acting as forensic accountants, were randomly assigned to act as independent expert for either the plaintiff or defendant in a commercial damages dispute. Even though the participants were instructed as to the requirement of independence, we hypothesized that the plaintiff experts would opine a higher damages award than those acting for the defendant. Consistently we found this to be the case in the experimental setting. The experiment provides evidence of attachment bias affecting professional decision making, meaning it is difficult to mandate independence. There are clear implications of these findings for corporate governance research, for example, in studying the performance of independent directors and independent committees such as audit committees.
This version: August 2011
Acknowledgements: We appreciate the helpful comments from workshop participants at the University of Melbourne, University of Queensland, Deakin University, La Trobe University, Macquarie University, AFAANZ Annual Conference, Paul Coram, Jason Hall, Matt Pinnuck, Kevin Stevenson & Anne Wyatt

AttachmentBias_Aug_2011.docx

Created on 11/8/2011 11:53:00 AM

Professional Independence and Attachment Bias: An Exploratory Study

1. INTRODUCTION AND SUMMARY The aim of this paper is to investigate how the exercise of professional judgment is inevitably affected by unconscious bias, even in the face of professional mandates to be free from bias (independence). Specifically, we examine a particular form of

unconscious bias, referred to as attachment bias, in a professional setting. Attachment bias refers to the psychological observation that human judgments are affected by the subconscious biases that arise from the contextual relationships in which the judgments are made. We show that, in an experimental setting involving expert valuation judgment in a litigation setting, the judgment is biased toward the interests of the client retainer, regardless of a professional mandate to maintain independence. Specifically, our results show that the loss quantifications provided by the plaintiffs expert witnesses are statistically significantly higher than those of the defendants expert witnesses. Through this, we highlight that bias can be unconscious and this has implications for the way that professional independence is perceived and regulated. In particular, this informs our understanding of bias in the audit judgment process. Our data are collected through a behavioural experiment where the judgment tested relates to that of an independent expert valuation assessment. This study uses the experimental setting where an independent accounting expert makes an assessment of the quantum of loss arising from a contract dispute. There are two parties to the dispute, and each party is entitled to retain their own expert to provide valuation evidence. However, in providing this professional opinion, the professional accountant is bound by a code of conduct mandating independence. To take another well known example of professional judgment, the quality of auditing, a process involving the exercise of professional judgment leading to an opinion or conclusion, is affected by unconscious judgment biases: Bazerman et al. (1997). The psychology literature asserts this bias is unconscious because in exercising their judgment to make a decision, individuals unconsciously reach conclusions that favour their own interests (or those of their relationships), whilst maintaining a belief in their own objectivity. This study

predicts and confirms the existence of attachment bias in an experimental professional services setting, where independence is a key professional mandate.

It is a truism that independence is the cornerstone of the auditing profession, to the extent that independence is generally perceived as the panacea to all potential biases. Yet whether this professional independence actually exists, or is able to be mandated, is a debate that seems to have consumed the world of corporate regulation, predominately United States, the United Kingdom (the regulatory posture of United Kingdom dominates the European Union) and Australia (Stevenson, 2006). A major impetus for the debate has been the perceived loss of credibility of assurance service providers following major corporate reporting scandals from late 2001, mainly in the United States. The response of regulators internationally has been a focus on auditor independence-related regulatory reforms, including provisions in the Sarbanes-Oxley Act of 2002 in the US, the UK Cocoordinating Group on Audit and Accounting Issues and the Australian Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (Treasury, 2006). This increased regulation clearly imposes costs, most directly upon financial statement preparers, but as is typically the case with regulation, the marginal social benefit is difficult to estimate.

Fearnley and Beattie (2004) review the various definitions of auditor independence around the world, in the pre-Enron period, noting that all statements make the distinction between independence in fact and independence in appearance. As discussed below, this distinction persists. Regulatory approaches inevitably seek to mandate independence. However, prescriptions can really only address the appearance of independence in any tangible way; for example, the prohibition on certain conflict of interest relationships, limitation or prohibition of the provision of non-audit services or the requirement for mandatory audit partner rotation. These are factors observable by external parties. Independence of mind cannot be created by mandate. The state of mind of a person making professional judgments is obviously not able to be observed by third parties. We would assert further, and test in this study, that those individuals do not have an accurate

knowledge of their own objective state of mind due to the existence of unconscious bias in judgment and decision making.

This study contributes to the auditor judgment setting in several ways. First, the experiment itself is novel yet pertinent. Prior studies finding attachment bias have used classroom experiments involving, for example, personal injury disputes. This experiment, using commercial litigation with an independent expert valuation report, more closely intimates a financial audit setting with a process of professional judgment leading to a professional opinion in a mandated independence setting. Our participants were graduate forensic accounting students. They were randomly assigned in pairs, to either the plaintiff or defendant in a moot court exercise, and provided with identical case information. The matter litigated is an economic loss dispute. They were required to independently produce, and defend in a moot court, an expert witness report quantifying the economic loss suffered in the case. Second, the study finds evidence of attachment bias, in a setting that more closely intimates audit judgment. Our results show that the loss quantifications provided by the plaintiffs expert witnesses are statistically significantly higher than those of the defendants expert witnesses. We interpret this as evidence of the existence of an unconscious attachment bias, which exists even in the absence of any economic or personally generated attachment. Third, in finding evidence of attachment bias, the significance of the study lends support to the professional independence debate that is that independence is a concept to be managed and monitored but ultimately independence in mind is a concept rather than reality.

The paper proceeds as follows: section 2 sets out the relevant theoretical issues and supporting literature to develop our primary hypothesis that subconscious attachment bias leads to higher economic loss quantification opinions in plaintiff expert witness reports compared to those opinions provided for in defendant expert witness reports. Note, the international standards and requirements have been adapted herein to the Australian equivalents, as this is the institutional environment presented to our experiment participants. Section 3 describes the experimental setting and method, demonstrating the

innovative features of this design compared to past literature. Section 4 describes the results showing a statistically significant bias and Section 5 concludes.

2. HYPOTHESIS DEVELOPMENT 2.1 Expert accountant witness independence The issue of professional independence has been appreciated for a long time. In contrast to the extensive body of research on auditor independence, the independence of expert witnesses has been the subject of limited scholarly research. However, the similarity in concepts between the independence mandated of auditors compared to expert witnesses is immediate and compelling and demonstrated in Figure 1. The expert witness in a court of law performs a special role in litigation. The common law rules of evidence generally exclude evidence of opinion. Expert witnesses are in effect an exception to the tradition1 that witnesses attest to facts and personal knowledge only. Expert witnesses must possess appropriate specialised qualifications or experience relevant to the opinion they seek to offer and their expertise must form part of a body of knowledge or experience which is sufficiently organised or recognised to be accepted as a reliable body of knowledge. That is to say they must be able to establish expertise. Therefore, the position has evolved that the expert witness is to assist the court in providing their expert, unbiased opinion on specific matters in dispute. Forensic accountants, providing expert opinion on commercial valuation, are a common manifestation of the Courts need for independent opinion.

