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Timing of Verification Procedures: Monitoring versus Auditing

  • Roland Strausz

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In an agency model this paper studies the strategic effect of a difference in timing of verification. A principal may choose between two equally efficient verification procedures: monitoring and auditing. Under auditing the principal receives additional information. Due to a double moral hazard problem there exists a tension between incentives for effort and incentives for verification. Auditing exacerbates this tension and, consequently, requires steeper incentive schemes than monitoring. Hence, auditing is suboptimal if 1) steep incentives structures are costly to implement due to bounded transfers, or 2) steep incentive schemes induce higher rents due to limited liability.

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Paper provided by Departmental Working Papers in its series Papers with number 015.

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Handle: RePEc:bef:lsbest:015
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  1. Eric Maskin, 1998. "Nash Equilibrium and Welfare Optimality," Harvard Institute of Economic Research Working Papers 1829, Harvard - Institute of Economic Research.
  2. Khalil, F. & Lawarree, J., 1993. "Input Versus Output Monitoring: Who Is the Residual Claimant?," Discussion Papers in Economics at the University of Washington 93-01, Department of Economics at the University of Washington.
  3. Strausz, Roland, 2006. "Buried in paperwork: Excessive reporting in organizations," Journal of Economic Behavior & Organization, Elsevier, vol. 60(4), pages 460-470, August.
  4. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
  5. Holthausen, Robert W. & Leftwich, Richard W., 1983. "The economic consequences of accounting choice implications of costly contracting and monitoring," Journal of Accounting and Economics, Elsevier, vol. 5(1), pages 77-117, April.
  6. Ross L. Watts, 1977. "Corporate Financial Statements, A Product of the Market and Political Processes," Australian Journal of Management, Australian School of Business, vol. 2(1), pages 53-75, April.
  7. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  8. Bester, Helmut & Strausz, Roland, 2001. "Contracting with Imperfect Commitment and the Revelation Principle: The Single Agent Case," Econometrica, Econometric Society, vol. 69(4), pages 1077-98, July.
  9. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  10. Eric Maskin & John G. Riley, 1984. "Input Versus Output Incentive Schemes," UCLA Economics Working Papers 354, UCLA Department of Economics.
  11. Roland Strausz, 2001. "Mitigating Non-Contractability with Interim Randomization," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 157(2), pages 231-, June.
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