Realigning Auditors' Incentives: Experimental Evidence

Abstract

Our experimental economic markets break the economic bond between the auditor and client by assigning auditors to clients. We examine the effects of doing so on audit quality and other market participants’ behavior. We find that auditors who are assigned to clients supply higher quality audits than when hired by the company, even when assignment occurs randomly and auditors do not have an explicit economic incentive for high quality. We also find that assigning auditors increases investor confidence in financial information. We predict and find that incentivizing auditor accuracy through the assignment process further increases audit quality, investor confidence, and managers’ investment level while decreasing managers’ misreporting. Our results suggest that audit quality is significantly enhanced simply by assigning auditors to clients despite concerns that removing competition will result in lower audit quality.