Realigning Auditors’ Incentives: Experimental Evidence of a Third-Party Hiring System

• In Event: Auditor Incentives and Ego Depletion

Abstract

We compare market dynamics when an independent third-party – as opposed to the client –hires an auditor using experimental economic markets. We examine independence – a first order determinant of audit quality –to understand if altering who hires the auditor improves audit quality. We find evidence that auditors who are hired by an independent third-party engage in significantly higher levels of investigation, even under moral hazard and when the third party randomly selects auditors to hire. Investor confidence in the financial information increases as evidenced by higher bids for assets audited by these higher quality auditors and when the auditor is selected by a third party. We also provide evidence that the higher quality auditing leads to less manager misreporting.

Authors

• Patrick J. Hurley, University of Wisconsin-Madison

• Brian Mayhew, University of Wisconsin-Madison

• Kara Obermire, University of Wisconsin-Madison