Cost observation, auditing and limited liability

In this paper we consider the effect of limited liability for agents in a principal-agent framework with imperfect auditing. We show that limited liability annihilates the incentive effects of auditing by preventing the principal from giving a negative rent to the bad type when an audit mistake occu...

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Bibliographic Details
Published in:Economics letters 1992-08, Vol.39 (4), p.419-423
Main Authors: Lawarrée, Jacques P., Van Audenrode, Marc A.
Format: Article
Language:English
Subjects:
Auditing
Costs
Liability
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Summary:In this paper we consider the effect of limited liability for agents in a principal-agent framework with imperfect auditing. We show that limited liability annihilates the incentive effects of auditing by preventing the principal from giving a negative rent to the bad type when an audit mistake occurs: if you cannot convict an innocent, do not audit.
ISSN:0165-1765
1873-7374
DOI:10.1016/0165-1765(92)90179-3