Study considers double-edged sword of trust in regulatory agencies' monitoring of firms

Governmental and third-party regulatory agencies (e.g., the Securities and Exchange Commission and independent auditing firms) are charged with monitoring firms to guard against behaviors that might have negative consequences for the economy, the environment, or society. This type of monitoring fails when the agents do not detect or report infractions by the firms they oversee. New research based on observations of auditors suggests that strong relationships and trust between auditing agencies and firms can reduce monitoring failures, such as unintended mistakes, to a point, but can also eventually lead to negligence and collusion. Using a combination of methods, researchers looked at the role of auditing relationships and trust in the monitoring of firms; their findings suggest that agents are more likely to miss infractions early in the relationship when trust is low or later in the relationship when trust is high. In concluding that there may be an optimal duration of relationships between regulators and firms, the study has implications for policy.