Reputation Effects in the Market of Certifiers: Evidence From the Audit Industry

Abstract

Certifiers verify unobserved product characteristics for buyers and thereby alleviate informational asymmetries and facilitate trade. When sellers pay for the certification, however, certifiers can be tempted to bias their opinion to favor sellers. Indeed, accounting scandals and inflated credit ratings suggest sellers may prefer to select dishonest certifiers. I test this proposition by estimating the effect of adverse quality signals on audit demand. Exploiting the natural experiment of Arthur Andersen's demise, I find that auditors with worse quality signals experience a fall in demand. This suggests that reputation effects are at work even in the presence of conflicts of interest. (JEL L15, L8, M4)

Time to certify: Explaining varying efficiency of private regulatory audits

“…Work on credit rating agencies, financial audits, codes governing labor practices, and certification for responsible forest management and organic agriculture has shed some light on the importance of auditors' and assessors' epistemic authority and level of training. Researching auditor reputation, Toth (2014), for example, argues that signals of audit quality can influence the choice for a particular credit rating agency, while Carter (2017) finds that farmers who highly value auditor reputation are more likely to choose private and nonprofit auditors instead of public ones for organic certification. Toffel et al (2015) and Short et al (2016) demonstrate, among other things, that better trained and more experienced auditors and audit teams identify more labor violations of private codes of conduct.…”