Regulatory enforcement with competitive endogenous audit mechanisms

Abstract

This article adds to the regulatory compliance literature through the theoretical development and experimental testing of two endogenous audit mechanisms that use contemporaneous relative comparisons, based on disclosed information or imperfect signals of compliance effort, to generate a compliance competition among agents. This type of audit mechanism has some advantages over the more widely studied dynamic audit mechanisms that condition an agent's audit probability on past compliance, and provides an alternative explanation for the stylized fact, in many settings, that most agents are compliant most of the time even though audit rates and expected penalties are low.

Regulatory performance of audit tournaments and compliance observability

“…Proposition 2: Reporting of output is greater under the rank order auditing tournament compared with random auditing. Gilpatric et al (2011) demonstrate that disclosure is higher with a rank order tournament or a more general relative audit mechanism than with random audits with a general error distribution but without the output choice. It is important to note however that we have demonstrated this result continues to hold even when output can be chosen.…”

“…The first is a more established literature on monitoring and auditing. Within this literature, our work is most closely related to Gilpatric et al (2011), who compare random auditing to two endogenous audit mechanisms similar to the rankorder tournament studied here. They focus on the reporting decision of firms in both their theoretical exposition and in their experimental design, and find that reporting, and hence compliance, is higher with the endogenous audit mechanisms.…”

“…Our model is similar to that ofGilpatric et al (2011) although they do not model the output choice. Other differences are that in their model audits are imperfect and the penalty function is linear.…”

Abatement, Care, and Compliance by Firms in Financial Distress

“…Nevertheless, such increased scrutiny is likely to be welfare-enhancing. A substantial literature on regulatory and tax compliance has addressed how compliance may be improved by employing an endogenous auditing process that accounts for past behavior or contemporaneous signals (see, for example, Harrington 1988;Harford 1991;Livernois and McKenna 1999;Alm and McKee 2004;Bayer and Cowell 2009;Gilpatric et al 2011;Oestreich 2014;Cason et al 2014). For example, in an endogenous mechanism the likelihood of audit may increase if a firm has past violations or if its current reported tax liability or reported emissions are low relative to some benchmark or peer group.…”

Experimental tests of water quality trading markets

“…Using the same set of control variables, we also examine the variance of efficiency and present this as Model 2 in Table 3. Similar to Gilpatric et al (2011), we calculate the variance of efficiency for group ݅ in period ‫ݐ‬ as ‫ݕ݂݂ܿ݊݁݅ܿ݅ܧ(‬ ௧ − ‫݂݂ܧ‬ଓܿଓ݁݊ܿ‫ݕ‬ തതതതതതതതതതതതതതത ௧ ) ଶ , where ‫݂݂ܧ‬ଓܿଓ݁݊ܿ‫ݕ‬ തതതതതതതതതതതതതതത ௧ is the treatment-specific mean efficiency in period ‫.ݐ‬ This measure thus captures the within-period variation across groups (i.e.…”