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The importance of reputation in the auditing of companies: A game theory analysis

Xeni Dassiou () and D. Glycopantis

Working Papers from Department of Economics, City University London

Abstract: Numerous, mainly empirical, studies of auditing behaviour have recently looked at the “reputation” of the auditor and the size of fees it attracts. Our model of the auditing market advances the study of the fundamental principles involved in determining behaviour in relation to the rewards and penalties using an extensive-form game of the auditing process. We set up a two-player fraud detection game with bribes, bonuses and fines faced by an auditor. Our model yields that the auditor’s reputation, reflected in the size of bonuses, is critical to establishing a non-fraudulent behaviour by the client. Hence the model confirms expected behaviour. We further find the new insight, that while the existence of penalties deters fraud by the client, their size is not critical. This is a new understanding of what determines auditor behaviour. It is the perception of a possible penalty that moves the auditor in the direction of executing a thorough investigation using his acquired expertise.

Keywords: interdependent decisions; auditor reputation; game theory; perfect Bayesian equilibria (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-acc and nep-gth
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