Why an independent audit reduces information risk

Why an independent audit reduces information risk

Independent audits act as a monitoring mechanism and credibility enhancer for reported numbers:

1. Assurance on reliability: Auditors test controls and transactions, providing reasonable assurance that the statements are free of material misstatement, shrinking information asymmetry.
2. Deterrence & detection: The prospect of audit testing and inquiry deters earnings management/fraud and helps detect material errors—lowering users’ estimation error.
3. Controls improvement: Recommendations from audits strengthen internal controls, reducing future misstatement risk.
4. Governance & stewardship: Independent auditors report to the board/Audit Committee, reinforcing oversight over management.
5. Contracting efficiency: More reliable numbers improve lending, investment, and compensation contracts, reducing agency costs.
6. Lower cost of capital: With reduced information risk, investors demand a smaller risk premium, often translating to cheaper financing and better market liquidity.