INSERT FIGURE 1 ABOUT HERE

The law itself has addressed the question of professionals giving so-called expert testimony. Foster (1897) wrote of This bias or inclination [of an expert witness to report] in favour of the party by whom they are called and a century later the problem of bias (lack of independence) in the professional opinions of expert witnesses, including
See for example s 79 of the Evidence Act (Cth) 1995: provides that if a person has specialised knowledge based on the person's training, study or experience, the opinion rule does not apply to evidence of an opinion of that person that is wholly or substantially based on that knowledge.
1

accountants, was considered at some length by Lord Woolf.2 Lord Woolfs report gave rise to the regulatory intervention of Rules of Court, which require an expert witness to acknowledge a primary obligation to the Court, or even to a single expert witness being appointed on behalf of both parties. However, if regulatory compliance has been

achieved, even a professional opinion which may be regarded as objectively likely to be biased, will be allowed into evidence, with the objective evidence of bias going to the weight that will be given to the opinion by the Court.3 perceived to be biased will be discounted by the judge. In other words, evidence

Forensic accountants, when acting as independent expert witnesses, have a primary duty to provide reliable and objective evidence to the Court under both professional accounting standards (APES 110 Code of Ethics for Professional Accountants and APES 215 Forensic Accounting Services) and court rules relating to expert witnesses.4 Such codes will specify that an expert witness has an overriding duty to assist the court impartially and that the expert witness's paramount duty is to the court and not to any party.

Figure 1 illustrates the comparative and analogous nature of the auditors judgment and the experts judgment. Foremost, each professional accounting task operates in an environment where absence from bias is mandated. Further, each judgment is made in an environment that is backed up by further guidance and professional standards5. Arguably, the outcome of an audit independence compromise, audit failure, has more widespread economic consequences than an experts independence compromise. However, both
Lord Woolf MR Access to justice Final Report to the Lord Chancellor on the Civil Justice system in England and Wales HMSO London 1996. 3 See for example FGT Custodians Pty Ltd v Fagenblatt [2001] VSC 454 where the accountant brother-inlaw of the defendant was allowed to give evidence of the value of the defendants interest in a partnership subject only to the Judges discretion as to what weight he would accord it.
4 2

Exert witnesses in Australian courts are subject to a Code of Conduct, see for example Uniform Civil Procedure Rules 2005 NSW - SCHEDULE 7; Family Law Rules (2004) R15.49; Federal Court of Australia Practice Note CM7. See Appendix 1 for an example of the Code. There are some differences. The audit is subject to quality control and review processes (Libby & Trotman, 1993; Solomon, Rich & Trotman, 1997); group rather individual decisions and multiple rather than a single valuation. The effect of these factors on bias is worthy of further empirical investigation.
5

groups of professionals have a reputation to protect. Receiving adverse comment in a judgment based on professional compromise is a very public event and potentially will negatively affect the securing of future expert witness work from the instructing barrister. The human capital of the individual expert is at stake, as opposed to the reputation of an audit firm, thus the consequences to the individual of compromised independence are more salient.

The objectivity of accountants when serving as an expert witness in a legal case has been experimentally examined by Ponemon (1995). Litigation specialists, as well as mainstream auditors, were allocated to either the plaintiff or defendant in a disputed insurance claim scenario. Subjects also completed the Defining Issues Test (DIT), a psychometric of ethical reasoning. His results found that individuals estimated higher damages when representing the plaintiff rather than the defendant insurance company. More senior, experienced accountants have lower DIT scores than less experienced accountants. However, higher DIT scores interacted with domain-specific experience to reduce bias in valuations.

Consistent with Ponemon (1995), we hypothesise the existence of bias in expert witness valuations. We extend the literature by identifying and testing the underlying cognitive bias implicated in the judgments, attachment bias. This study is not designed to measure the impacts or outcomes of professional judgment decisions per se, but to find evidence of attachment bias. 2.2 Auditor independence The IFAC Code of Ethics for Professional Accountants (adopted in Australia as APES 110) takes a conceptual approach to independence, stating that independence requires both independence of mind and independence in appearance. Independence of mind is defined as the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism; while independence in appearance is defined as the avoidance of facts and circumstances that

are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firms, or a member of the assurance teams, integrity, objectivity or professional skepticism had been compromised (APES 110, para. 290.8).

Objectivity is one of the fundamental ethical principles of the profession (APES 110, para.100.4), and one presumed of an accountant expressing an opinion on a professional issue. It requires that professional judgment not be compromised because of bias,

conflict of interest or the undue influence of others (para.120.1). Absence of bias is a noble ideal, but there is considerable evidence that it is no more than that. Professional service providers will naturally have economic, financial and other relationships with their clients, creating an attachment bias. Costly regulation of independence has focused on addressing the outward form of the relationships, but fails to acknowledge that this bias is arguably an inevitable component of the human psyche and may not be able to be addressed. Rather it must be recognized and taken into account when considering a professional opinion.

Auditor independence, and whether it has been compromised, has been addressed mainly from the perspective of apparent economic bias. Reflecting the expressed concerns of regulators, much attention has been focused on the role fees for audit and non-audit service fees may play in eroding independence6. Theoretically, two competing hypotheses have been proposed. One is that the joint provision of audit and non-audit services strengthens the economic bond between an auditor and client. In order not to jeopardize the fee income, an auditor has increased incentives to compromise his/her objective judgment and acquiesce to client-preferred accounting treatments (e.g, Simunic, 1984). In the terminology of the Code of Ethics, this is a self-interest threat to independence. This explanation continues to be intuitively appealing to regulators and media commentators (see, for example, Schapiro, 2004 and West, 2008).
Other issues examined have been the effect of audit tenure (the familiarity threat to independence) (e.g., Geiger and Raghundandan, 2002); the effect of employment affiliations (familiarity and self-interest) (e.g., Lennox, 2005) and capital market responses to fee disclosures (Krishnan, Sami and Zhang, 2005).
6

Alternatively, DeAngelo (1981) and Arrunada (1999) posit that the auditor has a greater investment in reputational capital, and will not risk jeopardizing this to please any one particular client7. Essentially, there is a trade-off: acquiescing to a clients aggressive accounting may increase short-term revenue but increases litigation risk and reputational damage in the longer term. In support of this argument, Moreno and Bhattacharjee (2003) find that the prospect of additional business opportunities does not affect the inventory valuation judgment of audit managers and partners, as they are exposed to the counterpressures of litigation and risk management concerns. Khurana and Raman (2004) also find audit quality to be driven by litigation risk. In contrast, these incentives to maintain audit firm reputation and avoid future litigation are argued by Trompeter (1994) to be insufficient to constrain bias at the level of the individual audit partner, whose compensation is dependent upon client retention. Other studies (Ferguson and Wines, 1993; Emby and Etherington, 1996; CAIP, 2010; McKnight and Wright, 2010) document that it is client relations that is the most highly valued attribute in partners of professional services firms, ahead of technical skills. From the perspective of the financial statement preparer, Carcello, Hermanson and McGrath (1992) found characteristics related to the members of the audit team were generally perceived to be more important to audit quality than characteristics related to the audit firm itself, such as litigation record. In descending order, the important audit quality factors were experience with the client, industry expertise, responsiveness to client needs, and compliance with standards of independence and competence. Mayhew, Schatzberg and Sevcik (2001) in an experimental market setting, show that where there is no accounting uncertainty, auditors will maintain their objectivity in order not to compromise their reputation. However, when uncertainty or ambiguity is introduced, the reputation incentive is insufficient to prevent the impairment of objectivity. In sum, auditors seek to maintain objectivity to preserve their reputational capital, but must do so in circumstances where there is often uncertainty or ambiguity in accounting judgments, where good client

