Truth-Telling In Third-Party Audits

Key Takeaways:

• When auditors were hired and paid by the firms they were auditing, as is the case in the status quo audit system, false reporting and pollution were high. Auditors systematically reported plant emissions just below the government standard, although true emissions were typically higher. For example, for particulate matter—a harmful air pollutant—auditors reported that only 7 percent of industrial plants violated the government standard when in reality 59 percent were emitting more than the standard.
• The new audit system led auditors to report pollution more truthfully and substantially lowered the number of plants that were falsely reported as compliant with pollution standards. In the restructured auditor market, the accuracy of auditor reports increased significantly: the auditors were 23 percentage points (80 percent) less likely to falsely report a pollution reading as in compliance with the relevant regulatory standard. Additionally, their reported pollution readings were 50–70 percent higher than those of auditors working in the status quo system.
• Industrial plants reduced pollution in response to more accurate audits. Plants facing the new audit system reduced pollution by 0.21 standard deviations on average. These pollution reductions came from the highest- polluting plants, which historically were the most likely to be penalized for violating pollution standards.