Discipline with Common Agency: The Case of Audit and Non-Audit Services
Fuqua School of Business
26 Pages Posted: 11 Jan 2001
Date Written: November 2000
Using a common agency model, we investigate the strategies of self-interested auditors (the agent) hired by both managers (for non-audit services) and shareholders (conducting an audit) of the same firm. In a single period model, managerial discretion over consulting fees can influence auditors to issue reports that are more favorable than warranted. Shareholders, represented by an audit committee cannot recover truth-telling. Removing the current restriction on contingent audit fees allows audit committees to offset the incentives provided by management and instead provide the auditor incentives to report truthfully. Extending the model to a multiperiod framework, the audit committee can motivate truth-telling by making retention decisions which are contingent on outcome. Auditors will consider the impact of overreporting on their ability to generate future audit fees from the same client.
Keywords: Auditor independence, Common agency, Truth telling, Contingent fees
JEL Classification: C70, M49, D81, G34
Suggested Citation: Suggested Citation