A similar set of incentives, with the short-term/long-term trade-off, face forensic accountants. As noted previously, judges can discount or refuse to admit evidence that is perceived to be overtly biased, leading to damage to the experts professional reputation.

relationships and client retention are critical performance measurements, valued by both auditors and clients, and the audit fees paid by clients create an economic bond. This relationship between the economic bond and audit independence has been empirically tested in a stream of literature, including DeFond, Raghunandan and Subramanyam (2002); Frankel, Johnson and Nelson (2002); Chung and Kallapur (2003); Geiger and Rama (2003); Ashbaugh, LaFond and Mayhew (2003); Reynolds, Deis and Francis (2004) and Ye, Carson and Simnett (2011). Nelson (2005) provides a review of much of the empirical research on auditor conflicts of interest. A variety of metrics have been used for audit fees, as a measure of the economic bond, and for the dependent variable, typically some measure of discretionary accruals or of audit opinion type, and an inference made as to whether auditor independence has been impaired. The results have been mixed, but on balance do not support the impairment of independence argument.

However, a key point is that these archival studies can only examine the appearance of independence, and test the efficacy of regulation of those appearances in a manner perhaps not dissimilar to those adopted in the Courts. To get closer to the concept of independence of mind, we need to turn to psychology theory. The psychology literature has extensively documented the existence of biases in human judgment and decision making (see Kahneman, Slovic and Tversky, 1982; Kahneman and Tversky, 2000; and Gilovich, Griffin and Kahneman, 2002 for summaries). A significant stream of behavioural auditing research, drawing upon this psychology framework, has identified biases affecting auditor judgments (see Koch and Wustemann, 2008 for a review), as well as testing strategies for debiasing those judgments (for example, Kennedy, 1993, 1995; Clarkson, Emby and Watt, 2002). A series of papers in the psychology and management literature (Bazerman, Morgan and Loewenstein, 1997; Bazerman, Loewenstein and Moore, 2002; Moore, Loewenstein, Tanlu and Bazerman, 2005; Moore, Tetlock, Tanlu and Bazerman, 2006; and Bazerman, Moore, Tetlock and Tanlu, 2006) have made the contention that auditor independence is

10

impossible. They argue as follows. Auditors and other professionals do not consciously give other than independent opinions. They are not knowingly self-serving or corrupt. They are however inevitably affected by very human self-serving bias; that is, individuals subconsciously reach conclusions that favour their own interests, whilst maintaining a belief in their own objectivity. That is, they exhibit bounded ethicality (Chugh, Bazerman and Banaji, 2005).

On what grounds are these allegations made? Bazerman et al (2002) identify three structural aspects of auditing that provide opportunities for the play of bias: ambiguity, attachment and approval. Auditing, and any activity that relies on professional judgment, requires decisions to be based on the interpretation of ambiguous information. The nature of GAAP necessitates the ambiguous interpretation and application of accounting rules to economic events and transactions, for example, in asset valuation or the appropriate level of provisioning. In an expert accounting opinion it may, for example, involve the selection of an applicable interest or discount rate, or assumptions about future sales. This is evidenced in the negotiation process that takes place between auditors and clients (Gibbins, Salterio & Webb, 2001) or discussions which occur between an expert and the client.

Auditors like expert witnesses are invariably paid by their client, and this can be seen to create an overt or explicit economic bond or attachment. Attachment can also be implicit, occurring in less obvious ways. An auditor could have friendly relations with company management; as noted above, this is an important performance indicator for the auditor. An expert may feel that one case is more morally justifiable than another. Psychologically, this attachment predisposes an individual to interpret information in a way favorable to the client, as their interests are subconsciously aligned.

The third element is approval. An auditor is required to approve or disapprove the clients financial statement assertions; an expert to approve or disapprove of their clients position in a dispute. Psychology research shows that individuals have a self-serving willingness to accept or rationalize existing resource allocations that favour themselves,

11

even beyond what they themselves would have recommended (Diekmann, Samuels, Ross & Bazerman, 1997). Bazerman et al (2002) use that finding to make the implication that auditors would approve more aggressive client-preferred accounting positions than they themselves would have independently recommended.

Whilst these arguments are plausible, what evidence exists in their support? In their alleged application to audit professionals, and by extension the role of accounting experts, the empirical evidence of support does not come from the auditing literature, but rather largely from psychology, in a non-accounting task setting (for example, Diekmann et al, 1997; Babcock and Loewenstein, 1997). The only extant accounting-based research on objectivity in litigation support judgments, Ponemon (1995), takes an ethics rather than a cognitive theory framework.

The objective of our study is to test the Bazerman et al proposition of the presence of self-serving bias, in an experimental setting utilizing a professional accounting task. The setting is litigation which entails the quantification of an economic loss. Participants are required to produce forensic accountants independent expert witness reports detailing this quantification. The reports are produced within the framework of the professional accounting standards and Rules of the Court that mandate professional objectivity.

We test only the unconscious attachment bias. The factors of approval and ambiguity are controlled by participants producing independent reports on the basis of identical case information, with no negotiation process or indeed contact with a client involved. They are not required to approve or dispute an existing quantification but rather to develop an independent quantification. As all participants receive identical information, ambiguity effects should be randomized. As this is an experiment, no economic incentive, bond or attachment exists. Consistent with Bazerman et al (2002), who argue that even a hypothetical relationship is sufficient to induce bias, we hypothesise that the economic loss quantifications in plaintiff expert witness reports will be significantly higher than those in defendant expert witness reports.

12

3. METHOD

3.1 Experimental Setting Bazerman et al (1997, 2002) make their case for the impossibility of auditor independence, on the basis of series of experiments reported by Loewenstein, Issacharoff, Camerer and Babcock (1993), and further discussed in Babcock, Loewenstein, Issacharoff and Camerer (1995) and Babcock and Loewenstein (1997). Their scenario is a damages claim following a collision between a motorist and a motorcyclist; participants are randomly assigned to the plaintiff or the defendant, provided with case information, and required to negotiate a settlement. Participants are subject to real economic incentives, with payments or penalties tied to their judgments. They find that plaintiff participants systematically make higher damages claims than do defendants, and the more divergent the amounts, the more likely it is a bargaining impasse is reached. Their argument that it provides a close analogy to the situation in auditing is not convincing. A single identified victim of personal physical injury (the motorcyclist) creates a different affect8 in judgments, and raises emotional issues of equity and fairness; contrast the remoteness of those economically affected by auditor judgments. There is not a clear test of attachment bias, and external validity to a business context is low.

