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

Fri, January 16, 1:45 to 3:00pm, TBA

Abstract

We use experimental economic markets to compare market dynamics when an independent third-party – as opposed to the company – hires an auditor. Our markets examine the effect on audit quality of directly increasing auditor independence by changing who hires the auditor. We find evidence that auditors who are hired by an independent third-party engage in significantly higher levels of investigation than when hired by managers, even under moral hazard and when the third party randomly selects auditors. Investor confidence in financial information increases as evidenced by higher bids for assets audited by these higher quality auditors selected by a third party. We also provide evidence that higher quality auditing leads to less manager misreporting.

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