The Market for Liars : Reputation and

In the model there are two types of nancial auditors with identical technology, one of which is endowed with a prior reputation for honesty. We characterize conditions under which there exists a \two-tier equilibrium" in which \reputable" auditors refuse bribes o ered by clients for fear of losing reputation, while \disreputable" auditors accept bribes because even persistent refusal does not create a good reputation. The main ndings are: (a) honest auditors charge higher fees, and have economic pro ts accruing to reputation; (b) as the fraction of auditors who are honest increases, the premium charged by reputable auditors eventually decreases, which diminishes the incentive to refuse bribes; (c) if the fraction of honest auditors exceeds an upper bound, there does not exist a two-tier equilibrium; (d) thus the reputation mechanism may be undermined by entry into the honest segment of the industry, if it is possible; (e) increasing auditor independence increases the upper bound. Journal of Economic Literature Classi cation Numbers M41, D82, G14.