The Market for Liars: Reputation and Auditor Honesty

Arbeitspapier

In the model there are two types of financial auditors with identical technology, one of which is endowed with a prior reputation for honesty. We characterize conditions under which there exists a "two-tier equilibrium" in which "reputable" auditors refuse bribes offered by clients for fear of losing reputation, while "disreputable" auditors accept bribes because even persistent refusal does not create a good reputation. The main findings are: (a) honest auditors charge higher fees, and have economic profits accruing to reputation; (b) as the fraction of auditors who are honest increases, the premium charged by reputable auditors eventually decreases, which diminishes the incentive to refuse bribes; (c) if the fraction of honest auditors exceeds an upper bound, there does not exist a two-tier equilibrium; (d) thus the reputation mechanism may be undermined by entry into the honest segment of the industry, if it is possible; (e) increasing auditor independence increases the upper bound.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Discussion Paper ; No. 321

Classification and Topics

• Classification: Wirtschaft ; Asymmetric and Private Information; Mechanism Design ; Accounting ; Information and Market Efficiency; Event Studies; Insider Trading
• Subject: Wirtschaftsprüfung ; Adverse Selection ; Prestige ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): McLennan, Andrew
• Event: Veröffentlichung
• (who): University of Minnesota, Center for Economic Research
• (where): Minneapolis, MN
• (when): 2003

Further information

• Handle: http://hdl.handle.net/10419/23499
• Last update: 10.03.2025, 11:41 AM CET