Currently, audit reports issued in the USA do not reveal the name of the lead partner at the audit firm who conducted the audit. In December 2015, PCAOB (Public Company Accounting Oversight Board) approved a new rule which mandates that the lead partner’s name be disclosed in audit reports. This rule was approved by the Securities and Exchange Commission (SEC) in May 2016 and will come into effect after January 2017 . In this paper, we analyse partner incentives under the two regimes (with and without disclosure of partner names) and explore the possible impact of the new rule on audit quality. This paper highlights an important tussle between monitoring and reputation incentives in a partnership under two different information structures – a collective reputation environment and an individual reputation environment. Thus, our paper contains a more general message but we set it in the audit market environment for two reasons – a) To analyse the impact of the proposed rule and b) To develop a rich model which incorporates many details particular to the audit industry in the hope that this model can be used for analyzing several questions related to the audit market.
We discuss three different solutions to the monitoring problem. One potential solution is to increase audit fees which in turn leads to increased revenue for the firm. For a given sharing rule, an increased audit fee can provide incentives for both the engagement partner and the monitor partner. The proposed solution is also supported by the empirical findings of Carcello and Li (2013) where the authors report the joint occurrence of higher quality of audits and higher audit fees after audit partners were mandated to sign the audit report in the UK.