Turning to the auditing context, Boylan (2008) describes a classroom exercise he uses to illustrate the Bazerman et al argument. Students role play auditors and managers and must negotiate and settle on an agreed number of items in a jar. However, the negotiation process brings the approval aspect into play, while Boylan states that it is the anchoring and adjustment judgment bias that is the key factor of influence in his exercise.

Our experiment is thus most similar in context to Ponemon (1995), using a litigation setting where accountants are required to provide independent quantifications of loss for either a plaintiff or defendant. We believe that our experiment enables more robust
Affect refers to feelings of goodness or badness experienced with or without conscious awareness, which give meaning to information and colour judgments. See Slovic (2010) for a discussion of the wellestablished difference in affect between a single victim and the remote many.
8

13

inferences to be made of the existence of attachment bias in auditing and accounting professionals, because the accounting professional case setting and moot court examination provides high external validity and the experimental design results in high internal validity.

3.2 Experimental Design

We investigate the role of attachment bias in the work of professional accountants by conducting an experiment.

We use a case based on a real dispute between two parties over an alleged economic loss incurred through the failure of refrigeration equipment in a dairy business. Further detail of the case is contained in Appendix 2. In the case, the plaintiff, the owner of the business, is claiming an economic loss as a consequence of this failure. Graduate forensic accounting students, acting as independent expert accountants with a primary duty to report fairly to the court, are asked to quantify this loss. The defendant supplier of the failed refrigeration equipment does not deny liability but disputes the quantum of loss claimed. The defendant has retained its own independent expert accountants with the same primary duty to report fairly to the court to quantify the plaintiffs loss.

In our experiment, both appointed independent accounting experts receive precisely the same facts, to prepare a report that quantifies the economic loss allegedly suffered by the plaintiff. Subjects are randomly assigned to groups of three to four with each group making up an expert accounting team or department and also having the effect of reducing differences between groups due to ambiguity effects. Each group is randomly assigned to act as either the expert for the plaintiff or the expert for the defendant in matched pairs to prepare a report quantifying the economic loss. Participants know that they will be required to present their report by oral testimony, and be cross-examined, in a moot court.

14

3.3 Participants

Table 1 describes the participants. Panel A sets out the number of participants, the number of experimental groups, and the number of matched pairs within each experimental group.

Panel B summarises the individual participants background and experience. The participants for the experiment are postgraduate students in the Melbourne Graduate School of Business and Economics, almost all of whom are enrolled in graduate accounting studies (92 percent). Over 60 percent of the participants have professional experience, with more than 50 percent having more than one years professional experience. All have completed six months of class room studies on the role of expert witnesses in forensic accounting and which have emphasized the importance of objective judgment and lack of bias.

INSERT TABLE 1 ABOUT HERE The use of students as participants in behavioral accounting research is supported by Moore (2005: 71-2): the expense of obtaining professionals as subjects is rarely worth the cost, unless the studys intent is to elicit some aspect of expertise or response to incentives that is developed with experience few would assert that, in the course of their training and professional socialization, auditors are made immune from the biases in judgment to which other human beings fall victim Unless there is a clear and compelling reason to expect a specific difference between two populations of people, we should assume that they are the same, especially with regard to basic psychological processes in judgment and decision making. Our student participants have the technical competence to make the economic quantifications necessary; our focus is purely on the existence of underlying attachment

15

bias. Additionally, as noted by Ponemon (1995), ethical reasoning as measured by the DIT is inversely related to experience.

3.4 Procedure The expert report is prepared as part of the participants forensic accounting studies9. In seminars across a twelve-week period, the participants are exposed to, inter alia, an understanding of the Australian legal system and the laws of evidence, damages and expert evidence in particular. The seminars are led by practicing forensic accountants, barristers and corporate regulators. It is made clear to the participants in these seminars that, as experts, they must act independently when preparing their report, that is, they are experts with obligations to the Court not to the plaintiff or defendant. This is reinforced by directing them to the relevant laws and regulations governing the role of the expert in court proceedings. These duties and responsibilities are: Expert evidence presented to the Court should be, and should be seen to be, the independent product of the expert uninfluenced as to the form or content by the exigencies of the litigation.10 This is identical to the independence of mind and independence in appearance required of auditors. An expert witness should provide independent assistance to the Court by way of objective unbiased opinion in relation to matters within his expertise11. An expert witness in the Court should never assume the role of an advocate. An expert witness should state the facts or assumptions upon which his opinion is based. He should not omit to consider material facts which could detract from his concluded opinion.

All participants are presented with identical case materials upon which to base their reports. They are also aware that, upon completion of their report, they will participate as

There is no assessment attached to the quantifications produced or moot court performance. Assessment on the report is based on the participants ability to comply with professional standards and Rules of the Court, with their emphasis on objectivity. If there is an approval bias at play seeking the approval of the instructors it would mitigate against finding a result. 10 Whitehouse v Jordan [1981] 1 W.L.R. 246 at 256, per Lord Wilburforce. 11 Polivitte Ltd v Commercial Union Assurance Co Plc [1987] 1 Lloyds Rep. 379 at 386 per Garland J. and Re J [1990] F.C.R. 193 per Cazalet J.

16

expert witnesses in a moot court. Practising barristers, one of whom is acting for the plaintiff and one acting for the defendant, examine and cross-examine the participants about their expert reports. This enhances the external validity of the expert witness exercise. Consequently, in preparing their report, there is a pervading tension brought about through the anticipation of appearing in court as an expert witness to defend the quantification of the economic loss and the underlying basis of the quantification. The participants know they must act independently and know that they will be examined in court on this issue. This cross-examination process creates the debiasing effect of accountability (Tetlock, 1985), as participants are made accountable for, and must justify, their judgments of economic loss. It adds to the experimental realism and militates against finding the hypothesised result.

The conditions of our experiment exhibit high internal validity. As noted above, participants receive extensive reinforcement of the principle that they are independent expert witnesses for the Court; they receive identical case information; they are required to produce independently-prepared reports quantifying the economic loss and so are not exposed to the views of any party with a vested interest; they work in groups so that ambiguity in interpretation should be minimised; they have the strong debiasing effect of accountability under cross-examination in Court for their judgments; and there are no financial or economic incentives. All of these factors bias against anything other than all reports producing very similar quantifications of economic loss. 4. RESULTS 4.1 Data Table 2 provides aggregated univariate statistics for the five iterations of the experiment. It shows the diverse range of possible valuation opinions on the same provided scenario. The total mean average plaintiff quantification across the five iterations of the experiment is over $4.2m, while the equivalent defendant quantification is $2.7m.12 These quantifications show the observable trend that the plaintiffs expert systematically
12

A range of values in expert witness reports occurs in practice (Betts, 2005) and for practising auditors under experimental conditions (Ponemon, 1995) and cannot be attributed to participants lack of litigation experience.

