Firm Corruption in the Presence of an Auditor

Abstract

We develop a theoretical framework exploring firm corruption accounting for interactions with an auditor who provides auditing and other services. A multiplicity of equilibria can exist including stable corruption and auditor controlled corruption. Whilst fining the auditor cannot eliminate all corruption, fining the firm can, but marginal increases in this fine can also have perverse effects. Investing in corruption detection may be effective in deterring auditor corruption but ineffective in deterring firm corruption. Policy effectiveness is highly dependent upon several factors which may be hard to observe in practice making general rules about policy interventions to address corruption very difficult.