The Auditor's Slippery Slope: The Ill Effects of Reputation

Abstract

Reputational concerns have been commonly perceived to have a positive effect on auditing firms' execution of their monitoring and attesting functions. This paper demonstrates that this need not always be the case by studying a two period game of repeated interaction between a manager and an auditor under the assessment of the market for audit services. Regarding reputation as the sole motivator for the auditor, we illustrate how reputational concerns induce an auditing firm to misreport. We investigate the reasons and circumstances under which such misreporting takes place. In particular, a strategic manager can induce the audit firm down a 'slippery-slope' situation, wherein the managerial fraud increases as the tenure of the audit firm progresses, while the auditor's fraud reporting probability decreases.

Keywords: Audit, Auditor, Reputation, Fraud, Reporting, Disclosure

JEL Classification: M49, M41, M43, G38