17

estimates a higher amount for economic loss than the defendant expert. For example, in the first iteration of the experiment the mean (median) for the plaintiff was $3.1m ($3.5m) whereas for the defendant, the mean (median) was $2.6m ($1.3m). This trend at the aggregate level is the same for further iterations of the experiment.

INSERT TABLE 2 ABOUT HERE 4.2 Analysis Table 3 Panel A reports a more detailed breakdown of the results of the study. In 16 of the 25 matched pairs, the plaintiff expert estimates the economic loss to be greater than the loss estimated by the defendant expert. While eight matched pairs show that the defendant expert estimates the economic loss as greater than the plaintiff expert, four of these estimates are not materially different.13

INSERT TABLE 3 ABOUT HERE The Wilcoxin Matched-Pairs Signed-Rank test14 confirms our hypothesis that plaintiff expert witnesses systematically and materially estimate economic losses of a greater dollar amount than defendant expert witnesses (where n=24 and T=62, p(2-tail)<0.01; p(1-tail)<0.005). Table 3 Panel B reports the student t-statistic for our data. These results are consistent with the results generated from the Wilcoxin Matched-Pairs Signed-Rank test. We interpret these results as evidence of the existence of unconscious attachment bias. Given the controls in our experiment, we note this attachment bias exists even in the absence of any explicit economic bond between plaintiff or defendant and their assigned expert.

13 14

The differences in these four instances are less than 5 percent. The Wilcoxon Matched-Pairs Signed-Rank test is a nonparametric test that is often regarded as being similar to a matched pairs Student t-test. This test is used to determine differences between groups of paired data where there are a small number of observations with unknown distributions. Typically, this test is even more sensitive than the Student t-test. Unlike less robust nonparametric tests such as the sign test, the Wilcoxon test is used to determine more than only the direction of difference between matched pairs it is also used to determine the magnitude of the difference between these matched groups (MacFarland, 1998).

18

5. SUMMARY AND CONCLUSION Concern is expressed on a continual basis by regulators, media commentators, and the judiciary over the independence of auditors and other accounting professionals in public practice. Bazerman et al (1997, 2002) provocatively argue that such independence is impossible, due to the existence of self-serving biases in judgments and decision making. We test this proposition by designing an experiment to investigate the existence of an unconscious attachment bias in the judgments of accounting professionals. Participants in our experiment are postgraduate students completing a forensic accounting course that strongly emphasises the relevance and importance of professional independence. To the extent that bias exists despite formal instruction, we suggest that unconscious attachment bias operates at a subtle level in professional decision making. In our experiment, graduate forensic accounting students, acting as independent expert witnesses, were randomly assigned to either the plaintiff or defendant, in an economic loss case study, and required to produce a quantification of the economic loss suffered using the same set of facts and information. These values had to be defended under cross-examination in a moot court, providing the debiasing context of accountability. An overwhelming majority of the plaintiff experts estimate a higher dollar amount compared with the defendant experts. We hypothesise, and find, the loss quantifications of the plaintiff expert witnesses to be statistically significantly higher than those of the defendant experts. We interpret this as evidence of the existence of an attachment bias. This attachment is manifest even in the complete absence of any economic attachment or bond, and under conditions that militate against finding it.

There are a variety of professional situations where professional independence is regulated and mandated, especially as relates to the auditing and accounting professions. There are clear policy implications of our identification of unconscious bias for the issue of auditor independence. Much public debate and costly regulation has been devoted to addressing allegations of impaired auditor independence caused by an economic dependence on the audit and non-audit fees paid by clients. The focus has been on the appearance of independence rather than independence of mind. Our findings suggest that, absent any economic attachment, an unconscious attachment still operates, created by just 19

being in a relationship (even if only a notional one). The implication is that being in a real, rather than hypothetical relationship, with economically significant fees involved, will considerably amplify this attachment bias. Thus, our findings support the contention of Bazerman et al (1997, 2002,) that true auditor independence is not possible.

Are there any solutions? Those proposed by Bazerman et al (1997, 2002) (fixed-term, fixed-fee contracts with mandatory firm rotation, or government-supplied auditing) are costly and impractical; may create incentives to reduce audit quality; and arguably would not remove the unconscious attachment bias that comes from being in a relationship. If complete independence is not possible, the necessity of the audit function nevertheless requires that audits be independent enough. An emphasis on professional education creating an awareness of the existence of bias is a starting point; as is an emphasis on reliability, integrity and expertise, per Taylor, DeZoort, Munn and Thomas (2003). There is some evidence that individual self-interest can be reduced by activating social values, such as the group affiliation of professionalism (King, 2002; Loewenstein, 2005; and Tyler, 2005). An alternative proposal is some kind of financial statements insurance scheme, as proposed by Ronen (2010). This is an exploratory study. While we report a strong result, many fruitful avenues for further research exist. The issue of whether independent expert witnesses are subject to bias, and if it can be mitigated, is clearly one that is of great interest to the legal profession, and warrants further investigation. Whether the judgments of auditors in other contexts, for example interpretations of accounting rules or asset valuations, are subject to attachment bias is an open question. Bringing in the added attachment of economic incentives facing auditors can provide insights to the interaction between financial and social incentives called for by Lerner and Tetlock (1999) and Koch and Wustermann (2008) and further contribute to the auditor independence debate. Finally, there are clear implications for corporate governance research. For example, the existence of directorauditors interlocks is an obvious site of attachment bias; and to what extent are independent directors subject to attachment bias and does this affect their performance?

20

REFERENCES APES 110 (2008) Code of Ethics for Professional Accountants APES 215 (2008) Forensic Accounting Services Arrunada, B. (1999) The Economics of Audit Quality: Private Incentives and the Regulation of Audit and Nonaudit Services, Norwell: MA: Kluwer Academic Publishers. Ashbaugh, H., LaFond, R. & B.H. Mayhew (2003) Do Nonaudit Services Compromise Auditor Independence? Further Evidence The Accounting Review, Vol. 78, No. 3, pp.611-639. Babcock, L., Loewenstein, G., Issacharoff, S. & C. Camerer (1995) Biased Judgments of Fairness in Bargaining, American Economic Review, Vol. 85, pp.1337-1342. Babcock, L. & G. Loewenstein (1997) Explaining Bargaining Impasse: The Role of SelfServing Biases, Journal of Economic Perspectives, Vol. 11, No. 1, pp.109-126. Bazerman, M.H., Morgan, K.P. & G.F. Loewenstein (1997) The Impossibility of Auditor Independence, Sloan Management Review, Summer, pp.89-94. Bazerman, M.H., Loewenstein, G. & D.A. Moore (2002) Why Good Accountants Do Bad Audits, Harvard Business Review, November, pp.97-102. Bazerman, M.H., Moore, D., Tetlock, P.E. & L. Tanlu (2006) Reports of Solving the Conflicts of Interest in Auditing are Highly Exaggerated, Academy of Management Review, Vol. 31, No. 1, pp.43-49. Betts, J.L. (2005) Business Valuation Practice Issues Under Family Court of Australia Proceedings, PhD thesis, Deakin University. Boylan, S.J. (2008) A Classroom Exercise on Unconscious Bias in Financial Reporting and Auditing, Issues in Accounting Education, Vol. 23, No. 2, pp.229-245. Carcello, J.V., Hermanson, R.H. & N.T. McGrath (1992) Audit Quality Attributes: The Perceptions of Audit Partners, Preparers, and Financial Statement Users, Auditing: A Journal of Practice & Theory, Vol. 11, No.1, pp.1-15. Centre for Accounting & Industry Partnerships (CAIP) (2010) Public Accounting Firm Services in Rural and Regional Australia, Research Monograph, The University of Melbourne.

