In theory, auditing should be unbiased and independent. In reality, biases abound. Auditors are human, and companies — even auditing firms— have agendas that shape how they approach audits. These blind spots can have real consequences for investors and the economy. Associate professor Minlei Ye joins Executive Summary to reveal where these hidden biases come from, how they influence decision-making, and why stronger safeguards and a shift in business thinking are essential for fairer results.
In theory, auditing should be unbiased and independent. In reality, biases abound. Auditors are human, and companies — even auditing firms— have agendas that shape how they approach audits. These blind spots can have real consequences for investors and the economy. Associate professor Minlei Ye joins Executive Summary to reveal where these hidden biases come from, how they influence decision-making, and why stronger safeguards and a shift in business thinking are essential for fairer results.
Show notes
[0:00] What happened with Enron and Arthur Andersen
[0:53] Meet Minlei Ye, an associate professor of accounting at the University of Toronto, and she says when audits fail to catch red flags, it can have devastating consequences on individuals and the economy.
[2:22] What is the role of an auditor, exactly?
[2:59] What role did auditors play in the Enron and Lehman Brothers scandals?
[4:49] How can an organizational focus on compliance lead to misrepresentation? And is fair representation a better option?
[6:03] Other systemic biases that shape an audit firms’ accuracy include the need to keep the client happy.
[6:42] Auditors’ personal biases – like familiarity bias, confirmation bias and groupthink also shape how accurate an audit will be.
[7:38] Minlei’s research into otherwise positive programs – like rewards for whistleblowing – can have unintentional consequences on how auditors approach a client.
[9:01] And then there are egos – like when bosses pull superstar employees off key client accounts out of fear the superstar will be poached by another firm.
[9:45] Team makeup – whether homogenous or diverse – matters too.
[10:40] Auditing is built on the fundamental principle of independence.
[11:29] To help mitigate some of the aforementioned biases, regulation is needed to protect that independence. But, in the U.S. in particular, those protections are under attack.
[13:00] In the meantime auditing firms need to step up to protect their independence…and so do the companies being audited.
[14:21] “Instead of looking at auditing as something that they have to do, like a compliance thing that you have to hire the auditor, they can think of the auditor as a strategic safeguard for the capital needs, for their reputation and stakeholder trust.”
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Megan Haynes: In the early 2000s, Enron — one of the U.S.’s largest energy companies — collapsed almost overnight. It had been hiding billions in debt through off-balance-sheet accounting tricks. The scandal wiped out not only Enron, but also Arthur Andersen, one of the world’s most respected auditing firms at the time.
So what went wrong, and why didn’t Arthur Andersen catch it? Well, they kind of did.
Minlei Ye: Enron used a special purpose entity and mark-to-market accounting, so they were technically allowed under U.S. GAAP at that time if certain conditions were met. So the auditor, Arthur Andersen, checked whether Enron’s special purpose entities met the formal rules for off-balance-sheet treatment. But once the box was ticked, then Andersen accepted that the debts could be kept off Enron's balance sheet.
MH: That’s Minlei Ye, an associate professor of accounting at the University of Toronto.
She studies the economics of auditing — the incentives, costs and market dynamics that shape the profession.
Auditors are meant to act as impartial gatekeepers, but their decisions are shaped by human biases, incentives and sometimes conflicts of interest.
Auditing firms are meant to be independent organizations that work to confirm that what a company is publicly saying about its finances to investors, regulators and the public is accurate.
In practice, sometimes you end up with situations like Enron or the Lehman Brothers — where auditing firms failed to catch the red flags that led to the pretty spectacular collapses of each organization. And this can have pretty devastating consequences.
MY: Well, the investors will lose their savings, right? They invest in the company. And in general overall, the investors will lose trust in the capital market. And then the businesses that require financing will not be able to raise sufficient funds, and it will hinder the growth of the company and the economy as a whole.
MH: What happens when the people entrusted to check the numbers miss the biggest red flags that can sink entire companies? What hidden biases shape their work?
What happens to the economy when trust in the auditing process erodes? And what, if anything, can we do about it? Welcome to the Executive Summary. I’m Megan Haynes, editor of the Rotman Insights Hub.
Musical interlude
MH: Let’s start with the basics. What exactly is the role of an auditor?
MY: Auditors are an independent third party, right? They are regarded as gatekeepers in capital markets to protect the interest of investors. They will check the company's books, financial statements, to make sure that they present fairly the economic conditions of the company, right, and they issue an opinion on the financial statements.
MH: In theory, this protects investors from buying into a company that’s riskier than it looks. In practice, though, it doesn’t always work out that way.
Even gatekeepers can miss or ignore the big picture. Take Enron. Executives hid nearly $40 billion U.S. in debt through accounting tricks and off-the-books entities, effectively inflating the value of Enron.
Like we mentioned earlier, they used some accounting maneuvers that were technically allowed.
Enron’s auditing firm, Arthur Andersen, signed off on the numbers even though the auditors knew something was shady.
