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Strategic Auditing: An Incomplete Information Model

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  • Peter Cheng
  • Bradley D. Childs
  • William W. Sheng

Abstract

This paper presents a stylized model of the strategy game between the auditor and the client. The client is assumed to have either good or bad inherent risk in her reporting system. She chooses a reporting effort level to maintain the accounting records and data management depending on her type of inherent risk. The auditor chooses a high or low level of audit procedures. A high level of auditing procedures will reveal the client's type and effort from which the auditor can decide either to qualify the financial statements or to issue a clean report. The client and the auditor are assumed to move simultaneously. Pure strategy equilibria are derived for all the undominated strategies between the auditor and the client in the region of the model that is more similar to the Fellingham and Newman (1985) model. Unlike their model in which a high auditing level is never a pure strategy in equilibrium, we obtain pure strategy equilibria for high auditing levels.

Suggested Citation

  • Peter Cheng & Bradley D. Childs & William W. Sheng, 2001. "Strategic Auditing: An Incomplete Information Model," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(5‐6), pages 631-652, June.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:5-6:p:631-652
    DOI: 10.1111/1468-5957.00387
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    Cited by:

    1. Bernardino, Wilton & Ospina, Raydonal & Souza, Filipe Costa de & Rêgo, Leandro & Pereira, Felipe, 2021. "Risk curves: A methodology to evaluate the risk of fraud by stock price manipulation based on game theory and detection software," Journal of Economics and Business, Elsevier, vol. 113(C).

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