21

Chugh, D., Bazerman, M.H., & Banaji, M.R. (2005) Bounded Ethicality as Psychological Barrier to Recognizing Conflicts of Interest, in Moore, D.A., Cain, D.M., Loewenstein, G. & Bazerman, M.H. (eds) Conflicts of Interest, Cambridge University Press: New York. Chung, H. & S. Kallapur (2003) Client Importance, Nonaudit Services and Abnormal Accruals, The Accounting Review, Vol. 78, No. 4, pp.931-955. Clarkson, P., Emby, C. & V.W.S. Watt (2002) Debiasing the Outcome Effect: The Role of Instructions in an Audit Litigation Setting, Auditing: A Journal of Practice & Theory, Vol. 21, No. 2, pp.7-20. DeAngelo, L.E. (1981) Auditor Size and Auditor Quality, Journal of Accounting & Economics, Vol. 3, pp. 183-199. DeFond, M., Raghunandan, K. & K. Subramanyam (2002) Do Non-audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions, Journal of Accounting Research, Vol. 40, pp. 1247-1274. Diekmann, K.A., Samuels, S.M., Ross, L. & M.H. Bazerman (1997) Self-Interest and Fairness in Problems of Resource Allocation: Allocators Versus Recipients, Journal of Personality and Social Psychology, Vol. 72, No. 5, pp. 1061-1074. Emby, C. & L.D. Etherington (1996) Performance Evaluation of Auditors: Role Perceptions of Superiors and Subordinates, Auditing: A Journal of Practice & Theory, Vol. 15 No. 2, pp.99-109. Fearnley, S. & Beattie, V. (2004) The Reform of the UKs Independence Framework after the Enron Collapse: An Example of Evidence-Based Policy Making, International Journal of Auditing, Vol. 8, No. 2, pp.117-138. Ferguson, C. & G. Wines (1993) Admission to Partnership in Australian Big Six Firms, Accounting Research Journal, Vol. 6, No. 2, pp.26-35. Foster, W. (1897) Expert Testimony- Prevalence Complaints and Proposed Remedies, Harvard Law Review, p169. Frankel, R.M., Johnson, M.F. & K.K. Nelson (2002) The Relation between Auditors Fees for Nonaudit Services and Earnings Management, The Accounting Review, Vol. 77, Supplement, pp. 71-105. Geiger, M.A. & Raghunandan, K. (2002) Audit Tenure and Audit Reporting Failures, Auditing: A Journal of Practice & Theory, Vol. 21, No.1, pp.67-78.

22

Geiger, M.A. & D.V. Rama (2003) Audit Fees, Nonaudit fees, and Auditor Reporting on Stressed Companies, Auditing: A Journal of Practice & Theory, Vol. 22, No. 2, pp.53-66. Gibbins, M., Salterio, S. & A. Webb, (2001) Evidence about Auditor-Client Management Negotiations Concerning Clients Financial Reporting, Journal of Accounting Research, Vol. 39 No. 3, pp. 535-563. Gilovich, T., Griffin, D. & D. Kahneman (2002) (eds) Heuristics and Biases: The Psychology of Intuitive Judgment, New York: Cambridge University Press. Kahneman, D., Slovic, P. & A. Tversky (1982) (eds) Judgment under uncertainty: Heuristics and biases, New York: Cambridge University Press. Kahneman, D. & A. Tversky (2000) (eds) Choices, Values and Frames, New York: Cambridge University Press & Russell Sage Foundation. Kennedy, J. (1993) Debiasing Auditor Judgment with Accountability: A Framework and Experimental Results, Journal of Accounting Research, Vol. 31, No. 2, pp.231245. Kennedy, J. (1995) Debiasing the Curse of Knowledge in Audit Judgment, The Accounting Review, Vol. 70, No. 2, pp.249-273. Khurana, I.K. & Raman, K.K. (2004) Litigation Risk and the Financial Reporting Credibility of Big 4 versus Non-Big 4 Audits: Evidence from Anglo-American Countries, The Accounting Review, Vol. 79, No. 2, pp.473-475. King, R.R. (2002) An Experimental Investigation of Self-Serving Biases in an Auditing Trust Game: The Effect of Group Affiliation, The Accounting Review, Vol. 77, No. 2, pp.265-284. Kinney, W.R. (1999) Auditor Independence: A Burdensome Constraint or Core Value?, Accounting Horizons, Vol. 13, No. 1, pp.69-75. Koch, C. & J. Wustemann (2008) A Review of Bias Research in Auditing: Opportunities for Combining Psychological and Economic Research, available at: http://ssrn.com/abstract=1032961 Krishnan, J., Sami, H. & Y. Zhang (2005) Does the Provision of Nonaudit Services Affect Investors Perceptions of Audit Independence? Auditing: A Journal of Practice & Theory, Vol. 24, No. 2, pp. 111-135. Lennox, C. (2005) Audit Quality and Executive Officers Affiliations with CPA Firms, Journal of Accounting and Economics, Vol. 39, pp.201-231.

