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«Corporate Audits and How to Fix Them Joshua Ronen A uditors are supposed to be watchdogs, but in the last decade or so, they sometimes looked like ...»

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Joshua Ronen 207 Financial statements insurance may encourage greater competition in audit markets as well. Because financial statements insurance is tailored to specific auditee risk, it should make it easier for smaller firms to enter existing insurance markets. Moreover, insurers, operating in a much more competitive industry than audit firms, could assemble audit teams or establish captive audit firms in direct competition with the existing Big Four auditing firms.

Variations on the basic financial services insurance scheme are also possible.

For example, in Ronen and Sagat (2007), my coauthor and I suggest that if auditing firms are reluctant to be hired by insurers, then the auditing firms could take on the insurance function explicitly. An existing audit firm could incorporate itself or, more likely, on a test basis incorporate a financial statements insurance affiliate for the conduct of certain audits; alternatively, an existing insurer or other riskbearing financial institution could establish an auditing insurer subsidiary. We lay out a number of other issues in detail about this version of the proposal, including how premiums might be set, what events could trigger payment, how liability might be calculated by formula, how liability law would work when losses were insured, a potential role for arbitrators to solve disagreements, and more.

The idea of financial statements insurance was first floated in a short op-ed piece I wrote for a popular audience in the New York Times (March 8, 2002). On July 10, 2002, a column by Susan Lee presented the idea in the Wall Street Journal..

The first detailed treatment of the proposal can be found in Ronen (2002).

Scholarly and general interest in financial statements insurance has grown; see, among others, Cunningham (2004a, 2004b), Skeel (2005), Shapiro (2005), Griffith (2006), Jopson (2006), and Moore (2006). Dontoh, Ronen, and Sarath (2008) provide a formal model demonstrating the superiority of financial statements insurance over the present and alternative regimes. Cunningham (2006) compares financial statements insurance to a number of alternatives discussed above and rejects them in favor of financial statements insurance. This literature adds up to a strong case that some form of financial statements insurance should become a mandatory component of U.S. federal securities regulation.

I wish to share my sincere appreciation to JEP Editors Timothy Taylor, David Autor, and ■ Jim Hines (I benefited tremendously from their comments) and to Ann Norman for the final copyedit.

208 Journal of Economic Perspectives References

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