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Sorting the Good Guys from Bad: On the Optimality of Deterministic Audit with Ex-Ante Information Acquisition

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Abstract

In a costly state verification model under commitment the principal may acquire a costly public and imperfectly revealing signal before or after contracting. If the project remains profitable after all signal realisations, optimally the signal is collected, if at all, after contracting, and it may be acquired randomly or deterministically. Moreover, audit is deterministic and targeted on some signal-state combinations. The paper provides a detailed characterisation of the optimal contract and performs a comparative static analysis of signal acquisition strategy and payoffs with respect to enforcement costs and informativeness of the signal. We explore robustness of the results, including commitment issues.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 201.

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Date of creation: 15 Jul 2008
Date of revision: 27 Oct 2012
Handle: RePEc:sef:csefwp:201

Note: A previous version has been circulated under the title “The Strategic and Social Power of Signal Acquisition".
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Keywords: contracts; auditing; ex-ante information;

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  1. Cremer, J. & Khalil, F & Rochet, J.-C., 1996. "Strategic Information Gathering Before a Contract is Offered," Papers 976.425, Toulouse - GREMAQ.
  2. Khalil, F & Rochet, J-C, 1997. "Contracts and Productive Information Gathering," Working Papers 97-16, University of Washington, Department of Economics.
  3. Lewis, Tracy R & Sappington, David E M, 1997. "Information Management in Incentive Problems," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 796-821, August.
  4. Khalil, Fahad & Parigi, Bruno M, 1998. "Loan Size as a Commitment Device," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 135-50, February.
  5. Crémer, Jacques & Khalil, Fahad, 1991. "Gathering Information before Signing a Contract," IDEI Working Papers 5, Institut d'Économie Industrielle (IDEI), Toulouse.
  6. Alberto Bennardo, 2008. "Information Gathering, Disclosure and Contracting in Competitive Markets," CSEF Working Papers 190, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  7. Cremer, Jacques & Khalil, Fahad, 1994. "Gathering information before the contract is offered: The case with two states of nature," European Economic Review, Elsevier, vol. 38(3-4), pages 675-682, April.
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