23

Lerner, J.S., & P.E. Tetlock (1999) Accounting for the Effects of Accountability, Psychological Bulletin, Vol. 125, No. 2, pp. 255-275. Libby, R. & Trotman, K.T. (1993) The Review Process as a Control for Differential Recall of Evidence in Auditor Judgments, Accounting, Organizations and Society, Vol. 18, No. 6, pp.559-574. Loewenstein, G. (2005) Commentary: Conflicts of Interest Begin Where Principal-Agent Problems End, in Moore, D.A., Cain, D.M., Loewenstein, G. & Bazerman, M.H. (eds) Conflicts of Interest, Cambridge University Press: New York. Loewenstein, G., Issacharoff, S., Camerer, C. & Babcock L. (1993), Self-Serving Assessments of Fairness and Pretrial Bargaining, Journal of Legal Studies, Vol.22, pp. 135-159. MacFarland, T.W, (1998) Wilcoxon Matched-Pairs Signed http://www.nyx.net/~tmacfarl/STAT_TUT/wilcoxon.ssi Ranks Test,

Mayhew, B.W., Schatzberg, J.W. & Sevcik, G.R. (2001), The Effect of Accounting Uncertainty and Auditor Reputation on Auditor Objectivity, Auditing: A Journal of Practice & Theory, Vol. 20, No. 2, pp.49-70. McKnight, C.A. & Wright, W.F. (2011) Characteristics of Relatively High-Performance Auditors, Auditing: A Journal of Practice & Theory, Vol. 30 No. 1, pp.191-206. Moore, D.A. (2005) Commentary: Conflicts of Interest in Accounting, in Moore, D.A., Cain, D.M., Loewenstein, G., & Bazerman, M.H. (eds) Conflicts of Interest, Cambridge University Press: New York. Moore, D.A., Loewenstein, G., Tanlu, L. & Bazerman, M.H. (2005) Auditor Independence, Conflict of Interest, and the Unconscious Intrusion of Bias, Working Paper, Carnegie Mellon University. Moore, D.A., Tetlock, P.E., Tanlu, L. & Bazerman, M.H. (2006) Conflicts of Interest and the Case of Auditor Independence: Moral Seduction and Strategic Issue Cycling, Academy of Management Review, Vol. 31, No. 1, pp.10-29. Moreno, K. & Bhattacharjee, S. (2003) The Impact of Pressure from Potential Client Business Opportunities on the Judgments of Auditors across Professional Ranks, Auditing: A Journal of Practice & Theory, Vol. 22, No. 1, pp.13-28. Nelson, M.W. (2005) A Review of Experimental and Archival Conflicts-of-Interest Research in Auditing, in Moore, D.A., Cain, D.M., Loewenstein, G. & Bazerman, M.H. (eds) Conflicts of Interest, Cambridge University Press: New York.

24

Nelson, M.W. (2006) Ameliorating Conflicts of Interest in Auditing: Effects of Recent Reforms on Auditors and their Clients, Academy of Management Review, Vol. 31, No. 1, pp.30-42. Ponemon, L.A. (1995) The Objectivity of Accountants Litigation Support Judgments, The Accounting Review, Vol. 70, No. 3, pp.467-488. Reynolds, J.K., Deis, D.R., Jr., & Francis, J.R. (2004), Professional Service Fees and Auditor Objectivity, Auditing: A Journal of Practice & Theory, Vol. 23, No. 1, pp. 29-52. Ronen, J. (2010) Corporate Audits and How to Fix Them, Journal of Economic Perspectives, Vol.24 No. 2, pp.189-210. Shapiro, A. (2004), Who Pays the Auditor Calls the Tune?: Auditing Regulations and Clients Incentives, Cornell Law School Legal Studies Research Papers, available at http://scholarship.law.cornell.edu/lsrp_papers/9 Simunic, D. (1984), Auditing, Consulting and Auditor Independence, Journal of Accounting Research, Vol. 22, pp.679-702. Slovic, P. (2010) The More Who Die, the Less We Care, in Michel-Kerjan E. & Slovic, P. (eds) The Irrational Economist, Public Affairs: New York. Solomon, I., Rich, J.S. & Trotman, K.T. (1997) The Audit Review Process: A Characterization from the Persuasion Perspective, Accounting, Organizations and Society, Vol. 22, No. 5, pp.481-505. Stevenson, J. (2006), Auditor independence: A comparative descriptive study of the UK, France and Italy, International Journal of Auditing Vol. 6, No. 2, pp.155-82. Taylor, M.H., DeZoort, F.T., Munn, E. & M. Wetterhall Thomas (2003) A Proposed Framework Emphasizing Auditor Reliability over Auditor Independence, Accounting Horizons, Vol. 17, No. 3, pp. 257-266. Tetlock, P.E. (1985) Accountability: The Neglected Social Context of Judgment and Choice, Research in Organizational Behavior, Vol. 7, p.297-332. The Treasury (2006) Australian Auditor Independence Requirements: A Comparative Review, available at http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1184 Trompeter, G. (1994) The Effect of Partner Compensation Schemes and Generally Accepted Accounting Principles on Audit Partner Judgment, Auditing: A Journal of Practice & Theory, Vol. 13, No. 1, pp. 56-69.

25

Tyler, T.R. (2005) Managing Conflicts of Interest within Organizations: Does Activating Social Values Change the Impact of Self-Interest in Behavior?, in Moore, D.A., Cain, D.M., Loewenstein, G. & Bazerman, M.H. (eds) Conflicts of Interest, Cambridge University Press: New York. Ye, P., Carson, E. & Simnett, R. (2011) Threats to Auditor Independence: The Impact of Relationship and Economic Bonds, Auditing: A Journal of Practice & Theory, Vol. 30, No. 1, pp.121-148. West, M. (2008) Who will call accountants to account?, available http://business.theage.com.au/who-call-accountants-to-account/20080312lz03.html at:

26

Figure 1: Independence attributes of professional accountants and auditors

Attribute

Auditors

Forensic accountant expert

Independence requirement Compliance standards Reputation risk with

Advocacy role

Yes mandated by IFAC Yes mandated by court standards rules other Yes - ISAs Yes professional standards on forensic accounting Yes underlying Yes underlying engagement relationship is engagement relationship is auditor - client instructing counsel and expert No No

27

Table 1 Descriptive Statistics

Panel A Experimental groups Experiment 1 Experiment 2 Experiment 3 Experiment 4 Experiment 5 No. of participants 20 46 30 17 20 133 No. of matched pair groups 5 5 5 4 5 24

Panel B Qualifications and work experience of participants* Type of degree Undergraduate Accounting Business Other Postgraduate (Current enrolment) Master of Accounting Master of Applied Commerce (Accounting) Graduate Certificate of Business Forensics Other None < 1 year accounting > 1 year accounting < 1 year business > 1 year other

Work experience

Percentage 84.96 6.19 8.85 100.00 72.57 5.31 14.16 7.96 100.00 36.60 11.83 49.45 1.06 1.06 100.00

28

Table 2 Univariate Statistics

Plaintiff expert accountants $(000) sd 1530.65 2952.10 1614.10 1000.81 3100.59 2357.72 Defendant expert accountants $(000) sd 2571.79 1117.28 826.71 546.35 1668.21 1501.11

Experiment 1 Experiment 2 Experiment 3 Experiment 4 Experiment 5 Total

Mean 3107.48 6236.39 3857.40 3259.80 4649.42 4262.19

Median 3518.30 6283.11 3715.45 3289.81 3434.06 3764.39

Mean 2642.33 3127.51 1906.62 2807.37 3255.24 2745.34

Median 1333.85 2521.76 2098.66 2949.66 2510.37 2510.37

29

Table 3 Differences in quantification of damages between matched pairs (plaintiff expert accountant vs. defendant expert accountant) Panel A
Matched Pair No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 P 448.91 4294.19 3518.30 3924.00 3352.00 1802.55 5688.46 6283.11 9870.14 7537.71 2026.62 3715.45 2630.38 4996.46 5918.08 2122.28 2766.29 3813.34 4337.29 2390.67 3434.06 4050.65 3278.32 10093.42
Where:

