Monitoring the Monitors: Auditors, Corporate Theft, and Corruption

Abstract

Using a unique database of banking transactions, I examine the relationship between auditing and income diversion in a sample of 3,681 companies with mandatory audit requirements. In contrast to other studies, my methodology enables me to accurately measure corporate theft and observe audit fees, which are undisclosed to the public. I find that Big 4 auditors receive higher audit and nonaudit fees when their clients transfer more money to fraudulent entities. A 1 standard deviation increase in income diversion corresponds to a 6.9% increase in audit fees and an 11.9% increase in other fees. Using the measure of corruptness developed by Mironov (2015), I find that this relationship is partially explained by the auditors’ propensity for corruption. This study contributes to our understanding of the relationship between auditing and corporate theft and is relevant to large swaths of the non-OECD global economy, on which prior research has not sufficiently focused.

Keywords: Audit quality, Big 4 auditors, corporate governance, income diversion, audit fees

JEL Classification: D73, G30, G38, H26, H83, M43