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Truth-telling by Third-Party Audits and the Response of Polluting firms: Experimental Evidence from India

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In many regulated markets, firms choose and pay private, third-party auditors, potentially creating a conflict of interest. This paper reports on a two-year field experiment in the Indian state of Gujarat that sought to curb such a conflict by reforming the system of environmental audits for industrial plants.

In the control group, plants remained in the status quo system, wherein they directly chose and paid their third-party auditors. In the treatment group, the researchers assigned auditors to plants randomly and paid them a fixed fee from a central pool. Independent agencies subjected their reports to random backchecks. In the second year, the auditors working in the treatment group additionally received a bonus for accurate reporting.

There are three main results:

the status quo system was largely corrupt, with auditors systematically reporting plant emissions just below the standard, although the true emissions were typically higher
the treatment caused auditors to report more truthfully and reduced the fraction of plants that they falsely reported as being compliant with pollution standards
the treatment plants, in turn, reduced their pollution emissions

The results suggest that reformed incentives for third-party auditors can improve the quality of their reports and make regulation more effective.