The Maximum Punishment Principle and Precision of Audits under Limited Commitment - Preliminary and Incomplete Version -

For optimal audit contracts the principle of maximum deterrence applies: penalties imposed by the contract are either zero or at their maximal level. Additionally, an imperfect audit technology which reveals the agent’s type only with an error makes the principal worse off. In this paper I show that both statements are no longer true when the principal cannot commit to an audit strategy. Both intermediate penalties and imperfect audits facilitate the creation of incentives for the principal to carry out an audit. Creation Date: 2015-03-18