The Auditor As an Economic Agent

Abstract

The purpose of this paper is to present and analyze some fundamental issues which arise when the auditor is modeled as an economic agent. There are many reasons that it is desirable to explicitly model the auditor. As Gjesdal [1981] points out, extant theories of the demand for auditing (see Ng [1978], Ng and Stoeckenius [1979], and Evans [1980]) are incomplete because they ignore the problem of the auditor's incentives. The first step in addressing the issue of the auditor's incentives is to model the auditor explicitly as an expected utility maximizer. As we shall see, this introduces many technical difficulties. At the same time, a new point in the study of the auditor's role in the firm arises; namely, risk-sharing with the auditor. These technical issues, which involve problems with modeling the owner-manager-auditor relationship in a tractable way, must be confronted before the demand for auditing can be fully established. Otherwise, we cannot compare the alternative of hiring an auditor to the owner's other alternatives, such as not hiring the auditor (standing pat), or renting the firm to the manager. Another reason to model the auditor as an expected utility maximizer is the obvious symmetry that such a model provides. If we seek to understand the behavior of owners, managers, and investors by modeling them as expected utility maximizers, why change the approach when studying auditors? Unless we believe that auditors are somehow qualitatively different from the other types of economic agents that we study,