The Market for Liars: Reputation and Auditor Honesty

Andrew McLennan () and In-Uck Park

ISER Discussion Paper from Institute of Social and Economic Research, The University of Osaka

Abstract: 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.

Date: 2003-06
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Citations: View citations in EconPapers (5)

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Journal Article: The market for liars: Reputation and auditor honesty (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:dpr:wpaper:0587

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