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Economic effects of a mandated audit in a contingent†claims production economy

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  • WILLIAM R. SCOTT

Abstract

. This paper considers the effects of a mandated audit when the firm operates in a contingent†claims production economy. An adverse selection problem is introduced by assuming that random state realization and resulting productive outcome is not observable to consumer†investors, but is observable to the firm manager. This raises the possibility that managers may cheat by reporting a lower outcome than actual, and appropriating the difference. Such behavior is controlled, but not eliminated, by the presence of a costly mandated audit, which may detect such cheating. Managers compete for positions in a competitive managerial labor market, and managerial effort is assumed to be observable. Despite this, cheating managers do not deliver a first†best level of effort in the model and this is a second cost to society of the assumed information asymmetry. The economic impact of changes in audit intensity on manager and investor decision making is examined. Résumé. L'auteur étudie, dans l'article qui suit, les conséquences de la vérification demandée par les instances supérieures de l'entreprise lorsque cette dernière œuvre dans une économie de production de titres de créance conditionnels. Un problème qui complique la sélection tient à l'hypothèse selon laquelle la réalisation aléatoire de l'état de la nature et le rendement qui en découle ne peuvent être observés par les consommateurs†investisseurs, mais peuvent l'être par le gestionnaire de l'entreprise. Ainsi est†il possible pour les gestionnaires de tromper les consommateurs†investisseurs en faisant état d'un rendement inférieur au rendement réel et en s'appropriant la différence. Ce genre de comportement peut être contrôlé, mais non supprimé, grâce à une vérification demandée par les instances supérieures de l'entreprise, opération coûteuse mais qui peut permettre de détecter les fraudes. Les gestionnaires se disputent des postes administratifs dans un marché concurrentiel. L'on suppose que l'effort qu'ils fournissent est observable. Malgré cela, les gestionnaires qui fraudent ne fournissent pas un effort de tout premier ordre à l'Intérieur du modèle, et c'est un second coût pour la société que l'asymétrie supposée de l'information. L'auteur analyse l'incidence économique de la modification de l'intensité de la vérification sur la prise de décisions des gestionnaires et des investisseurs.

Suggested Citation

  • William R. Scott, 1988. "Economic effects of a mandated audit in a contingent†claims production economy," Contemporary Accounting Research, John Wiley & Sons, vol. 4(2), pages 354-388, March.
  • Handle: RePEc:wly:coacre:v:4:y:1988:i:2:p:354-388
    DOI: 10.1111/j.1911-3846.1988.tb00671.x
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    References listed on IDEAS

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    1. Penno, M, 1985. "Informational Issues In The Financial-Reporting Process," Journal of Accounting Research, Wiley Blackwell, vol. 23(1), pages 240-255.
    2. Campbell, Tim S. & Kracaw, William A., 1985. "The Market for Managerial Labor Services and Capital Market Equilibrium," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(3), pages 277-297, September.
    3. HOLMSTROM, Bengt, 1979. "Moral hazard and observability," LIDAM Reprints CORE 379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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    6. Antle, R, 1982. "The Auditor As An Economic Agent," Journal of Accounting Research, Wiley Blackwell, vol. 20(2), pages 503-527.
    7. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    8. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
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    Cited by:

    1. Philip R. Beaulieu, 1994. "Utilisation par les prêteurs commerciaux de l'information comptable en interaction avec la crédibilité de la source," Contemporary Accounting Research, John Wiley & Sons, vol. 10(2), pages 587-623, March.
    2. David R. Finley, 1994. "Game Theoretic Analysis of Discovery Sampling for Internal Fraud Control Auditing," Contemporary Accounting Research, John Wiley & Sons, vol. 11(1), pages 91-114, June.
    3. Philip R. Beaulieu, 1994. "Commercial Lenders' Use of Accounting Information in Interaction with Source Credibility," Contemporary Accounting Research, John Wiley & Sons, vol. 10(2), pages 557-585, March.

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