Sustainability Science Program

Truth-telling by Third-party Auditors: Evidence from a Randomized Field Experiment in India

Overview

Truth-telling by Third-party Auditors: Evidence from a Randomized Field Experiment in India

Esther Duflo, Michael Greenstone, Rohini Pande, and Nicholas Ryan

The research team is in advanced stages of analysis of a two-year randomized field experiment on environmental audits of industrial plants conducted in collaboration with the Gujarat Pollution Control Board in India. For a set of plants, the financial relationship between auditors and client plants was severed, in that auditors were randomly assigned to plants and paid from a central pool of funds. Random backchecks by independent surveyors allowed researchers to observe “true” pollution outcomes. The study produced two main findings. First, auditors who faced the standard incentives in the control group systematically underreported pollution readings relative to the truth. They falsified reports in a targeted fashion, reporting many plants as just meeting regulatory limits. Second, the reports of auditors for the treatment group of plants were statistically equal to the truth. Notably, many auditors worked simultaneously in the treatment and control groups of plants, and the results were evident when the research team compared the reporting of the same auditors across the two sets of economic incentives.

The findings of this study are forthcoming in two top economics journals: American Economic Review (Duflo et al. 2013a) and Quarterly Journal of Economics (Duflo et al. 2013b). A third article on another treatment arm of the experiment, which increased the frequency of government inspections of polluting plants, is in progress. The findings have also been presented at multiple academic and policy forums. Policy briefs based on this research are forthcoming at International Growth Centre and Jameel Poverty Action Lab. Finally, media outlets have begun showing interest in this work: The Wall Street Journal recently published an article on the study and what it means not only to environmental regulation in India, but also to other systems that depend on private auditing (Wessel 2013).

Furthermore, this study has led to interest from the Gujarat State Pollution Control Board in permanently incorporating the results of the study into audit policy, and from the Maharashtra State Pollution Control Board, in developing a more systematic and rational way of allocating their monitoring and inspection resources. The Initiative will work with these partners to design and implement policy recommendations based on this study. In Gujarat, the research team will especially target the permanent adoption of audit reforms—such as random assignment of auditors, central auditor payments and backchecks of auditor performance—that we have found to be effective in improving reporting and reducing pollution.

References

Duflo, E., Greenstone, M., Pande, R., and Ryan, N. (2013). “What Does Reputation Buy? Differentiation in a Market for Third-Party Auditors.” American Economic Review Papers and Proceedings 2013, 103 (3).

Duflo, E., Greenstone, M., Pande, R., and Ryan, N. (forthcoming). “Truth Telling by Third-party Auditors and the Response of Polluting Firms: Experiment Evidence from India.” Forthcoming, Quarterly Journal of Economics, 128(4): 314-9.

Wessel, D. (2013). “Paying Auditors for Honest Appraisals: An Experiment in India’s Gujarat State Shows a Way to Realign Interests and Incentives.” The Wall Street Journal. Available at http://online.wsj.com/article/SB10001424127887324263404578611392640896694.html (accessed 27 August 2013).