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Timing of Verification Procedures: Monitoring versus Auditing

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  • Roland Strausz

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Abstract

In an agency model this paper studies the strategic effect of a difference in timing of verification. A principal may choose between two equally efficient verification procedures: monitoring and auditing. Under auditing the principal receives additional information. Due to a double moral hazard problem there exists a tension between incentives for effort and incentives for verification. Auditing exacerbates this tension and, consequently, requires steeper incentive schemes than monitoring. Hence, auditing is suboptimal if 1) steep incentives structures are costly to implement due to bounded transfers, or 2) steep incentive schemes induce higher rents due to limited liability.

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Paper provided by Departmental Working Papers in its series Papers with number 015.

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Handle: RePEc:bef:lsbest:015

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  1. Eric Maskin & John G. Riley, 1984. "Input Versus Output Incentive Schemes," UCLA Economics Working Papers 354, UCLA Department of Economics.
  2. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
  3. Ross L. Watts, 1977. "Corporate Financial Statements, A Product of the Market and Political Processes," Australian Journal of Management, Australian School of Business, vol. 2(1), pages 53-75, April.
  4. Bester, Helmut & Strausz, Roland, 2001. "Contracting with Imperfect Commitment and the Revelation Principle: The Single Agent Case," Econometrica, Econometric Society, vol. 69(4), pages 1077-98, July.
  5. Roland Strausz, . "Buried in Paperwork: Excessive Reporting in Organizations," Papers 021, Departmental Working Papers.
  6. Eric Maskin, 1998. "Nash Equilibrium and Welfare Optimality," Harvard Institute of Economic Research Working Papers 1829, Harvard - Institute of Economic Research.
  7. Khalil Fahad & Lawarree Jacques, 1995. "Input versus Output Monitoring: Who Is the Residual Claimant?," Journal of Economic Theory, Elsevier, vol. 66(1), pages 139-157, June.
  8. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  9. Roland Strausz, 2001. "Mitigating Non-Contractability with Interim Randomization," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 157(2), pages 231-, June.
  10. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  11. Holthausen, Robert W. & Leftwich, Richard W., 1983. "The economic consequences of accounting choice implications of costly contracting and monitoring," Journal of Accounting and Economics, Elsevier, vol. 5(1), pages 77-117, April.
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Cited by:
  1. Kuhn, Michael & Siciliani, Luigi, 2013. "Manipulation and auditing of public sector contracts," European Journal of Political Economy, Elsevier, vol. 32(C), pages 251-267.
  2. Roland Strausz, . "Buried in Paperwork: Excessive Reporting in Organizations," Papers 021, Departmental Working Papers.
  3. Luc E. Leruth & Elisabeth Paul, 2006. "A Principal-Agent Theory Approach to Public Expenditure Management Systems in Developing Countries," IMF Working Papers 06/204, International Monetary Fund.
  4. Langinier, Corinne & Marcoul, Phillipe, 2009. "Search of Prior Art and Revelation of Information by Patent Applicants," Working Papers 2009-21, University of Alberta, Department of Economics.
  5. Langinier, Corinne & Marcoul, Philippe, 2007. "Patents, Search of Prior Art, and Revelation of Information," Staff General Research Papers 10489, Iowa State University, Department of Economics.

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