but who will monitor the monitor suppose that providing incentives for a group of individuals in a strategic context requires a monitor to detect their deviations what about the monitor s deviations to address this question i propose a contract that makes the monitor responsible for monitoring and thereby provides incentives even when the monitor s observations are not only private but costly too i also characterize exactly when such a contract can provide monitors with the right incentives to perform in doing so i emphasize virtual enforcement and suggest its implications for the theory of repeated games jel c78 d23 d82 d86

optimality of the friedman rule in an overlapping generations model with spatial separation recent models with spatial separation and limited communication suggest that the friedman rule may not be optimal this is important in light of the disparity between theory and practice concerning optimal monetary policy we take a close look at these models and show that intergenerational transfers are key to the suboptimality of the friedman rule the friedman rule is a necessary condition for achieving the efficient allocation in equilibrium we also show that the friedman rule is chosen whenever agents can implement mutually beneficial arrangements

capital budgeting and delegation abstract as part of our ongoing research into capital budgeting processes as responses to decentralized information and incentive problems we focus in this paper on when a level of a managerial hierarchy will delegate the allocation of capital across projects and time to the level below it in our model delegation is a way to save on costly investigation of proposed projects therefore it is more extensive the larger are the costs of such investigations this delegation takes advantage of the fact that the lower level manager s preferences are assumed to be similar though not identical to those of the higher level

strategic pricing signalling and costly information acquisition abstract consider a market where an informed monopolist sets the price for a good or asset with a value unknown to potential buyers upon observing the price buyers may pay some cost for information about the value before deciding on purchases under a belief restriction which generalizes the idea of the cho kreps intuitive criterion we establish a version of the grossman stiglitz paradox there is no separating equilibrium with fully revealing prices yet we also resolve the paradox there is a unique equilibrium and as the cost of information becomes small the equilibrium approaches the full information outcome and prices become perfectly revealing

delegation of monitoring in a principal agent relationship this paper studies a principal agent relationship with moral hazard in which the principal or the supervisor can monitor the agent s hidden action by using identical monitoring technologies the paper shows that delegation of monitoring to the supervisor is profitable because of two effects with delegation the principal can better regulate the incentives incentive effect and can commit to wage structures to which she could not commit without delegation commitment effect as a logical step collusion is introduced and it is shown that even with the possibility of collusion delegation is an optimal strategy

optimal environmental taxation and enforcement policy abstract we study the optimal environmental taxation and enforcement policy when i the regulator does not know the firms abatement costs ii penalties for tax evasion are limited and iii monitoring of pollution is costly we show that the threat of being audited alter the usual firms incentives to over estimate their abatement costs in particular depending on the firms abatement costs the optimal policy may involve over or under deterrence compared to the full information outcome we then investigate the properties of a pollution standard we show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered

how good are standard debt contracts stochastic versus nonstochastic monitoring in a costly state verification environment the authors investigate ex ante efficient contracts in an environment in which implementation is costless in this environment standard debt contracts will typically not be optimal optimal contracts may involve defaults even in states in which the borrower is fully able to repay the authors then examine the welfare costs of arbitrarily restricting the set of feasible contracts to standard debt contracts when model parameters are calibrated to realistic values the welfare loss from exogenously imposing this restriction is extremely small thus if implementation costs are actually nontrivial as seems likely standard debt contracts will be very close to optimal copyright 1994 by university of chicago press

the friedman rule in an overlapping generations model with nonlinear taxation and income misreporting this paper models a two period overlapping generations economy with money populated with individuals of different skills they face a nonlinear income tax schedule and can engage in tax evasion money serves two purposes the traditional one modeled through a money in the utility function it also facilitates tax evasion the main message of the paper is that income tax evasion in this framework leads to the violation of the friedman rule the paper also shows that even in the absence of tax evasion when optimality requires differential commodity taxation complementarity of real cash balances and labor supply does not guarantee the optimality of the friedman rule as a boundary solution an additional assumption is required

