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Optimal Regulation of Auditing

  • Marco Pagano
  • Giovanni Immordino

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 it 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. (JEL Classification: G28, K22, M42). Copyright , Oxford University Press.

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Article provided by CESifo in its journal CESifo Economic Studies.

Volume (Year): 53 (2007)
Issue (Month): 3 (September)
Pages: 363-388

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Handle: RePEc:oup:cesifo:v:53:y:2007:i:3:p:363-388
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  1. Immordino, Giovanni & Pagano, Marco, 2008. "Corporate Fraud, Governance and Auditing," CEPR Discussion Papers 7104, C.E.P.R. Discussion Papers.
  2. 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.
  3. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169.
  4. Steven Shavell & A. Mitchell Polinsky, 2000. "The Economic Theory of Public Enforcement of Law," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 45-76, March.
  5. 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.
  6. Paul K. Chaney, 2002. "Shredded Reputation: The Cost of Audit Failure," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1221-1245, 09.
  7. 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.
  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. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
  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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