We develop a model in which there is conflict of interest between the management and the shareholders of an organization. Incompleteness of contracts, prevents a simple solution to this problem. We suggest that auditors can play a role in aligning these conflicting interests. Again however, the incompleteness of contracts causes difficulties because it may be hard to ensure that auditors maintain this required independence. In this context, the imposition of potential legal liability (punishment) on the auditor, may be an important commitment mechanism for the auditors, making it credible that they will not collude with the management. In order to give our model institutional structure we study how this collusion may take place through the reappointment concerns of the auditor. In the reappointment game, we consider how legal liability levels could be chosen so as to ensure that auditors do not collude with management when performing audits and that they do not provide a low duty of care.
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