taxation with costly administration the concept of a tax technology is used here as providing a unified framework for analyzing both administrative activity by tax authorities and tax resisting activity by taxpayers this framework provides a simple formalization of adam smith s four components of tax costs administration substitution active noncompliance and passive compliance the model is used to derive policy implications concerning the proper measurement of the cost of public funds and concerning the criterion for optimal administration

exploring the scope of neurometrically informed mechanism design a basic goal in mechanism design is to construct mechanisms that simultaneously satisfy efficiency voluntary participation and dominant strategy incentive compatibility previous work has shown that this is impossible unless the agents and planner have sufficient information about each other and common knowledge these results have remained largely theoretical because the required information is generally not available in practical applications however recent work has shown that these limitations can be overcome in simple settings using neurometric technologies that provide noisy signals of subjects preferences that can be used in the mechanism design problem here we build on this work by carrying out two new experiments designed to test the extent to which these neurometrically informed mechanisms nims can be applied to more complicated and realistic environments we find robustness to large type and action space and to the degrees of loss and risk aversion observed in most of our sample

optimal allocation with costly verification consider a principal with a good to allocate among a number of agents each of whom wants the good each agent i knows the value the principal receives if he gives the good to i but the principal does not this value need not coincide with the value to i of getting the good the principal can verify the agents private information at a cost but cannot use transfers there are a number of economic environments of interest that roughly correspond to this scenario we discuss a few below how does the principal maximize the expected gain from allocating the good less the costs of verification we characterize optimal mechanisms for such settings we construct an optimal mechanism with a particularly simple structure which we call a favored agent mechanism there is a threshold value and a favored agent say i if each agent other than i reports a value for the good below the threshold then the good goes to the favored agent and no verification is required if some agent other than i reports a value above the threshold then the agent who reports the highest value is checked this agent receives the good if and only if his claims are verified and the good goes to any other agent otherwise in addition we show that every optimal mechanism is essentially a randomization over optimal favored agent mechanisms in this sense we can characterize the

tax evasion and the optimum general income tax abstract this paper incorporates tax evasion into an optimum general income tax problem with endogenous labor supply it posits a two group model with high and low wage individuals to investigate the properties of optimal audit and tax structures the following main results are obtained first high wage persons are never audited while low wage persons are audited with a probability strictly less than one secondly high wage persons should face a zero marginal tax rate thirdly low wage individuals who have been audited and found innocent should pay a lower tax than those who are not audited fourthly there are two possible tax regimes low wage persons face a positive marginal tax rate under one regime and a zero rate under the other fifthly even if honesty cannot be rewarded the other results of the paper continue to hold

hierarchical design and enforcement of income tax policies abstract a hierarchical model of tax compliance is studied in which the government selects a tax policy and then delegates the responsibility to collect taxes to the irs there is a fixed distribution of income in the economy individuals differ by their income which is known niether to the government nor to the irs we completely characterize the solution to the irs s revenue maximizing problem when taxpayers are risk neutral the optimal auditing policy divides the reported incomes into at most three groups we show that the government provides a smaller budget to the irs than the irs would wish

certification and market transparency we provide elementary insights into the effectiveness of certification to increase market transparency in a market with opaque product quality sellers use certification as a signaling device while buyers use it as an inspection device this difference alone implies that seller certification yields more transparency and higher social welfare under buyer certification profit maximizing certifiers further limit transparency but because seller certification yields larger profits active regulation concerning the mode of certification is not needed these findings are robust and widely applicable to for instance patents automotive parts and financial products

monopoly with incomplete information recent theoretical research on principal agent relationships has emphasized incentive problems that arise when the parties involved are constrained by either asymmetric information or their inability to monitor each other s actions here we concentrate on the former constraint and consider the case of a single principal the monopolist the main contribution is to show that under a separability assumption strong conclusions can be drawn about the nature of optimal incentive schemes although the primary focus is on optimal quantity discounts in a monopolized market the results also shed light on related topics such as optimal income taxation and commodity bundling

