The valley of trust: The effect of relational strength on monitoring quality

Abstract Effective monitoring of firms by regulatory agencies is essential to maintaining economic sustainability, correcting information asymmetry in markets, and mitigating social and environmental externalities. Yet, monitoring failures often arise where the monitoring agent fails to detect or report infractions by the firms they monitor. Whereas organizational scholars cite weak relationships and a lack of trust between firms and monitors as a key source of monitoring failures, research in organizational deviance contends that increased trust in strong relationships promotes monitoring failures via negligence and collusion. Drawing on these two literatures, we propose that relationship strength exhibits a U-shaped relationship with monitoring quality, as mediated by trust: increasing relationship strength reduces monitoring failures to a certain point, but beyond which it increases monitoring failures. We test our theory with three studies: a field study using longitudinal archival data on financial restatements, a survey of Certified Public Accountants, and an experimental audit simulation.