How Audits Moderate the Effects of Incentives and Peer Behavior on Misreporting

Classical agency theory argues that economic incentives can have a strong impact on opportunistic reporting behavior. On the other hand, behavioral literature suggests that agents also adhere to descriptive norms established by peers. Most studies examine these effects in isolation, ignoring the role of mechanisms that firms use to detect misreporting. This research examines if the effects of incentives and descriptive peer norms depend on whether the firm uses an audit system to detect misreporting. In an experiment, we vary the material payoffs for lying (low vs. high compensation rate), the behavior of peers (low vs. high honesty), and the use of audits to detect misreporting (audited vs. not audited). Results indicate that the effect of peer behavior depends on the use of audits. When reporting decisions are audited, descriptive peer norms have a strong effect on the level of truthful reporting. We do not find evidence indicating that the effect of incentives depends on audits. Our findings have important implications for practice. Firms may need to consider the use of audits if they want to promote honesty through positive peer-established social norms.