The quality of bank portfolios has declined in recent times, and allegations have been made that auditors have failed to detect material overstatements of the value of bank loan portfolios (McCoy et al. 1990; Thomas and Ricks 1990), lawsuits have sought to hold auditors liable for the misleading financial statements (Bailey 1987; Finn 1984), and audit firms have been censured by the SEC for improper professional conduct in the audits of banks (Grisdela and Berton 1987). This research examines the evaluation of the bank loan portfolio, a critical and high-risk component of the audit of banks. The Allowance for Credit Losses "should be adequate to cover specifically identified loans, as well as loans and pools of loans for which losses are probable but not identifiable on a specific loan-by-loan basis" (AICPA 1986, 3). The focus of this research is the effect of participation in sequential audits on auditors' loan evaluation judgments. The sequential nature of audit judgments is an important consideration, but previous research has considered only the sequential nature of individual audit tasks (see, e.g., Ashton and Ashton 1988; Cushing and Loebbecke 1986; Gibbins 1984). To date, research has not focused on the fact that audits themselves are sequential; most audits are repeat engagements, and the same auditors participate in the audit year after year. A theoretical framework for the effect of personal involvement on judgment (Kiesler 1971; Staw 1976; Staw and Ross 1987) suggests that personal involvement fosters commitment and an escalation of commitment occurs when there is personal responsibility for a series of judgments. The current research extends previous studies by evaluating the effect of personal responsibility in a professional environment with experienced subjects performing a realistic task. The literature suggests that experience could significantly affect the tendency of subjects to escalate their commitment to a chosen course of action. Experience is expected to improve judgments when (1) the decision maker is exposed to a variety of exemplars so that information about relative frequencies is learned, (2) the task is sufficiently complex and is either semistructured or unstructured, and (3) feedback on decisions is available. These conditions are all present for loan riskiness evaluations by auditors. Previous research results also indicate that experience may improve judgments by mitigating the effect of cognitive heuristics on judgments (see, e.g., Libby et al. 1985; Shields et al. 1987). Mechanisms leading to these results include (1) improved probabilistic reasoning as a function of experience, (2) incentives to learn decision rules with accountability for judgments, and (3) sensitivity to evidence. Ashton and Ashton (1988, 1990) indicate that experienced auditors are particularly sensitive to evidence. Uke many other audit decisions, loan evaluation involves sequential judgments. The research reported here seeks to determine (1) whether personal involvement in sequential audits leads to an escalation of commitment to previous loan evaluation decisions and (2) whether experience in the audit environment diminishes or eliminates any negative consequences of personal responsibility. Personal involvement is manipulated across two groups of independent auditors, and audit experience and loan evaluation judgments are elicited. It is hypothesized that the interaction between personal involvement and experience affects the loan evaluation judgment. When there is a high level of personal involvement, the loan evaluation judgments of inexperienced auditors are predicted to be more favorable than those of experienced auditors; when there is a low level of personal involvement, no differences between the judgments of experienced and inexperienced auditors are predicted. Based on experimentation with 41 auditors, the results indicate that a significant interaction does exist. Escalation behavior in loan evaluation judgments was evident in the evaluations of inexperienced auditors; experience mitigates the escalation effect.
