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Efficient audits by pooling projects

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  • Anna Maria C. Menichini
  • Peter J. Simmons

Abstract

In a costly state verification model under commitment, the paper shows that jointly financing multiple independent projects reduces the deadweight loss of inefficient audits. This is true for both simultaneous and sequential audit, since each system reveals the same information about the project outcomes at the same cost. Moreover, the audit combination under sequential audit is indeterminate. Audits are decreasing in the reported income and, for sufficiently high projects profitability, deterministic for lower income reports. We explore robustness of the results, including commitment issues. The results are interpreted in the light of observed features of financial contracts.

Suggested Citation

  • Anna Maria C. Menichini & Peter J. Simmons, 2017. "Efficient audits by pooling projects," Discussion Papers 17/19, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:17/19
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    References listed on IDEAS

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    1. Kim C. Border & Joel Sobel, 1987. "Samurai Accountant: A Theory of Auditing and Plunder," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 54(4), pages 525-540.
    2. Dilip Mookherjee & Ivan Png, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(2), pages 399-415.
    3. Fahad Khalil, 1997. "Auditing Without Commitment," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 629-640, Winter.
    4. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    5. Menichini Anna Maria C. & Simmons Peter J., 2006. "Liars and Inspectors: Optimal Financial Contracts When Monitoring is Non-Observable," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 6(1), pages 1-21, June.
    6. Khalil, Fahad & Parigi, Bruno M, 1998. "Loan Size as a Commitment Device," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 135-150, February.
    7. Gregory Phelan, 2017. "Correlated Default and Financial Intermediation," Journal of Finance, American Finance Association, vol. 72(3), pages 1253-1284, June.
    8. Anna Maria Menichini & Peter Simmons, 2014. "Sorting the good guys from bad: on the optimal audit structure with ex-ante information acquisition," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 57(2), pages 339-376, October.
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    Cited by:

    1. Rosa Ferrentino & Luca Vota, 2023. "The optimal financing of a conglomerate firm with hidden information and costly state verification," Annals of Finance, Springer, vol. 19(1), pages 23-62, March.

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    More about this item

    Keywords

    contracts; auditing; diversification.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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