COLLUSION IN AUDITING

This paper is concerned with the effects of collusion between agents in a principal-agent model of auditing. By collusion we mean private, extralegal arrangements in which agents agree to act in ways not intended by the owner.1 The effects of collusion can extend beyond cases when it is detected and prosecuted, because the potential for collusion may cause the owner to modify the agents' contracts or the firm's operating policies and accounting procedures. These actions by the owner may, in turn, distort economic activity relative to an environment with no potential for collusion. Such repercussions can be especially serious in auditing. Because auditing arose to overcome informational asymmetries between owners of resources and managers who acted on their behalf, its value depends crucially on whether the manager and the auditor collude. Owners can