Using an Augmented Revelation Mechanism to Resolve Tacit Collusion in Auditing

Abstract

This paper reexamines the problem of multiple equilibria in an audit setting. When both the manager and the auditor are subject to moral hazard and truth-telling problems, one undesirable equilibrium that may arise results in both parties exerting low effort and reporting high output, interpreted here as tacit collusion. The Ma, Moore and Turnbull (1988) augmented revelation mechanism is used to remove the undesirable equilibrium. To keep the mechanism simple, only one agent (the manager) is given an expanded message space.