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Is Auditor Moral Hazard the Only Reason to Ban Contingent Fees for Audit Services?

Is Auditor Moral Hazard the Only Reason to Ban Contingent Fees for Audit Services? In most countries, auditors are banned from accepting a report contingent fee from their clients. The main reason for this ban might be that such contingent fees would compromise auditor independence by motivating the auditors to issue an unjust favourable report. In this paper we argue that in addition, in a market characterized by information asymmetry, allowing favourable reports to command higher fees, would compromise the informational efficiency of the market by making separation of firm types more difficult. We arrive at our conclusion through a model where informed managers appoint auditors to signal their true value. We analyse the resulting equilibria of the signalling game and argue that the Differentiated Semi‐Separation (DSS) equilibrium is the most intuitive and interesting one. Our main results are presented through three examples. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Auditing Wiley

Is Auditor Moral Hazard the Only Reason to Ban Contingent Fees for Audit Services?

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References (17)

Publisher
Wiley
Copyright
Copyright © 1997 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1090-6738
eISSN
1099-1123
DOI
10.1111/1099-1123.00022
Publisher site
See Article on Publisher Site

Abstract

In most countries, auditors are banned from accepting a report contingent fee from their clients. The main reason for this ban might be that such contingent fees would compromise auditor independence by motivating the auditors to issue an unjust favourable report. In this paper we argue that in addition, in a market characterized by information asymmetry, allowing favourable reports to command higher fees, would compromise the informational efficiency of the market by making separation of firm types more difficult. We arrive at our conclusion through a model where informed managers appoint auditors to signal their true value. We analyse the resulting equilibria of the signalling game and argue that the Differentiated Semi‐Separation (DSS) equilibrium is the most intuitive and interesting one. Our main results are presented through three examples.

Journal

International Journal of AuditingWiley

Published: Nov 1, 1997

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