Center for Economic Research, Department of Economics, University of Minnesota
In the model there are two types of financial auditors with identical technology, one
of which is endowed with a prior reputation for honesty. We characterize conditions under
which there exists a "two-tier equilibrium" in which "reputable" auditors refuse bribes
offered by clients for fear of losing reputation, while "disreputable" auditors accept bribes
because even persistent refusal does not create a good reputation. The main findings are:
(a) honest auditors charge higher fees, and have economic profits accruing to reputation;
(b) as the fraction of auditors who are honest increases, the premium charged by reputable
auditors eventually decreases, which diminishes the incentive to refuse bribes; (c) if the
fraction of honest auditors exceeds an upper bound, there does not exist a two-tier equilibrium;
(d) thus the reputation mechanism may be undermined by entry into the honest
segment of the industry, if it is possible; (e) increasing auditor independence increases the
McLennan, Andrew; Park, In-Uck.
The Market for Liars: Reputation and Auditor Honesty.
Center for Economic Research, Department of Economics, University of Minnesota.
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