The control problem of the supervisory board in a manager-auditor-conflict in banking

In the German legislative process two main questions currently dominate the discussion of bank auditing: 1) How can managers and accountants be motivated by legal penalties or incentives to compile proper balance sheets and verify their accuracy?; 2) Which kind of liabilities should be imposed by law on individual members of the board of directors and the board as a whole to motivate them to monitor the integrity of the auditing report and to take measures against managers if their activities are found wanting. This paper contributes a decision-oriented MCDM game to this discussion. In the framework of financial problems in the last five years that derive, at least in part, from the interpretation and attestation of banking balance sheets, this paper presents and discusses a three-person inspection game as a special version of MCDM games to be applied to an auditing process in which an auditor (inspector), a CEO (inspectee) and the supervisory board (board) of a bank play the principal roles. To facilitate this game we calculate a non-cooperative Nash solution and discuss the influence of the inspectees non-legal behaviour. We endeavour to measure how the inspector's losses in reputation, penalty payments for the inspectee and the inspector as well as monitoring activities of the board might change the Nash equilibrium. It turns out that the board cannot trust the balance sheet at all and must rigorously check the data it provides. But it cannot be shown that higher penalties influence the Nash solution's regulation of strategic rational behaviour that might induce the two players, the inspectee and inspector to conduct themselves within legal boundaries.