Financial Effects of External Auditing

30 Pages Posted: 19 Mar 2008

See all articles by Gorazd Brumen

Gorazd Brumen

University of Zurich - Swiss Banking Institute (ISB); Princeton University - Bendheim Center for Finance

Bogdan Stacescu

BI Norwegian Business School

Date Written: March 2, 2008

Abstract

The paper develops a model of optimal auditing behavior when the economic environment adds a noise term to the firm's cash flows, which can be reduced by employing an external auditor. The paper connects the optimal auditing policy and (i) share prices of the firm and (ii) auditor's compensation. Results show that the optimal auditing amount is below the amount needed to totally eliminate the noise in the economy. Moreover there exist a cut-off point for the auditing costs (economic noise) above (below) which auditing is not anymore optimal. In the presence of incomplete information setting, the theory of global games is used to determine the optimal auditing behavior.

Keywords: Optimal auditing, auditor's compensation, coalitional game theory, entropy

JEL Classification: M42, G12, C71

Suggested Citation

Brumen, Gorazd and Stacescu, Bogdan, Financial Effects of External Auditing (March 2, 2008). Available at SSRN: https://ssrn.com/abstract=1101205 or http://dx.doi.org/10.2139/ssrn.1101205

Gorazd Brumen (Contact Author)

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland
+41 44 634 27 85 (Phone)
+41 44 634 49 03 (Fax)

HOME PAGE: http://www.gorazdbrumen.net

Princeton University - Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Bogdan Stacescu

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

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