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Optimal Regulation of Auditing

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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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Bibliographic Info

Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 133.

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Date of creation: 01 Mar 2005
Date of revision: 01 May 2007
Publication status: Published in CESifo Economic Studies, Vol. 53, No. 3, September 2007, pages 363–388
Handle: RePEc:sef:csefwp:133

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Keywords: auditing; regulation; enforcement; collusion.;

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  1. Edward L. Glaeser & Andrei Shleifer, 2003. "The Rise of the Regulatory State," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 401-425, June.
  2. Immordino, Giovanni & Pagano, Marco, 2008. "Legal Standards, Enforcement and Corruption," CEPR Discussion Papers 7071, C.E.P.R. Discussion Papers.
  3. Marco Pagano & Giovanni Immordino, 2009. "Corporate Fraud, Governance and Auditing," EIEF Working Papers Series 0909, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2009.
  4. A. Mitchell Polinsky & Steven Shavell, 1999. "The Economic Theory of Public Enforcement of Law," NBER Working Papers 6993, National Bureau of Economic Research, Inc.
  5. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169.
  6. 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.
  7. 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.
  8. 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.
  9. Paul K. Chaney, 2002. "Shredded Reputation: The Cost of Audit Failure," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1221-1245, 09.
  10. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
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Cited by:
  1. 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.
  2. J. Atsu Amegashie & Bazoumana Ouattara & Eric Strobl, 2007. "Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid," Working Papers 0702, University of Guelph, Department of Economics and Finance.
  3. 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.
  4. Immordino, Giovanni & Pagano, Marco, 2008. "Corporate Fraud, Governance and Auditing," CEPR Discussion Papers 7104, C.E.P.R. Discussion Papers.
  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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