Agency Theory in Auditing: Review of Past and Present

Abstract

Agency theory is a widely recognized framework used to explain the relationship between principals (capital owners or shareholders) and agents (capital users or managers) in modern corporate entities. This study reviews the past and present perspectives of agency theory in auditing and examines how the theory explains the demand for independent and statutory auditing as a monitoring mechanism in corporate entities. The separation of ownership and control in modern companies often creates conflicts of interest because capital users may pursue personal goals that differ from those of capital users. These conflicts are commonly associated with information asymmetry, incomplete contracts, and differing risk preferences between principals and agents. As a result, auditing has emerged as a fundamental governance mechanism designed to enhance accountability, transparency, and reliability in financial reporting. The study adopts a conceptual research design based on an extensive review of secondary sources, including academic journals, professional publications, and relevant literature on agency theory and auditing. The literature review highlights the evolution of agency theory from its early foundations to its modern applications in auditing and corporate governance. Historically, auditing was influenced by the police theory of auditing, which emphasized fraud detection. However, as corporate entities became larger and more complex, auditing practices evolved to focus more on providing assurance on financial statements, strengthening internal controls, and supporting corporate governance structures. The findings reveal that agency theory provides a strong justification for the existence of auditing because it helps reduce agency costs, mitigate information asymmetry, and improve the credibility of financial information. Independent auditors play a crucial role in verifying financial statements and ensuring that management actions align with the interests of capital owners. The study also highlights criticisms of agency theory, including its emphasis on self-interest and its limited focus on capital owners while overlooking other stakeholders. Summarily, the review concludes that agency theory remains highly relevant in contemporary auditing and corporate governance. The study recommends strengthening governance mechanisms, promoting auditor independence, and encouraging future empirical research to explore the impact of technological developments and evolving governance systems on auditing practices.