The Market for Liars: Reputation and Auditor Honesty

McLennan, Andrew
Park, In-Uck
2003-06
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The Market for Liars: Reputation and Auditor Honesty

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2003-06

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Center for Economic Research, Department of Economics, University of Minnesota

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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 upper bound.

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Center for Economic Research Discussion Papers

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Discussion Paper
 321

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McLennan, A. and Park, I., (2003), "The Market for Liars: Reputation and Auditor Honesty", Discussion Paper No. 321, Center for Economic Research, Department of Economics, University of Minnesota.

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McLennan, Andrew; Park, In-Uck. (2003). The Market for Liars: Reputation and Auditor Honesty. Retrieved from the University Digital Conservancy, https://hdl.handle.net/11299/55888.

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