Truth-Telling by Third-Party Auditors : Evidence from a Randomized Field Experiment in India ∗

In a wide range of markets, from environmental and corporate audits to credit ratings, private third-party entities are directly hired and paid by the firms on which they report. In this paper, we demonstrate that the conflict of interest faced by third-party auditors can corrupt the information they provide and undermine regulation. Our evidence comes from a two-year randomized field experiment on environmental audits of industrial plants conducted in collaboration with a state regulator in India. For a randomly selected set of plants, the relationship between auditors and client plants was severed, in that auditors were randomly assigned to plants and backchecked on their accuracy. Random backchecks by independent surveyors allow us to observe true pollution outcomes. We report three main findings. First, auditors who face the standard incentives, in the control group of plants, systematically underreport pollution readings relative to the truth, as revealed by independent backchecks of the same readings. Auditors working in the control falsify reports in a targeted fashion, reporting many plants as just meeting regulatory limits. Second, the reports of auditors for the treatment group of plants are statistically equal to the truth. Notably, many auditors worked simultaneously in the treatment and control groups of plants, and the improvement in reporting is evident when we compare the reporting of the same auditors across the two sets of economic incentives. Third, plants in the treatment group, assigned to independent auditors, reduced pollution emissions relative to the control group of plants. This response is seen only for water pollutants, which are subject to greater regulatory scrutiny. ∗We thank Sanjiv Tyagi, R. G. Shah, and Hardik Shah for advice and support over the course of this project. We thank Pankaj Verma, Eric Dodge, Vipin Awatramani, Logan Clark, Yuanjian Li and Nick Hagerty for excellent research assistance. We thank the Sustainability Science Program (SSP), the Harvard Environmental Economics Program, the Center for Energy and Environmental Policy Research (CEEPR), the International Initiative for Impact Evaluation (3ie), the International Growth Centre (IGC) and the National Science Foundation (NSF Award #1066006) for financial support. Ryan thanks an AMID Early Stage Researcher Fellowship for financial support. All views and errors are solely ours.