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  • 2021
  • Working Paper
  • HBS Working Paper Series

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

By: Ashley Palmarozzo, Jodi L. Short and Michael W. Toffel
  • Format:Print
  • | Language:English
  • | Pages:54 
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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.

Keywords

Transaction Cost Economics; Outsourcing; Suppliers; Monitoring; Business Strategy; Vertical Integration; Supply Chain Management; Quality; Safety; Risk And Uncertainty; Apparel And Accessories Industry; Retail Industry; China; India; Bangladesh

Citation

Palmarozzo, Ashley, Jodi L. Short, and Michael W. Toffel. "Auditor Independence and Outsourcing: Aligning Incentives to Mitigate Shilling and Shirking." Harvard Business School Working Paper, No. 21-078, January 2021.
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About The Author

Michael W. Toffel

Technology and Operations Management
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