Buying Truth in a Competitive Market

Abstract

Organizations face a competitive certification market for their statements, the statements do not convince third parties unless certified, the organizations are sometimes better served by a lie, and honest mistakes are possible. In our model of such a market: if certifiers are liable for mistakes, certifier contracts must be contingent; when certification is inelastically demanded, increases in certifier liability effectively reduce third party trust; organizational liability for mis-statements has a strong deterrent effect on mis-statements and increases third party trust; and after a strong negative shock to the financial system, loosening certification standards can only make it harder to raise third party trust levels.

Keywords: auditing, certification, game theory