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Auditing Policies and Information Systems in Principal-agent Analysis

Marie-Cecile Fagart and Bernard Sinclair-Desgagné

No 02-02, Cahiers de recherche from HEC Montréal, Institut d'économie appliquée

Abstract: This paper considers the information systems induced by auditing policies in a principal- agent model with moral hazard. We point out that two such information systems A and B are seldom comparable using the customary mean-preserving spread relation between their respective likelihood ratio distributions. We offer a general extension of this criterion, however, and we use it to show that, provided the sign of the third derivative of the agent’s inverse utility function is constant, it is yet often possible to rank A against B because one of the corresponding likelihood ratio distributions dominates the other in the third order. The upshot is that the design of optimal auditing policies involves not only the well-known trade-off between risk-sharing and incentives, but also an examination of the location of risk.

Keywords: Principal-agent; moral hazard; audits; prudence; likelihood ratio distribution; third-order stochastic dominance. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cdm
Date: 2002-01
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