Truth-telling by Third-party Auditors and the Response of Polluting Firms: Experimental Evidence from India

Key Insights for Managers

Firms often learn about the conditions of suppliers by reviewing the results of third-party audits. But this study, by authors Esther Duflo, Michael Greenstone, Rohini Pande and Nicholas Ryan, finds that such audits were 80% more likely to report a falsely rosy picture when the audited factory selected and paid for the auditor. When factories were required to use auditors they did not choose or pay directly, audits are more accurate, and factories improved their performance over time. This suggests that audits can actually motivate suppliers to improve their conditions when proper incentives are in place.

These results were drawn from a large experiment conducted on over 400 Indian industrial plants - mostly from the textile industry - that were subjected to periodic environmental audits to assess whether their pollution levels were within regulated limits. To examine how potential conflicts of interest biased audit reports, the experiment compared auditors’ pollution records of one group of plants that selected and directly paid their auditors to another group of plants that were randomly assigned an auditor that was not paid directly by the plant but from a common pool of auditor payments.