Maintaining Auditor Independence

Anil Arya () and Jonathan Glover

Corporate Finance & Organizations from Ohio State University

Abstract: In this paper, we resolve the auditor independence problem that arises in the model studied in Antle (1982, 1984). We argue that the owner-manager-auditor relationship exhibits a "separability" that facilitates the use of a particularly simple mechanism that prevents collusion. The mechanism prevents collusion as long as th e agents do not play strictly dominated strategies and assume the same to be true of the other agent; the owner's profits under this mechanism are arbitrarily close to second-best (the optimal Nash contract). The fact that a simple mechanism can be used to maintain auditor independence in a theoretical model strengthens our belief that, in practice, there exist institutions (e.g., the courts) that can maintain auditor independence with relative ease. This may be one reason why the institution of auditing is so enduring.

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