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Sorting the good guys from bad: on the optimal audit structure with ex-ante information acquisition

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  • Anna Maria Menichini
  • Peter Simmons

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 realizations, optimally the signal is collected, if at all, only 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 characterization 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 the robustness of the results, including commitment issues. The results are interpreted in light of the observed features of financial contracts, showing that the optimality of the standard debt contract with deterministic audit extends to a setting with random audit. Copyright Springer-Verlag Berlin Heidelberg 2014

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  • Anna Maria Menichini & Peter Simmons, 2014. "Sorting the good guys from bad: on the optimal audit structure with ex-ante information acquisition," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 57(2), pages 339-376, October.
    • Handle: RePEc:spr:joecth:v:57:y:2014:i:2:p:339-376
    DOI: 10.1007/s00199-014-0818-y
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    Cited by:

    1. Bilancini, Ennio & Boncinelli, Leonardo, 2018. "Signaling with costly acquisition of signals," Journal of Economic Behavior & Organization, Elsevier, vol. 145(C), pages 141-150.
    2. Anna Maria C. Menichini & Peter J. Simmons, 2017. "Efficient audits by pooling projects," Discussion Papers 17/19, Department of Economics, University of York.
    3. M. Martin Boyer & Philippe d'Astous, 2023. "Tax compliance and firm response to electronic sales monitoring," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 56(4), pages 1430-1468, November.
    4. Peter J. Simmons & Anna Maria C. Menichini, 2022. "Efficient audits by pooling independent projects: Separation vs. conglomeration," Discussion Papers 22/06, Department of Economics, University of York.

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    More about this item

    Keywords

    Contracts; Auditing; Ex-ante information; Debt contract; D82; D83; D86;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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