The Public Auditor as an Explicit Insurer of Client Restatements: A Proposal to Promote Market Efficiency

This paper presents a proposal for reform of the public auditor—client relationship. We suggest the creation of incentives to permit public auditors to form, as an optional matter, audit risk insurers (ARIs) to assume the risk of a deficient public audit. We discuss the following in turn: (1) the need for this radical structural change, (2) why the change will produce benefits justifying the cost and dislocation resulting from implementing it, (3) how it will work, (4) the incentives necessary to bring it about, including limitations on liability, (5) the need for a transition period, and (6) the resulting benefit to not only the audit process but also the promotion of efficiency in the securities markets. An increasingly complex financial world demands better and more transparent signaling to investors. In our view, the ARI, powered by its risk assumption attributes, will function as a more efficient intermediary for transmitting financial information to investors.