INCENTIVE CONTRACTS UNDER IMPERFECT AUDITING*

Hsiao‐chi Chen and Shi‐miin Liu

Manchester School, 2008, vol. 76, issue 2, 131-159

Abstract: In this paper we analyze the optimal incentive contracts under imperfect auditing. Both principal's commitment and no commitment to auditing cases are investigated. In the commitment case, the Baron–Besanko‐type (RAND Journal of Economics, Vol. 15 (1984), pp. 447–470) contract would fail under imperfect auditing. In the no‐commitment case, the Baron–Myerson (Econometrica, Vol. 50 (1982), pp. 911–930) and the Khalil‐type (RAND Journal of Economics, Vol. 28 (1997), pp. 629–640) contracts could survive under specific misjudging probabilities. In addition, there exists a separate equilibrium with the agent's full compliance and the principal's sure ex post auditing.

Date: 2008
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