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CESifo Economic Studies Advance Access originally published online on November 2, 2007
CESifo Economic Studies 2007 53(3):363-388; doi:10.1093/cesifo/ifm016
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© The Author 2007. Published by Oxford University Press on behalf of Ifo Institute for Economic Research, Munich. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Optimal Regulation of Auditing

Marco Pagano and Giovanni Immordino*

* Marco Pagano is affiliated with Università di Napoli Federico II, CSEF and CEPR, Via Cintia, 80126 Napoli, Italy, e-mail: mrpagano{at}tin.it and Giovanni Immordino is affiliated with Università di Salerno and CSEF, 84084 Fisciano (SA), Italy, e-mail: giimmo{at}tin.it

We study regulation of the auditing profession in a model where audit quality is unobservable and enforcing regulation is costly. The optimal audit standard falls short of the first-best audit quality, and it is increasing in the riskiness of firms and in the amount of funding they seek. The model can encompass collusion between clients and auditors, arising from the joint provision of auditing and consulting services: deflecting collusion requires less ambitious standards. Finally, banning the provision of consulting services by auditors eliminates collusion but may not be optimal in the presence of economies of scope. (JEL Classification: G28, K22, M42).

Key Words: auditing • regulation • enforcement • collusion.


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