Auditing with a Chance of Whistleblowing

This paper investigates the impact of promoting whistleblowing on audit quality and the efficiency of detecting misstatements. On the one hand, whistleblowing alerts the enforcer to the possibility of a misstatement and intensifies the regulatory effort, thereby incentivizing the auditor to improve audit quality. On the other hand, promoting whistleblowing reduces the enforcer’s investigative effort when there is no whistleblowing allegation, which in turn dampens the auditor’s incentive to enhance audit quality. We demonstrate that, under certain conditions, encouraging more whistleblowing can impair audit quality and reduce detection efficiency. We also examine the socially optimal whistleblowing program, and our analysis implies that the optimal whistleblowing intensity is increasing in investment cost and the quality of the whistleblower’s information. This paper was accepted by Ranjani Krishnan, accounting. Funding: C. Tang acknowledges financial support from the Hong Kong Research Grant Council [Project 16503921]. M. Ye thanks the Canadian Social Sciences and Humanities Research Council for funding support [Grant 435-2022-0093]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2024.04808 .