Sorting the Good Guys from Bad: On the Optimality of Deterministic Audit with Ex-Ante Information Acquisition

In a costly state verification model under commitment the principal may acquire a costly public and imperfectly revealing signal before or after contracting. If the project remains profitable after all signal realisations, optimally the signal is collected, if at all, after contracting, and it may be acquired randomly or deterministically. Moreover, audit is deterministic and targeted on some signal-state combinations. The paper provides a detailed characterisation of the optimal contract and performs a comparative static analysis of signal acquisition strategy and payoffs with respect to enforcement costs and informativeness of the signal. We explore robustness of the results, including commitment issues.