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The Andersen effect refers to the increased scrutiny of financial records seen after a major financial scandal in 2001 involving accounting firm Arthur Andersen. Worried by the outcome of the scandal and the issues it revealed with auditing and accounting practices, companies increased the intensity of their auditing programs to avoid encountering similar problems. Indirectly, the scandal contributed to improvements in corporate accounting standards and practices.
Arthur Andersen was charged after its role in the downfall of the energy firm Enron was revealed. Enron had been posting positive financial statements after auditing by the accounting company indicated that the information was accurate and correct. When Enron filed for bankruptcy, the event was unexpected, because the company shouldn’t have failed, according to its financial reports. Further muddying the waters, members of the firm destroyed and hid evidence, exposing themselves to criminal charges in connection with their role in the case.
In response to the scandal, which dominated US headlines and attracted considerable public attention around the world, some firms started looking at audits more closely. The Andersen effect included more intense evaluations of auditing practices, personnel involved in reviewing financial records, and the records themselves. Firms also wanted to catch errors as early as possible, no matter their origins, in order to correct statements. The Andersen effect could serve members of the board making decisions about the company as well as shareholders who needed accurate financial information to guide their investment practices.
Enron was accused of using “creative accounting” to hide losses and create a rosier picture than actually existed. One sign of the Andersen effect was an increased reliance on outside directors and auditors with less of a personal stake in financial statements. Their objective views could uncover more information than might be provided by auditors tied too closely to a company, who might experience pressure to return a positive audit in order to get more work in the future. Accounting firms also developed more stringent ethical guidelines to address specific concerns about conflicts of interest that might interfere with the fairness of their work.
For shareholders, the Andersen effect resulted in more detailed and accurate annual reports and other accounting documents. Reforms to accounting practices were also designed to increase confidence among consumers and the general public who wanted to be assured that companies took accounting seriously. The government also got involved with legislation to limit abuses, while the accounting industry took an active role in the development of more effective standards and practices.