evading auditing and taxing the equity compliance tradeoff tax evasion and auditing are analyzed in a model of linear income taxation taxpayers minimize expected tax payments including penalty for underreporting while the tax administration sets its audit policy to maximize expected net revenue under the restriction of only two audit rates per class of taxpayers given the reaction of taxpayers and tax administration we derive the optimal income tax that the government should adopt to maximize social welfare there are several classes of taxpayers each characterized by a given distribution of pretax income and specific audit policy parameters

guilty until proven innocent regulation with costly and limited enforcement abstract we consider optimal regulations for a polluting firm when regulators cannot observe emission control costs and can only observe emissions via costly monitoring fines or subsidies for enforcing compliance are also limited the optimal regulations resemble a deposit refund system the firm reports its emissions and pays an initial tax based on this report if the firm is monitored it receives a rebate when actual and reported emissions coincide the enforcement constraints and the firm s rights determine whether the incentives to reduce emissions are optimally provided by varying the rebate for compliance the monitoring probability or the initial tax

income distribution and equilibrium multiplicity in a stigma based model of tax evasion abstract this paper incorporates continuous income distribution into the stigma based model of tax compliance the paper investigates the effect of income distribution on the existence of multiple equilibria and characterizes the conditions under which multiple equilibria emerge precisely multiple equilibria exist if taxpayer incomes are sufficiently homogeneous because the social coordination effect dominates the individual characteristics effect numerical simulations show that the main proposition is robust to allowing two step audit policies on the part of the tax agency under the presumption that the best or good equilibrium is selected whenever there are multiple equilibria as a byproduct the effect of various forms of tax reforms on the optimal two step audit policy the equilibrium compliance and fiscal revenue is analyzed

pareto efficient income taxation under costly monitoring abstract this paper studies the problem of pareto efficient fiscal policies when labour supply is elastic and the government has no a priori information on income earned the model is a two class economy with an official and an unofficial labour market official income is taxed non linearly while unofficial income is only observable after a costly audit upon which it is taxed at an exogenous penalty rate after characterisation of the pareto efficient audit and tax policies it is verified how these policies react to a higher government revenue requirement an increase in the penalty rate a stronger ambition to redistribute in the two last scenarios the effect on the marginal tax and the audit rate is shown to decompose into a government revenue effect and a substitution effect a numerical example shows that the substitution effects are of minor importance suggesting that first intuition about the best way for a government to cope with increased evasion opportunities substituting auditing effort for high marginal tax rates sketches only part of the picture

optimal auditing with heterogeneous income sources the optimal enforcement policy when households are heterogeneous with respect to both income level and to income source leads to more intense income auditing for easy to monitor sources we obtain the common result that within each income source any taxpayer reporting less than a predetermined cut off level will be audited while taxpayers reporting at least this level will never be audited however this audit policy leads to very different reporting behavior depending on the income source the internal revenue service does not audit only honest taxpayers and an increase in the audit budget may lead to a larger segment of full evaders

pretrial bargaining and the design of fee shifting rules legal rules for allocating the private costs of civil litigation or fee shifting rules provide powerful incentives for settlement within the context of a direct revelation mechanism the fee shifting rule that generates the highest probability of settlement bases the allocation of costs upon the proximity of the court s award to the pretrial announcements this mechanism resembles rule 68 of the federal rules of civil procedure and other offer based rules in a simple extensive form game if the litigants have asymmetric information about the level of damages probability of prevailing then rule 68 increases decreases the settlement rate

corruption in tax administration abstract we extend the game theoretic model of graetz reinganum and wilde 1986 to allow for corruption in tax administration in the presence of corruption audit rates are generally higher than in its absence in fact in the presence of corruption it is possible to sustain equilibria in which all returns are audited moreover when some auditors accept bribes it is possible for increases in the fine rate or the tax rate to reduce expected government revenue

