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Optimal Regulation of Auditing

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  • Marco Pagano
  • Giovanni Immordino

Abstract

We study regulation of the auditing profession in a model where audit quality is unobservable and enforcing regulation is costly. The optimal audit standard falls short of the first-best audit quality, and is increasing in the riskiness of firms and in the amount of funding they seek. The model can encompass collusion between clients and auditors, arising from the joint provision of auditing and consulting services: deflecting collusion requires less ambitious standards. Finally, banning the provision of consulting services by auditors eliminates collusion but may not be optimal in the presence of economies of scope.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2007/wp-cesifo-2007-05/cesifo1_wp1980.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1980.

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Date of creation: 2007
Date of revision:
Handle: RePEc:ces:ceswps:_1980

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Keywords: auditing; regulation; enforcement; collusion;

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References

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  1. Edward L. Glaeser & Andrei Shleifer, 2001. "The Rise of the Regulatory State," Harvard Institute of Economic Research Working Papers 1934, Harvard - Institute of Economic Research.
  2. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
  3. Giovanni Immordino & Marco Pagano, 2008. "Corporate Fraud, Governance and Auditing," CSEF Working Papers 203, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 26 Apr 2012.
  4. Klein, April, 2002. "Audit committee, board of director characteristics, and earnings management," Journal of Accounting and Economics, Elsevier, vol. 33(3), pages 375-400, August.
  5. Agrawal, Anup & Chadha, Sahiba, 2005. "Corporate Governance and Accounting Scandals," Journal of Law and Economics, University of Chicago Press, vol. 48(2), pages 371-406, October.
  6. Giovanni Immordino & Marco Pagano, 2010. "Legal Standards, Enforcement, and Corruption," Journal of the European Economic Association, MIT Press, vol. 8(5), pages 1104-1132, 09.
  7. Gary S. Becker, 1974. "Crime and Punishment: An Economic Approach," NBER Chapters, in: Essays in the Economics of Crime and Punishment, pages 1-54 National Bureau of Economic Research, Inc.
  8. Paul K. Chaney, 2002. "Shredded Reputation: The Cost of Audit Failure," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1221-1245, 09.
  9. A. Mitchell Polinsky & Steven Shavell, 1999. "The Economic Theory of Public Enforcement of Law," NBER Working Papers 6993, National Bureau of Economic Research, Inc.
  10. Dye, Ronald A, 1993. "Auditing Standards, Legal Liability, and Auditor Wealth," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 887-914, October.
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Cited by:
  1. J. Atsu Amegashie & Bazoumana Ouattara & Eric Strobl, 2007. "Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid," CESifo Working Paper Series 1996, CESifo Group Munich.
  2. Michael Dietrich & Jolian McHardy & Abhijit Sharma, 2010. "Firm corruption in the presence of an auditor," Working Papers 2010016, The University of Sheffield, Department of Economics, revised Jul 2010.
  3. Giovanni Immordino & Marco Pagano, 2008. "Corporate Fraud, Governance and Auditing," CSEF Working Papers 203, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 26 Apr 2012.
  4. Sergey Stepanov, 2010. "Shareholder access to manager-biased courts and the monitoring/litigation trade-off," RAND Journal of Economics, RAND Corporation, vol. 41(2), pages 270-300.
  5. Forster, Josef, 2008. "The Optimal Regulation of Credit Rating Agencies," Discussion Papers in Economics 5169, University of Munich, Department of Economics.

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