Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/92584
Authors: 
McLennan, Andrew
Park, In-Uck
Year of Publication: 
2003
Series/Report no.: 
ISER Discussion Paper, Institute of Social and Economic Research, Osaka University 587
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.
Subjects: 
auditing
reputation
adverse selection
auditor independence
JEL: 
M41
D82
G14
Document Type: 
Working Paper

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