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Optimal Auditing in Hierarchical Relationships

  • Anke S. Kessler

This paper studies a principal-agent model with third-party auditing. Auditing technologies are distinguished according to the quantity (frequency) and the quality (accuracy) of the information they deliver. We show that the frequency of audits is irrelevant if the auditor either is honest or colludes with the agent but auditing evidence can only be concealed and not forged. Only if auditing evidence can be falsified does the principal benefit both from the frequency and from the accuracy of the auditor's observations. The findings therefore indicate that firms should opt for accurate rather than frequent audits under a wide range of circumstances.

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Article provided by Mohr Siebeck, Tübingen in its journal Journal of Institutional and Theoretical Economics.

Volume (Year): 160 (2004)
Issue (Month): 2 (June)
Pages: 210-

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Handle: RePEc:mhr:jinste:urn:sici:0932-4569(200406)160:2_210:oaihr_2.0.tx_2-2
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  1. Anke S. Kessler & Christoph Lülfesmann & Patrick W. Schmitz, 2005. "Endogenous Punishments In Agency With Verifiable Ex Post Information ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(4), pages 1207-1231, November.
  2. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter.
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