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In the absence of commitment to auditing, we study the optimal auditing contract when collusion between an agent and an auditor is possible. We show that the auditor can be totally useless if the auditor's independence can be compromised with relative ease. Even very stiff sanctions on fraud will be unable to make auditing optimal. We then derive a demand for independent external auditing. We endogenize collusion cost as the cost from the risk of future detection. We also derive a justification for the focus of the recent audit reforms on penalties on CEOs in cases of audit fraud. Copyright Blackwell Publishing Ltd. 2006.

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  • Fahad Khalil & Jacques Lawarrée, 2006. "INCENTIVES FOR CORRUPTIBLE AUDITORS IN THE ABSENCE OF COMMITMENT -super-," Journal of Industrial Economics, Wiley Blackwell, vol. 54(2), pages 269-291, June.
  • Handle: RePEc:bla:jindec:v:54:y:2006:i:2:p:269-291

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    References listed on IDEAS

    1. Jean-Jacques Laffont & David Martimort, 1999. "Separation of Regulators Against Collusive Behavior," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 232-262, Summer.
    2. Bester, Helmut & Strausz, Roland, 2000. "Imperfect commitment and the revelation principle: the multi-agent case," Economics Letters, Elsevier, vol. 69(2), pages 165-171, November.
    3. Yeon-Koo Che, 1995. "Revolving Doors and the Optimal Tolerance for Agency Collusion," RAND Journal of Economics, The RAND Corporation, vol. 26(3), pages 378-397, Autumn.
    4. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, January.
    5. Roland Strausz, 1997. "Delegation of Monitoring in a Principal-Agent Relationship," Review of Economic Studies, Oxford University Press, vol. 64(3), pages 337-357.
    6. Helmut Bester & Roland Strausz, "undated". "Imperfect Commitment and the Revelation Principle," Papers 004, Departmental Working Papers.
    7. Itoh, Hideshi, 1991. "Incentives to Help in Multi-agent Situations," Econometrica, Econometric Society, vol. 59(3), pages 611-636, May.
    8. Fahad Khalil, 1997. "Auditing Without Commitment," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 629-640, Winter.
    9. Strausz, Roland, 1997. " Collusion and Renegotiation in a Principal-Supervisor-Agent Relationship," Scandinavian Journal of Economics, Wiley Blackwell, vol. 99(4), pages 497-518, December.
    10. Kofman, Fred & Lawarree, Jacques, 1996. "On the optimality of allowing collusion," Journal of Public Economics, Elsevier, vol. 61(3), pages 383-407, September.
    11. Picard, Pierre, 1996. "Auditing claims in the insurance market with fraud: The credibility issue," Journal of Public Economics, Elsevier, vol. 63(1), pages 27-56, December.
    12. repec:bla:joares:v:25:y:1987:i:2:p:217-244 is not listed on IDEAS
    13. Garoupa, Nuno, 1997. " The Theory of Optimal Law Enforcement," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 267-295, September.
    14. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," Journal of Law, Economics, and Organization, Oxford University Press, vol. 2(2), pages 181-214, Fall.
    15. Kessler, Anke S., 2000. "On Monitoring and Collusion in Hierarchies," Journal of Economic Theory, Elsevier, vol. 91(2), pages 280-291, April.
    16. 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 135-150, February.
    17. Faure-Grimaud, Antoine & Laffont, Jean-Jacques & Martimort, David, 1999. "The endogenous transaction costs of delegated auditing," European Economic Review, Elsevier, vol. 43(4-6), pages 1039-1048, April.
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    Cited by:

    1. Raffaele Fiocco & Mario Gilli, 2016. "Bargaining and collusion in a regulatory relationship," Journal of Economics, Springer, vol. 117(2), pages 93-116, March.
    2. Fahad Khalil & Jacques Lawarrée & Troy J. Scott, 2015. "Private monitoring, collusion, and the timing of information," RAND Journal of Economics, RAND Corporation, vol. 46(4), pages 872-890, October.
    3. Mark Schelker, 2009. "Auditor Terms and Term Limits in the Public Sector: Evidence from the US States," CREMA Working Paper Series 2009-19, Center for Research in Economics, Management and the Arts (CREMA).
    4. De Chiara, Alessandro & Livio, Luca, 2017. "The threat of corruption and the optimal supervisory task," Journal of Economic Behavior & Organization, Elsevier, vol. 133(C), pages 172-186.
    5. Fahad Khalil & Jacques Lawarrée & Sungho Yun, 2010. "Bribery versus extortion: allowing the lesser of two evils," RAND Journal of Economics, RAND Corporation, vol. 41(1), pages 179-198.
    6. Jodi L. Short & Michael W. Toffel & Andrea R. Hugill, 2016. "Monitoring global supply chains," Strategic Management Journal, Wiley Blackwell, vol. 37(9), pages 1878-1897, September.
    7. Mark Schelker, 2016. "Unabhängige Finanzkontrolle in der Demokratie," CREMA Working Paper Series 2016-06, Center for Research in Economics, Management and the Arts (CREMA).
    8. Yun Sungho, 2012. "Costs of Engaging in Corruption: Equilibrium with Extortion and Framing," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 12(1), pages 1-32, December.

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