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    Auditor Independence and Outsourcing: Aligning Incentives to Mitigate Shilling and Shirking
    22 Feb 2021Working Paper Summaries

    Auditor Independence and Outsourcing: Aligning Incentives to Mitigate Shilling and Shirking

    by Ashley Palmarozzo, Jodi L. Short, and Michael W. Toffel
    Firms use external auditors to monitor the quality of difficult-to-observe aspects of their business partners’ performance, including the working conditions of their suppliers. Firms can improve monitoring accuracy by having their own employees conduct some audits, and by rotating across third-party auditing firms.
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    Author Abstract

    Multinational corporations (MNCs) hire auditors to assess their business partners’ compliance with quality, working conditions, and environmental standards. Independent third-party auditors are widely assumed to outperform second-party auditors employed and thus controlled by MNCs. Synthesizing literatures on auditor independence and outsourcing decisions, we compare how independence and control can affect auditor performance. Using proprietary data from a global apparel brand, we find that second-party auditors outperform independent third-party auditors, and that third-party auditors’ performance improves when MNCs concurrent source audits, using both second- and third-party auditors. However, both second- and third-party auditors perform better with more independence from the entities they audit—specifically, when auditing factories most recently audited by a different firm. These findings yield important insights for more effective monitoring of business partners.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: January 2021
    • HBS Working Paper Number: 21-078
    • Faculty Unit(s): Technology and Operations Management
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    Michael W. Toffel
    Michael W. Toffel
    Senator John Heinz Professor of Environmental Management
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