Make It 'Til You Fake It
72 Pages Posted: 11 Mar 2020
Date Written: February 17, 2020
We study a dynamic model of fraud and trust-building featuring two parties: a principal, who has limited power of commitment and who wishes to accept real projects and reject fake ones, and an agent, who is either an ethical type that produces only a real project, or a strategic type that produces a real project but can also choose to generate a fake. Producing a real project takes a positive and uncertain amount of time, while a fake project can be manufactured instantaneously at some cost. In the unique equilibrium, the strategic agent randomizes the timing of fraud and the principal randomizes between acceptance and rejection. As time passes without a submission, the principal's belief that the agent is ethical grows until the point when she fully trusts the agent and accepts any subsequent submission with certainty. We explore several institutional remedies designed to improve the principal's welfare. These include: an imperfect auditing technology, opaque standards, commitment to suppress fraud, and requiring submissions to occur on a specified date.
Keywords: audit, counterfeit, deception, fraud, innovation, opaque standards, research, trust
JEL Classification: C73, D21, D82, L15, M42
Suggested Citation: Suggested Citation