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Optimal Audit Policies with Correlated Types

  • M. Martin Boyer

    (Ecole de Hautes-Etudes Commerciales)

  • Patrick Gonzalez

    (Universite Laval)

We propose a multi-agents adverse selection version of Townsend's (1979) model of costly audits where the agents' types are correlated. Audits are used because agents have a limited ability to bear risk so that the Full Surplus Extraction (FSE) scheme a la Cremer and McLean (1985,1988) and McAfee and Reny (1992) would be suboptimal here. It is shown that Townsend's result of an optimal marginal arbitrage between rent extraction and efficiency does not hold in the case of perfect correlation: FSE is feasible -- even in dominant strategies -- by devising a contract that put the agents in a prisoner's dilemma. A numerical simulation of the model is performed which suggests that the single agent model is not a good approximation of the multi-agents case.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1514.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1514
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  1. Dominique M. Demougin & Devon a. Garvie, 1991. "Contractual Design with Correlated Information Under Limited Liability," Working Papers 815, Queen's University, Department of Economics.
  2. Cremer, Jacques & McLean, Richard P, 1988. "Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions," Econometrica, Econometric Society, vol. 56(6), pages 1247-57, November.
  3. Graetz, Michael J. & Reinganum, Jennifer F. & Wilde, Louis L., . "The Tax Compliance Game: Toward an Interactive Theory of Law Enforcement," Working Papers 589, California Institute of Technology, Division of the Humanities and Social Sciences.
  4. Brusco, Sandro, 1998. "Unique Implementation of the Full Surplus Extraction Outcome in Auctions with Correlated Types," Journal of Economic Theory, Elsevier, vol. 80(2), pages 185-200, June.
  5. 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.
  6. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  7. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
  8. Cremer, Jacques & McLean, Richard P, 1985. "Optimal Selling Strategies under Uncertainty for a Discriminating Monopolist When Demands Are Interdependent," Econometrica, Econometric Society, vol. 53(2), pages 345-61, March.
  9. Aoyagi, Masaki, 1998. "Correlated Types and Bayesian Incentive Compatible Mechanisms with Budget Balance," Journal of Economic Theory, Elsevier, vol. 79(1), pages 142-151, March.
  10. Robert M. Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  11. Dilip Mookherjee & Ivan Png, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 399-415.
  12. M. Boyer, 2003. "Contracting under ex post moral hazard and non-commitment," Review of Economic Design, Springer;Society for Economic Design, vol. 8(1), pages 1-38, August.
  13. Robert, Jacques, 1991. "Continuity in auction design," Journal of Economic Theory, Elsevier, vol. 55(1), pages 169-179, October.
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