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Audits as Signals

24 Pages Posted: 18 Aug 2013 Last revised: 18 Sep 2013

Maciej H. Kotowski

Harvard University - Harvard Kennedy School (HKS)

David A. Weisbach

University of Chicago - Law School; Center for Robust Decisionmaking on Climate & Energy Policy (RDCEP)

Richard J. Zeckhauser

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Date Written: August 16, 2013

Abstract

A broad array of law enforcement strategies, from income tax to bank regulation, involve self-reporting by regulated agents and auditing of some fraction of the reports by the regulating bureau. Standard models of self-reporting strategies assume that although bureaus only have estimates of the of an agent’s type, agents know the ability of bureaus to detect their misreports. We relax this assumption, and posit that agents only have an estimate of the auditing capabilities of bureaus. Enriching the model to allow two-sided private information changes the behavior of bureaus. A bureau that is weak at auditing, may wish to mimic a bureau that is strong. Strong bureaus may be able to signal their capabilities, but at a cost. We explore the pooling, separating, and semi-separating equilibria that result, and the policy implications. Important possible outcomes are that a cap on penalties increases compliance, audit hit rates are not informative of the quality of bureau behavior, and by mimicking strong bureaus even weak bureaus can induce compliance.

Suggested Citation

Kotowski, Maciej H. and Weisbach, David A. and Zeckhauser, Richard J., Audits as Signals (August 16, 2013). HKS Working Paper No. RWP13-026; University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 651. Available at SSRN: https://ssrn.com/abstract=2311417 or http://dx.doi.org/10.2139/ssrn.2311417

Maciej H. Kotowski

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

David Weisbach (Contact Author)

University of Chicago - Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States
773-702-3342 (Phone)
773-702-0730 (Fax)

Center for Robust Decisionmaking on Climate & Energy Policy (RDCEP) ( email )

5735 S. Ellis Street
Chicago, IL 60637
United States

Richard J. Zeckhauser

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
617-495-1174 (Phone)
617-496-3783 (Fax)

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States
617-495-1174 (Phone)
617-384-9340 (Fax)

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