Truth-telling by Third-party Auditors and the Response of Polluting Firms: Experimental Evidence from India∗

In many regulated markets, private, third-party auditors are chosen and paid by the firms that they audit, potentially creating a conflict of interest. This paper reports on a twoyear field experiment in the Indian state of Gujarat that sought to curb such a conflict by altering the market structure for environmental audits of industrial plants to incentivize accurate reporting. There are three main results. First, the status quo system was largely corrupted, with auditors systematically reporting plant emissions just below the standard, although true emissions were typically higher. Second, the treatment caused auditors to report more truthfully and very significantly lowered the fraction of plants that were falsely reported as compliant with pollution standards. Third, treatment plants, in turn, reduced their pollution emissions. The results suggest reformed incentives for third-party auditors can improve their reporting and make regulation more effective. ∗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, Sam Norris and Nick Hagerty for excellent research assistance and numerous seminar participants for comments. 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. †MIT, [email protected] ‡MIT, [email protected] §Corresponding author. Harvard Kennedy School, Harvard University, Mailbox 46, 79 JFK St., Cambridge, MA 02138, [email protected] ¶Harvard, [email protected]