Quantification of damages $ D 463.43 3405.00 1202.64 1333.85 6806.75 2459.60 2521.76 3100.47 5068.91 2486.86 2098.66 2723.53 984.47 2629.85 1096.60 2035.06 3051.29 2848.03 3295.10 2498.98 3816.01 1733.20 5910.36 2317.66

d -14.52 889.19 2315.66 2590.15 -3454.75 -657.05 3166.70 3182.64 4801.23 5050.85 -72.04 991.92 1645.92 2366.61 4821.48 87.22 -285.00 965.31 1042.19 -108.32 -381.95 2317.45 -2632.04 7775.77

Direction of differences XP < XD XP > XD XP > XD XP > XD XP < XD XP < XD XP > XD XP > XD XP > XD XP > XD XP < XD XP > XD XP > XD XP > XD XP > XD XP > XD XP < XD XP > XD XP > XD XP < XD XP < XD XP > XD XP < XD XP > XD

Sign + + + + + + + + + + + + + + + +

Rank of d 1 8 13 16 20 7 18 19 21 23 2 10 12 15 22 3 5 9 11 4 6 14 17 24

Rank of ve sign 1

20 7

4 6 17

P is plaintiff expert accountants quantification of loss D is defendant expert accountants quantification of loss d is the difference between P and D Wilcoxin Matched Pairs Signed-Rank Test: Where: n = 24 and T (sum of the rank of ve sign) = 62, p(2-tail)<0.01; p(1-tail)<0.005 H0: XP = XD rejected

Panel B
t-test (n=24) mean ($000) 4,262.19 2,745.34
0.007 0.004

plaintiff expert defendant expert

p(2-tail)= p(1-tail)=

s.d. ($000) 2,357.72 1,501.11

median ($000) 3,764.39 2,510.37

30

APPENDIX 1 Expert witness code of conduct

(Example taken from Uniform Civil Procedure Code)

1 Application of code This code of conduct applies to any expert witness engaged or appointed: (a) to provide an expert's report for use as evidence in proceedings or proposed proceedings, or (b) to give opinion evidence in proceedings or proposed proceedings. 2 General duty to the court (1) An expert witness has an overriding duty to assist the court impartially on matters relevant to the expert witness's area of expertise. (2) An expert witness's paramount duty is to the court and not to any party to the proceedings (including the person retaining the expert witness). (3) An expert witness is not an advocate for a party. 3 Duty to comply with court's directions An expert witness must abide by any direction of the court. 4 Duty to work co-operatively with other expert witnesses An expert witness, when complying with any direction of the court to confer with another expert witness or to prepare a parties' expert's report with another expert witness in relation to any issue: (a) must exercise his or her independent, professional judgment in relation to that issue, and (b) must endeavour to reach agreement with the other expert witness on that issue, and (c) must not act on any instruction or request to withhold or avoid agreement with the other expert witness. 5 Experts' reports (1) An expert's report must (in the body of the report or in an annexure to it) include the following: (a) the expert's qualifications as an expert on the issue the subject of the report, (b) the facts, and assumptions of fact, on which the opinions in the report are based (a letter of instructions may be annexed), (c) the expert's reasons for each opinion expressed, (d) if applicable, that a particular issue falls outside the expert's field of expertise, (e) any literature or other materials utilised in support of the opinions, (f) any examinations, tests or other investigations on which the expert has relied, including details of the qualifications of the person who carried them out, (g) in the case of a report that is lengthy or complex, a brief summary of the report (to be located at the beginning of the report).

31

(2) If an expert witness who prepares an expert's report believes that it may be incomplete or inaccurate without some qualification, the qualification must be stated in the report. (3) If an expert witness considers that his or her opinion is not a concluded opinion because of insufficient research or insufficient data or for any other reason, this must be stated when the opinion is expressed. (4) If an expert witness changes his or her opinion on a material matter after providing an expert's report to the party engaging him or her (or that party's legal representative), the expert witness must forthwith provide the engaging party (or that party's legal representative) with a supplementary report to that effect containing such of the information referred to in subclause (1) as is appropriate. 6 Experts' conference (1) Without limiting clause 3, an expert witness must abide by any direction of the court: (a) to confer with any other expert witness, or (b) to endeavour to reach agreement on any matters in issue, or (c) to prepare a joint report, specifying matters agreed and matters not agreed and reasons for any disagreement, or (d) to base any joint report on specified facts or assumptions of fact. (2) An expert witness must exercise his or her independent, professional judgment in relation to such a conference and joint report, and must not act on any instruction or request to withhold or avoid agreement.

APPENDIX 2
Extracts from Economic Loss Case Study Dairy Pty Ltd The case materials are based on a real (but disguised) company operating in Australia. On 1 July Dairy suffered an interruption to its business due to a fire at its manufacturing plant, which required that it cease manufacturing all of its dairy products for a period of two weeks. The fire started in a milk pasteurizing machine, which had recently been serviced and repaired by Repairer. Although the milk pasteurizing machine was damaged beyond repair and had to be scrapped, the damage to the rest of the factory was minimal. Nonetheless, the Health & Safety Authority (HSA) required that no manufacturing be undertaken in the factory until it had inspected possible damage to other machinery and contamination of the plant. During the interruption period, Dairy was not able to stand down its production workers due to an Enterprise Bargaining Agreement with the workers union. During this period the production workers were reassigned to other duties around the factory, including maintenance of other manufacturing machinery. After 14 days, a clearance certificate was provided by the HSA and manufacturing recommenced immediately. During the interruption period, Dairy acquired a new version 2 pasteurizing machine from Sussex, which was installed during the week commencing 8 July and commenced production on 15 July. Dairy commenced proceedings in the Supreme Court of Victoria against Repairer, alleging that it was negligent in its servicing and maintenance of the pasteurizing

32

machine. Dairy claims that it has suffered loss and damage to the reputation of its business arising from the negligence of Repairer. Participants were provided with a letter of engagement as an expert witness, detailing the above facts, along with extracts from the Statement of Claim, detailing: Cost of new replacement pasteurizing machine; Installation costs associated with the new pasteurizing machine; Cost of scrapping the damaged pasteurizing machine; Cost of raw milk disposed of by farms contracted to sell milk to Dairy; Loss of profit on the products Dairy would have manufactured and sold from the disposed raw milk; Loss of future orders; and Loss of reputation. Participants also received relevant extracts from the alleged plaintiffs books detailing sales histories price etc Participants, acting as forensic accountant expert witnesses, were required to prepare reports quantifying the loss and damage arising from the fire and cessation of production during the two week period and the ongoing loss suffered to Dairys reputation.

33