Limits to Auditor Reputational Incentives
39 Pages Posted: 21 Jun 2016
Date Written: June 17, 2016
Why do reputable audit firms fail? This paper provides a formal theory of auditor reputation formation. Even under well-functioning reputation mechanisms, an auditor with a strong reputation has incentives to shirk. Above a threshold-reputation, the market belief about the auditor’s ability dissipates slowly, leading to low audit quality. Reputation incentives weaken further under fee competition in audit markets. The results are robust under contigent fees for auditors.
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