Auditing Standards, Professional Judgement, and Audit Quality∗

This paper examines the economic consequences of tightening auditing standards. We recognize that both auditors’ incentives and expertise are relevant for audit effectiveness. On one hand, tighter auditing standards counter the misbehavior of rogue auditors. On the other hand, tighter standards restrict auditors’exercise of professional judgement, leads to auditors’compliance mentality, and reduces their ex ante acquisition of professional expertise. In the short run, tighter standards could increase both audit fee and audit quality, but may result in lower social welfare. In the long run, they may lead to the least desirable scenario of higher audit fee, lower audit quality, and lower social welfare. Finally, the optimal auditing standards are higher when the auditor’s incentives are more misaligned with investors, when the audit tasks are less complex, and when the audit market is more competitive. JEL classification: G18, G38, M42, M48, K22