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Auditing Policies and Information Systems in Principal-Agent Analysis

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  • Marie-Cécile Fagart
  • Bernard Sinclair-Desgagné

    ()

Abstract

This paper considers the information systems induced by auditing policies in a principal-agent model with moral hazard. We point out that two such information systems A and B are seldom comparable using the customary mean-preserving spread relation between their respective likelihood ratio distributions. We offer a general extension of this criterion, however, and we use it to show that, provided the sign of the third derivative of the agent's inverse utility function is constant, it is yet often possible to rank A against B because one of the corresponding likelihood ratio distributions dominates the other in the third order. The upshot is that the design of optimal auditing policies involves not only the well-known tradeoff between risk-sharing and incentives, but also an examination of the location of risk. Cet article traite des mesures de la performance qui sont induites par les politiques optimales d'audit, dans un modèle principal-agent avec aléa moral. Nous faisons d'abord remarquer que deux mesures A et B sont rarement comparables selon l'étalement (en anglais "mean-preserving spread") de la distribution de leur ratio de vraisemblance respectif. Nous offrons toutefois une généralisation de ce critère usuel, que nous utilisons pour montrer que, si le signe de la troisième dérivée de l'inverse de la fonction d'utilité de l'agent est constant, alors il est possible de comparer A et B parce que l'une des distributions de ratio de vraisemblance qui leur sont associées domine l'autre au sens de la dominance stochastique du troisième ordre. La conséquence pratique de ce résultat est que le design des politiques optimales d'audit nécessite non seulement l'arbitrage bien connu entre incitations et assurance, mais aussi l'examen des risques contingents.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2002s-18.

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Date of creation: 01 Feb 2002
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Handle: RePEc:cir:cirwor:2002s-18

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Keywords: Principal-agent; moral hazard; audits; prudence; likelihood ratio distribution; third-order stochastic dominance; Principal-agent; aléa moral; audits; prudence; distribution du ratio de vraisemblance; dominance stochastique du troisième ordre;

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  1. Menezes, C & Geiss, C & Tressler, J, 1980. "Increasing Downside Risk," American Economic Review, American Economic Association, vol. 70(5), pages 921-32, December.
  2. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  3. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  4. EECKHOUDT, Louis & Christian GOLLIER & Thierry SCHNEIDER, 1994. "Risk Aversion, Prudence and Temperance : A Unified Approach," Working Papers 006, Risk and Insurance Archive.
  5. Sinclair-Desgagne, Bernard, 1999. "How to Restore Higher-Powered Incentives in Multitask Agencies," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(2), pages 418-33, July.
  6. Kim, Son Ku, 1995. "Efficiency of an Information System in an Agency Model," Econometrica, Econometric Society, vol. 63(1), pages 89-102, January.
  7. Hartwick, John M., 1999. "Insuring and u'''(y)," Economics Letters, Elsevier, vol. 65(2), pages 205-212, November.
  8. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  9. Sanford Grossman & Oliver Hart, . "An Analysis of the Principal-Agent Problem," Rodney L. White Center for Financial Research Working Papers 15-80, Wharton School Rodney L. White Center for Financial Research.
  10. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  11. Ronald A. Dye, 1986. "Optimal Monitoring Policies in Agencies," RAND Journal of Economics, The RAND Corporation, vol. 17(3), pages 339-350, Autumn.
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