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Cost Padding, Auditing and Collusion

Listed author(s):
  • Jean-Jacques Laffont
  • Jean Tirole

This paper first studies how cost padding, auditing and collusion with auditors affect the power of incentive schemes in procurement and regulation. Unaudited cost padding requires fixed price contracts. Incentive schemes are more powerful under imperfect auditing than under perfect auditing and less powerful than under no auditing. The effect of collusion in auditing on the optimal power of incentive schemes is ambiguous; high-powered schemes reduce the incentive for cost padding and thus are less affected by collusion; however, they also yield higher rents and therefore make firms more willing to prevent release of evidence of cost padding. Monitoring of effort, the second topic of this paper, is a substitute for the use of low-powered incentive schemes to extract the informational rents. It thus enables the regulator to afford more powerful incentive schemes. Collusion in auditing unambiguously lowers the power of incentive schemes.

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Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 571.

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Date of creation: 1991
Handle: RePEc:mit:worpap:571
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