The Accounting Review Vol. 73 No. 4 1998
Low balling, legal liability and auditor independence.
Abstract
We construct a dynamic multi-agent moral hazard model to analyze the interactions among the firm owner, the manager and the auditor. Moral hazard may arise in hierarchical agency because a rational monitoring agent may accept a side payment from the monitored agent for misrepresenting information to the principal. This multi-agent moral hazard problem is the essence of the concern for auditor independence. We show that a "low-balling" compensation scheme and the auditor's legal liability constitute an efficient dynamic contracting mechanism for hierarchical agency. In particular, low balling serves as a substitute for legal liabilities for maintaining auditor independence. Low balling reduces the transaction costs associated with the audit engagement relative to the flat-fee structure and can actually improve auditor independence.
- DOI
- 10.2308/tar-1325295
- Volume
- 73
- Issue
- 4
- Pages
- 533-555
- Language
- en
- Sources
- openalex crossref