efficient committed budget for implementing target audit probability for many inspectees strategic models of auditor inspectee interaction have neglected implementation details in multiple inspectee settings with multiple inspectees the target audit probability derived from the standard analysis can be implemented with sampling plans differing in the budgets committed to support them overly committed audit budgets tie up unneeded resources that could have been allocated for better uses this paper studies the minimum committed budget required to implement a target audit probability when i the audit sample can be contingent on red flags due to signals of inspectees private information e g from self reporting and ii the number of inspectees is large it proposes an audit rule called bounded simple random sampling srs which is shown to require no more committed budget to support than two other rules naturally generalized from the one to one analysis when the number of inspectees is large enough bounded srs is nearly as good as any efficient audit rule which demands the lowest committed budget necessary to implement the target audit probability the results offer insights on how audit sampling plans may be formulated to reduce inefficiency and what budget usage ratios should be expected accordingly

the endogenous transaction costs of delegated auditing abstract this paper analyzes the deadweight loss of delegated auditing in a three tier hierarchy in a costly state verification model this cost depends on the endogenous information structure the auditor s degree of risk aversion and the size of the punishment we identify the optimal contractual outcome of this delegation model with the solution obtained in a standard three tier hierarchical model of collusive auditor we then derive from this identification the set of parameters of the physical environment which may affect the efficiency of side contracting within the firm

a contest with the taxman the impact of tax rates on tax evasion and wastefully invested resources abstract we develop a moral hazard model with auditing where both the principal and the agent can influence the probability that the true state of nature is verified this setting is widely applicable for situations where fraudulent reporting with costly state verification takes place however we use the framework to investigate tax evasion we model tax evasion as a concealment detection contest between the taxpayer and the authority we show that higher tax rates cause more evasion and increase the resources wasted in the contest additionally we find conditions under which a government should enforce incentive compatible auditing in order to reduce wasted resources

self regulation and government oversight self regulation is a feature of a number of professions for example in the u s the government delegates aspects of financial market regulation to self regulatory organizations sros like the new york stock exchange and the national association of securities dealers we analyse one regulatory task of an sro enforcing antifraud rules so agents will not cheat customers specifically we model contracting enforcement as a two tier problem an sro chooses its enforcement policy the likelihood that an agent is investigated for fraud and a penalty schedule given an enforcement policy agents compete by offering contracts that maximize customers expected utility we assume that the sro s objective is to maximize the welfare of its members the agents we show that the sro chooses a more lax enforcement policy meaning less frequent investigations than what customers would choose a general conclusion is that control of the enforcement policy governing contracts confers substantial market power to a group of otherwise competitive agents we also investigate government oversight of the self regulatory process the threat of government enforcement leads to more enforcement by the sro just enough to pre empt any government enforcement copyright 2005 wiley blackwell

regulation asymmetric information and auditing this article analyzes a model of a regulated firm that is better informed about its cost function than is the regulator by auditing at a cost however the regulator is assumed to be able to observe the realized cost of the firm if the regulator finds that the firm had misrepresented its costs at the time at which prices were set he can order a refund to consumers in the optimal policy the regulator audits when the firm reports for pricing purposes that its costs will be high and orders a refund when the auditfinds that realized costs are lower than anticipated given the original report a separation result that obtains for an important case indicates that the initial pricing decision is independent of the auditing decision the auditing decision however depends on the price that was initially set the optimal auditing strategy is characterized and the nature of the welfare gains are identified the methodology used in the analysis involves the characterization of an equilibrium of a revelation game with an ex post observable

optimal allocation with ex post verification and limited penalties several agents with privately known social values compete for a prize the prize is allocated based on the claims of the agents and the winner is subject to a limited penalty if he makes a false claim if the number of agents is large the optimal mechanism places all agents above a threshold onto a shortlist along with a fraction of agents below the threshold and then allocates the prize to a random agent on the shortlist when the number of agents is small the optimal mechanism allocates the prize to the agent who makes the highest claim but restricts the range of claims above and below

