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The Auditor's Slippery Slope: An Analysis of Reputational Incentives

  • Carlos Corona

    ()

    (McCombs School of Business, The University of Texas at Austin, Austin, Texas 78712)

  • Ramandeep S. Randhawa

    ()

    (Marshall School of Business, University of Southern California, Los Angeles, California 90089)

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    Reputational concerns have commonly been perceived to have a positive effect on auditing firms' execution of their monitoring and attesting functions. This paper demonstrates that this need not always be the case by studying a two-period game of repeated interaction between a manager and an auditor under the assessment of the market for audit services. Regarding reputation as the sole motivator for the auditor, we illustrate how reputational concerns induce an auditing firm to misreport. We investigate the reasons and circumstances under which such misreporting takes place. In particular, a strategic manager can induce the audit firm down a slippery slope, wherein the managerial fraud increases as the tenure of the audit firm progresses, whereas the auditor's fraud reporting probability decreases.

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    File URL: http://dx.doi.org/10.1287/mnsc.1100.1166
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 56 (2010)
    Issue (Month): 6 (June)
    Pages: 924-937

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    Handle: RePEc:inm:ormnsc:v:56:y:2010:i:6:p:924-937
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    1. DeAngelo, Linda Elizabeth, 1981. "Auditor size and audit quality," Journal of Accounting and Economics, Elsevier, vol. 3(3), pages 183-199, December.
    2. Schwartz, Rachel, 1998. "Auditors' Liability, Vague Due Care, and Auditing Standards," Review of Quantitative Finance and Accounting, Springer, vol. 11(2), pages 183-207, September.
    3. Stanley Baiman & Paul E. Fischer & Madhav V. Rajan, 2000. "Information, Contracting, and Quality Costs," Management Science, INFORMS, vol. 46(6), pages 776-789, June.
    4. 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.
    5. Stanley, Jonathan D. & Todd DeZoort, F., 2007. "Audit firm tenure and financial restatements: An analysis of industry specialization and fee effects," Journal of Accounting and Public Policy, Elsevier, vol. 26(2), pages 131-159.
    6. Kashi R. Balachandran & Suresh Radhakrishnan, 2005. "Quality Implications of Warranties in a Supply Chain," Management Science, INFORMS, vol. 51(8), pages 1266-1277, August.
    7. Anne Beyer & Sri S. Sridhar, 2006. "Effects of Multiple Clients on the Reliability of Audit Reports," Journal of Accounting Research, Wiley Blackwell, vol. 44(1), pages 29-51, 03.
    8. Titman, Sheridan & Trueman, Brett, 1986. "Information quality and the valuation of new issues," Journal of Accounting and Economics, Elsevier, vol. 8(2), pages 159-172, June.
    9. Bharat Sarath, 1991. "Uncertain Litigation and Liability Insurance," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 218-231, Summer.
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