Auditor Independence and Outsourcing: Aligning Incentives to Mitigate Shilling and Shirking

51 Pages Posted: 13 Jan 2021

See all articles by Ashley Palmarozzo

Ashley Palmarozzo

Harvard Business School

Jodi L. Short

University of California Hastings College of the Law

Michael W. Toffel

Harvard Business School

Date Written: December 3, 2020

Abstract

Multinational corporations (MNCs) hire auditors to assess their business partners’ compliance with quality, working conditions, and environmental standards. Independent third-party auditors are widely assumed to outperform second-party auditors employed and thus controlled by MNCs. Synthesizing literatures on auditor independence and outsourcing decisions, we compare how independence and control can affect auditor performance. Using proprietary data from a global apparel brand, we find that second-party auditors outperform independent third-party auditors, and that third-party auditors’ performance improves when MNCs concurrent source audits, using both second- and third-party auditors. However, both second- and third-party auditors perform better with more independence from the entities they audit—specifically, when auditing factories most recently audited by a different firm. These findings yield important insights for more effective monitoring of business partners.

Keywords: Working Conditions, Supply Chain, Auditing, Monitoring, Concurrent Sourcing, Labor, Corporate Social Responsibility, Sustainability, Sustainable Operations, Sustainable Supply Chain, NGO

JEL Classification: M11, M14, M42, M54, J81

Suggested Citation

Palmarozzo, Ashley and Short, Jodi L. and Toffel, Michael W., Auditor Independence and Outsourcing: Aligning Incentives to Mitigate Shilling and Shirking (December 3, 2020). Available at SSRN: https://ssrn.com/abstract=3758992

Ashley Palmarozzo

Harvard Business School ( email )

Boston, MA 02163
United States

Jodi L. Short

University of California Hastings College of the Law ( email )

200 McAllister Street
San Francisco, CA 94102
United States

Michael W. Toffel (Contact Author)

Harvard Business School ( email )

Boston, MA 02163
United States
617.384.8043 (Phone)

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