Auditor independence when management attempt to mislead: a rational economic analysis

Paul Barnes

Research output: Contribution to journalOther journal contribution

Abstract

We examine the economic factors affecting the auditor’s independence when management wishes to mislead investors. By means of a single person decision-theoretic model, we show that, in the absence of transaction costs, audited financial statements are unlikely to be biased. However, when transaction costs in the form of legal costs are introduced, bias is likely to occur. By means of a game-theoretic model, we also examine two areas of information asymmetry and the economic factors involved causing a ‘rogue auditor’ compared with a ‘professionally correct’ auditor to fail to act independently. We also examine the implications of this both at the micro and public policy level and whether the ‘bad auditors’ will drive out the ‘good auditors’. We find that the ‘good corporations’ have an incentive to drive out the ‘bad auditors’. However, whilst investors have negligible information about audit quality, scandals such as Enron and Arthur Andersen are likely to occur.
Original languageEnglish
Pages (from-to)107-149
Number of pages43
JournalJournal of Forensic and Investigative Accounting
Volume3
Issue number2
Publication statusPublished - 2011

Keywords

  • auditor independence
  • rational economic analysis
  • rogue auditor
  • transaction costs
  • game-theoretic model

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