There was a clear conflict of interest: not only did Arthur Andersen offer auditing services, but also other consulting services — to the tune of millions per year — putting its status as an independent auditor on shaky ground.
It was later revealed the firm even helped cover up some more fraudulent activity, shredding documents. As the fraud unravelled in the early 2000s, Enron collapsed, and investors lost upwards of $76 billion U.S.
A similar situation played out over at the Lehman Brothers. While it was also being hammered by the sub-prime mortgage crisis in the U.S., it came to light that it had also been using an accounting trick — what it called Repo 105 — to hide some of its risk.
MY: So in that case, the short-term loans were disguised as sales by over-collateralizing and relying on a U.K. legal opinion.
MH: In simple terms — Lehman labelled more than $50 billion worth of liabilities as “sales.” On paper, it looked profitable.
In reality, the company was dangerously exposed, and ultimately was forced to file for bankruptcy — which kicked off the 2008 financial crisis, wiped out the investments of millions of Americans, and left thousands of employees looking for work.
Both Enron and Lehman had auditors whose job it was to catch these red flags. And in both cases, the auditors signed off — because the companies were technically compliant with the rules.
MY: Compliance means just following the rules. So it means that the auditor only focuses on checking whether the financial statements are in compliance with financial reporting standards, rather than to check whether the financial statements present fairly the financial conditions of the company.
MH: And that’s a danger. Compliance-based audits can be technically correct — but still mislead investors and hide risks in plain sight. To get a truer picture of a company’s financial health, Minlei suggests instead companies try what’s called “fair presentation.”
MY: Instead of asking, “Does this contract meet the technical definition of revenue recognition under certain standards?” the auditor can ask, “Is management using this contract to accelerate revenue in a misleading way?”
MH: But if that’s the more accurate way to approach accounting, it’s worth asking why companies don’t already take this approach. Well, for some firms a compliance-first approach is just baked into their philosophy.
For others, a focus on compliance keeps clients happy.
MY: There are many incentives that can affect the auditor's decisions. For example, because an auditor needs to maintain a good client relationship with the manager to retain the clients, right?
They are, after all, profit-seeking companies. They also want to maximize their profits. So retaining clients is a very important part of it.
Musical interlude
MH: So when it comes to the quality of a company’s audits, there are systemic biases that shape the outcome — like whether a company is incentivized to keep its clients happy, or if they take a strict compliance approach to auditing.
But the auditors themselves bring their own human biases to the table.
MY: I’m not sure that they are not aware of it, but it's probably always there — like the familiarity threat. Maybe I should say it again: familiarity threat — which means that when the audit firm has audited the client for a long period of time, they tend to do the same thing next year instead of looking at what the new risk could be. So that’s one common type of bias. And then there can be confirmation bias — only looking at evidence that supports the manager’s assertions rather than looking for possible questioning or being skeptical about what has been presented in front of them. And then there can also be, for example, groupthink-type bias.
MH: Groupthink can lead to multiple people agreeing with something, with no one on a team questioning whether it’s correct or accurate. Groupthink, familiarity and confirmation bias aren’t malicious choices — they’re natural human shortcuts.
But when the stakes are billions of dollars, even small blind spots can have massive consequences. Even positive external programs — like incentives for whistleblowing — can also have unexpected effects on auditors.
These programs often provide substantial rewards to employees who bring forward the financial misdeeds at their company, and in a 2025 study, Minlei looked at the impact those whistleblowing programs had on auditors.
MY: Intuitively, we think audit effort increases because, well, when whistleblowers are more incentivized to come forward to reveal, let's say, accounting wrongdoing, then the auditors are more likely to be found — again, audit failure is more likely to be discovered, and the auditor will likely be held responsible for failing to discover the material misstatements in financial statements.
MH: Effectively, when auditors know a whistleblower could expose an error, they feel heightened pressure to do their job carefully. That’s generally good — and Minlei’s study finds whistleblowing programs do improve audit quality.
But there’s a flip side: when no whistleblowers come forward, regulators may take that as a signal there’s no wrongdoing, making them less likely to hold auditors liable for mistakes — resulting in the auditors putting less effort into their work.
This isn’t to say we need a rethink of all whistleblowing programs because having them makes auditor reports worse — it’s just an example of how economic incentives and human nature inevitably impact the quality of an audit.
Take another example: one of Minlei’s studies found that superstar auditors sometimes are kept off high-profile projects because the bosses are worried they’ll be poached.
MY: Instead of assigning the high-talent partners to high-risk clients and the relatively low-quality partners to low-risk clients, they might switch the order to avoid the high-quality audit partner being poached and leaving the firm.
MH: Ultimately, people have egos and fears, and sometimes that crops up in these supposedly objective practices in unexpected ways.
The makeup of the audit team itself also matters. Different auditors bring different motivations, perspectives and levels of experience, which ultimately shapes the quality of an audit.
In a 2025 paper, Minlei and her co-authors looked at how the team makeup — if it was homogeneous or diverse — affected the outcomes of an audit, and when one might be preferable to another.
