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Is Auditor Moral Hazard the Only Reason to Ban Contingent Fees for Audit Services?
Author(s) -
De Sankar,
Sen Pradyot K.
Publication year - 1997
Publication title -
international journal of auditing
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.583
H-Index - 21
eISSN - 1099-1123
pISSN - 1090-6738
DOI - 10.1111/1099-1123.00022
Subject(s) - compromise , audit , moral hazard , accounting , information asymmetry , auditor independence , business , independence (probability theory) , value (mathematics) , signaling game , control (management) , actuarial science , microeconomics , law and economics , economics , joint audit , finance , incentive , law , internal audit , computer science , statistics , mathematics , management , machine learning , political science
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.