Regulatory Oversight Mechanisms and Their Influence on Auditor Independence

Abstract

This paper presents a novel, cross-disciplinary investigation into the complex
relationship between regulatory oversight mechanisms and auditor independence,
moving beyond traditional compliance-based frameworks. We introduce a dynamic,
multi-agent simulation model that conceptualizes the audit ecosystem as a complex
adaptive system, where regulators, audit firms, corporate clients, and investors
interact in non-linear ways. Our methodology uniquely applies principles from
behavioral economics, institutional theory, and network science to model how different oversight structures—ranging from strict punitive regimes to collaborative,
principles-based approaches—affect not just the observable compliance of auditors,
but their underlying cognitive and institutional independence. We define independence across three novel dimensions: cognitive insulation from client pressure,
structural insulation from economic dependencies, and reputational insulation from
market perceptions. The simulation, parameterized with data from regulatory enforcement actions and audit firm disclosures over a ten-year period, reveals counterintuitive findings. Contrary to conventional wisdom, we find that excessively
rigid and punitive oversight can, under certain network conditions, create perverse
incentives that erode genuine independence by fostering a ’checklist mentality’ and
driving problematic auditor-client relationships underground. Conversely, oversight
systems that incorporate transparency mechanisms, peer review networks, and dynamic risk-based targeting promote more robust and resilient independence. Our
results demonstrate that the efficacy of a regulatory mechanism is not intrinsic but
is contingent on the density and topology of the professional network in which it is
deployed. This research contributes an original theoretical framework and methodological approach for evaluating audit regulation, offering evidence-based insights
for designing oversight systems that genuinely fortify the bedrock of audit quality.