Financial Reporting and Blockchains : Audit Pricing, Misstatements, and Regulation

To understand the implications of decentralized ledger technology for financial reporting and auditing, we analyze auditor competition, audit quality, client misstatements, and regulatory policy all in a unified framework. We demonstrate how collaborative auditing using a federated blockchain can improve verification efficiency for not only transactions recorded on auditors or clients' proprietary databases, but also cross-auditor verifications through zero-knowledge protocols that preserve data privacy. Consequently, the technology disrupts conventional audit pricing and effort focus: Auditors' competitive fees depend on clients' counter-parties' characteristics and corresponding transaction volume instead of client size. Blockchains also reduces clients' incentives to misreport and auditors' sampling costs, allowing auditors to reallocate effort from transaction-based auditing to discretionary account auditing. Importantly, auditors' technology adoption is costly and exhibits strategic complementarity, hence a regulator can help select an equilibrium with lower endogenous misstatements, audit sampling, and regulatory costs