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Regulatory Auditing and Ramsey Pricing

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  • Devon Garvie

Abstract

Truthful revelation mechanisms with auditing have the undesirable property that audits are not actually performed in equilibrium because all inference problems have been solved. A model is proposed in which the inference problem is preserved by separating the regulatory and auditing functions and transfers are costly. The auditor designs a Bayesian audit procedure and the regulator credibly commits to using this procedure in the regulatory mechanism. The auditor is conservative, that is, he does not like to make mistakes for his client. Second-best allocation is achieved over a well-defined auditing region of the regulator's prior beliefs about firm type. The auditing region is increasing in the precision of the auditing technology and is decreasing in the strength of the regulator's prior beliefs.

Suggested Citation

  • Devon Garvie, 1991. "Regulatory Auditing and Ramsey Pricing," Working Paper 824, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:824
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    File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_824.pdf
    File Function: First version 1991
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