MY: Diverse teams are less likely to collude because of the different backgrounds.
MH: In some situations, diverse teams are more likely to be effective at discovering issues in financial statements. Homogeneous teams — those with similar backgrounds and thinking — can also be effective.
MY: The homogeneous teams might provide a higher audit quality because of the productive synergy, because they have the similar background.
MH: But which type of team performs better depends on human factors — particularly the partner’s leadership style and the staff’s career perspective. Are partners conservative or willing to take risks? Do staff see their time at the firm as short-term, or plan to stay long-term? We won’t get into the specifics, since there’s a lot of nuance, but ultimately, Minlei’s findings remind us that audits aren’t just about checking boxes. They’re about people — their incentives, habits and the subtle ways biases shape decisions. Getting the team right can make the difference between catching a problem early… or missing a risk that sinks a company. And that’s something auditing firms need to keep a bit more top of mind.
Musical interlude
MH: Auditing is built on a critical principle: independence.
But as we mentioned earlier, there are plenty of organizational or personal biases that can erode that independence.
They are paid by the very companies they’re auditing, and they operate in an environment full of human biases, client pressures and career incentives.
If independence is compromised, auditors might not dig deeply enough, and even when they spot a problem, they may hesitate to push for adjustments.
MY: There are plenty of opportunities for managers to manipulate the financial statements. So if the auditors are not independent, they, first of all, might not exert sufficient effort to collect audit evidence to discover what's wrong. And then secondly, if they discover something wrong, they might not insist on the accounting adjustments that they propose the managers do.
MH: As a result, regulations exist to protect auditor independence.
In both Canada and the U.S., rules prevent auditing firms from having a financial stake in clients’ companies and require public companies to have audit committees composed of independent directors to oversee the process — among other checks and balances.
Oversight bodies like the Public Company Accounting Oversight Board, or the PCAOB, in the U.S. and the Canadian Public Accountability Board set and monitor the standards for auditors.
Minlei says that regulation is often like a pendulum — following a major accounting scandal, we usually see a big push towards more protection of auditor independence. After Enron, for example, the U.S. introduced the Sarbanes-Oxley Act, largely prohibiting auditing firms from offering non-auditing services to clients. But when things have been quiet, scandal-wise, for a little while, the pendulum swings back towards deregulation.
MY: Recently, there are signs indicating a potential cooling down of the regulatory environment in the U.S. For example, the PCAOB quietly withdrew two major rules. One is firm reporting, and the other one is a firm and engagement matrix, which were intended to increase audit transparency — such as how much partners are involved, how much time they spent in an audit, the training they had, the experience and the retention, etc. But then these proposals were pulled and not required anymore. And then the recent PCAOB chair, Erica Williams, was also pulled. In her tenure, she had made quite a few advancements in terms of regulation. And then there is also a potential dismantling of the PCAOB — that proposal in Congress pushed by some lawmakers who tried to transfer the PCAOB’s function into the SEC. But then this one was not successful. The good news in terms of strong regulation is that the proposal to eliminate the PCAOB and transfer its authority to the SEC violates the Byrd Rule. So that means — put simply — the PCAOB is safe for now.
MH: So what can organizations do while the pendulum swings? For auditing firms, that might mean a bit of self-reflection.
MY: For audit firms, they need to set up proper quality control within the firm.
MH: Ask yourself: Are your teams mostly diverse or homogeneous? Do you have conservative or risk-taking partners at the top? Are you purposefully keeping superstars off the high-profile projects out of fear they’ll be poached? Do you suffer from familiarity bias or groupthink? Is your organization so compliance-focused that your teams are missing out on clients’ true financial health? These are questions leaders at these companies need to be asking themselves.
And for the companies being audited, Minlei has three thoughts: First, she thinks it’s critical that companies take a closer look at creating strong auditing committees — the internal committees that are responsible for hiring the auditors and resolving any issues that are brought forward.
Second, while most of the biases we’ve talked about so far apply to auditors, Minlei reminds us that the same incentives and biases can sway managers at companies who are responsible for putting these financial statements together in the first place.
That means these companies being audited need to think through whether they have optimal compensation and the right internal and external monitoring.
But most importantly, she thinks it’s time that companies see auditing in a new light — not a chore that needs to be done to satisfy regulators, but an opportunity.
MY: Instead of looking at auditing as something that they have to do — like a compliance thing, that you have to hire an auditor — they can think of the auditor as a strategic safeguard for their capital needs, for their reputation and the stakeholder trust. So that mindset needs to change, I think.
MH: This has been Rotman Executive Summary, a podcast bringing you the latest insights and innovative thinking from Canada's leading business school.
Special thanks to associate professor Minlei Ye.
Join us next month as we chat with associate professor George Newman about the real secret behind sparking creativity.
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This episode was written and produced by Megan Haynes. It was recorded by Dan Mazzotta and edited by Avery Moore Kloss.
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