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Corporate Audits and How to Fix Them


  • Joshua Ronen


Auditors are supposed to be watchdogs, but in the last decade or so, they sometimes looked like lapdogs -- more interested in serving the companies they audited than in assuring a flow of accurate information to investors. The auditing profession is based on what looks like a structural infirmity: auditors are paid by the companies they audit. An old German proverb holds: "Whose bread I eat, his song I sing." While this saying was originally meant as a prayer of thanksgiving, the old proverb takes on a darker meaning for those who study the auditing profession. This paper begins with an overview of the practice of audits, the auditing profession, and the problems that auditors continue to face in terms not only of providing audits of high quality, but also in providing audits that investors feel comfortable trusting to be of high quality. It then turns to a number of reforms that have been proposed, including ways of building reputation, liability reform, capitalizing or insuring auditing firms, and greater competition in the auditing profession. However, none of these suggested reforms, individually or collectively, severs the agency relation between the client management and the auditors. As a result, the conflict of interest, although it can be mitigated by some of these reforms, continues to threaten auditors' independence, both real and perceived. In conclusion, I'll discuss my own proposal for financial statements insurance, which would redefine the relationship between auditors and firms in such a way that auditors would no longer be beholden to management.

Suggested Citation

  • Joshua Ronen, 2010. "Corporate Audits and How to Fix Them," Journal of Economic Perspectives, American Economic Association, vol. 24(2), pages 189-210, Spring.
  • Handle: RePEc:aea:jecper:v:24:y:2010:i:2:p:189-210 Note: DOI: 10.1257/jep.24.2.189

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    References listed on IDEAS

    1. Arrunada, Benito & Paz-Ares, Candido, 1997. "Mandatory rotation of company auditors: A critical examination," International Review of Law and Economics, Elsevier, vol. 17(1), pages 31-61, March.
    2. repec:bla:joares:v:32:y:1994:i::p:1-30 is not listed on IDEAS
    3. DeAngelo, Linda Elizabeth, 1981. "Auditor size and audit quality," Journal of Accounting and Economics, Elsevier, vol. 3(3), pages 183-199, December.
    4. Mark L. DeFond, 2002. "Do Non-Audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1247-1274, September.
    5. Shyam Sunder, 2003. "Rethinking the Structure of Accounting and Auditing," Yale School of Management Working Papers ysm382, Yale School of Management.
    6. Coffee, John C., 2004. "Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms," Berkeley Olin Program in Law & Economics, Working Paper Series qt13d8s2qs, Berkeley Olin Program in Law & Economics.
    7. Goldberg, Victor P, 1988. "Accountable Accountants: Is Third-Party Liability Necessary?," The Journal of Legal Studies, University of Chicago Press, vol. 17(2), pages 295-312, June.
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    Cited by:

    1. repec:oup:revfin:v:21:y:2017:i:1:p:7-31. is not listed on IDEAS
    2. Esther Duflo & Michael Greenstone & Nicholas Ryan, 2013. "Truth-telling by Third-party Auditors and the Response of Polluting Firms: Experimental Evidence from India," The Quarterly Journal of Economics, Oxford University Press, vol. 128(4), pages 1499-1545.
    3. repec:kap:jmgtgv:v:21:y:2017:i:4:d:10.1007_s10997-016-9369-x is not listed on IDEAS
    4. Mauricio Jara-Bertin & Jean P. Sepulveda, 2014. "Earnings Management and Performance in Family-Controlled Firms:Evidence from an Emerging Economy," Serie Working Papers 01, Universidad del Desarrollo, School of Business and Economics, revised Nov 2014.

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    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L84 - Industrial Organization - - Industry Studies: Services - - - Personal, Professional, and Business Services
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing


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