Title
The Market for Liars: Reputation and Auditor Honesty
Publisher
Center for Economic Research, Department of Economics, University of Minnesota
Abstract
In the model there are two types of financial auditors with identical technology, one
of which is endowed with a prior reputation for honesty. We characterize conditions under
which there exists a "two-tier equilibrium" in which "reputable" auditors refuse bribes
offered by clients for fear of losing reputation, while "disreputable" auditors accept bribes
because even persistent refusal does not create a good reputation. The main findings are:
(a) honest auditors charge higher fees, and have economic profits accruing to reputation;
(b) as the fraction of auditors who are honest increases, the premium charged by reputable
auditors eventually decreases, which diminishes the incentive to refuse bribes; (c) if the
fraction of honest auditors exceeds an upper bound, there does not exist a two-tier equilibrium;
(d) thus the reputation mechanism may be undermined by entry into the honest
segment of the industry, if it is possible; (e) increasing auditor independence increases the
upper bound.
Previously Published Citation
McLennan, A. and Park, I., (2003), "The Market for Liars: Reputation and Auditor Honesty", Discussion Paper No. 321, Center for Economic Research, Department of Economics, University of Minnesota.
Suggested Citation
McLennan, Andrew; Park, In-Uck.
(2003).
The Market for Liars: Reputation and Auditor Honesty.
Center for Economic Research, Department of Economics, University of Minnesota.
Retrieved from the University of Minnesota Digital Conservancy,
https://hdl.handle.net/11299/55888.