Working Paper: What's in a Name? Reputation and Monitoring in the Audit Market

​​​​​​Paper authors: Somdutta Basu and Suraj Shekhar

Abstract: Since February 2017, the name of the engagement partner has to be disclosed for all audit reports issued in the USA. We show that this quest for transparency has its pitfalls. Though this rule increases the level of information for investors, it can have negative consequences if we ignore how the rule changes the incentives of the relevant players (auditors). There is a tension between monitoring and reputation incentives when moving from collective reputation environments to individual reputation environments. We analyze the new rule and study the resulting change in auditor incentives to show that while the consequent higher reputation incentives can improve audit quality, partners have a lower incentive to monitor other partners when names are disclosed. This may lead to a fall in audit quality when the rule is implemented. We present several solutions to this problem.