optimal taxation with costly enforcement and evasion abstract this paper analyzes the relationship between optimal taxation and optimal tax enforcement a central question concerns the extent to which revenue should be raised through higher tax rates which distort behavior or greater enforcement which distorts behavior and also entails direct resource costs in the models examined some expenditure on enforcement may be optimal despite its resource cost its distortionary effect and the availability of other revenue sources having no enforcement costs rules for optimal tax rates and enforcement expenditures are derived which also indicate the marginal cost of government funds and optimal enforcement priorities for a tax collection agency

managers compensation and misreporting a costly state verification approach i introduction the use of stock options in compensation packages as a way of providing the firm management with the right incentives has been quite popular in the 1990s the favor encountered by options started however to decrease in the past few years the decline in the use of option grants in top executives compensation packages occurred mainly as a reaction to the recent accounting scandals which has prompted the design of alternative stock based compensation schemes e g restricted stock grants or indexed options as reported by hall and murphy 2003 the grant date value of options assigned to all employees of an average standard poor s 500 firm measured in millions of 2002 constant us increased from 22 in 1992 to 238 in 2000 and subsequently decreased to 141 in 2002 although percentages varied from year to year the ceos share of the total grant has fallen from about 7 in the mid 1990s to less than 5 in 2000 2002 1 the decline in the use of options for top management is widely confirmed according to a pearl meyer partners study for the new york times stock option grants that accounted for 52 of the pay of the average ceo of a major company in 2002 were down to an estimated 35 in 2003 a recent watson wyatt report states that the value of new stock option awards granted to ceos at large companies fell by nearly 60 between 2001 and 2003 with the average value of new stock option grants declining from us 10 2 million in 2001 to us 4 2 million in 2003 the decline in options has been softened by the sharp increase in restricted stock grants and other long term incentive award values 2 in this paper we aim to reevaluate the role of stock options as an ingredient of top management compensation packages able to align the interests of managers and shareholders avoiding misreporting of the firm value at the same time 3 in a costly state verification csv model with moral hazard we show that incentive compatible contracts inducing both incentive alignment and truthful revelation of the firm value must entail a strictly convex compensation schedule that is a fixed payment wage when the firm value is sufficiently low and a state contingent claim increasing in the firm value otherwise a simple and commonly observed way to achieve a convex compensation scheme is to design a remuneration including a fixed wage and a call option on the firm equity as we will show such remuneration allows on the one hand to preserve top management incentives providing for a compensation increasing in equity value and on the other hand to reduce the verification costs that must be incurred to avoid misreporting as verification is not needed in the region where the remuneration is fixed 4 options are by no means the only way to achieve a convex compensation however many other schemes having otherwise desirable properties over options do not have the convex shape discussed above for instance combining a fixed wage with restricted stock grants defines a compensation linearly increasing in the firm s equity value which does not allow to reduce misreporting verification costs that always have to be sustained in this case using an incentive compatible compensation scheme fixed wage plus call options we characterize the contract offered by the firm under the assumption of a deterministic and perfect audit technology showing that for any given value of the option package the manager should receive the largest possible number of options at the highest strike price allowing shareholders to reduce the expected verification cost furthermore the strike price of the option turns out to be determined by incentive compatibility i e the option value must be such that the manager is induced to exert the desired level of effort while the magnitude of the fixed wage is defined by individual rationality there are three main policy implications of our analysis

does organic command a premium when the food is already local the emergence of community supported agriculture csa farms has been recognized as a new way for small farms to remain competitive while engaging in their local community through direct marketing in this study we report on first revealed preference valuation of csa attributes using data on share prices and csa characteristics for the summer 2012 growing season using data covering 453 csa farms in michigan new york ohio and pennsylvania we develop a hedonic model based on firm level prices to reveal consumer valuations of csa attributes including various types of organic certification we also test for competition in the csa market using a model of firm entry to evaluate whether firms appear perfectly competitive which is a requirement when using firm level prices in our hedonic analysis our results reveal a price premium of approximately 7 for usda organic certification although this value is heterogeneous across states we find no premium associated with competing certified naturally grown programs finally we find that csa farms exhibit little market power and appear to act competitively even with few market entrants

income tax compliance in a principal agent framework previous analyses have modeled income tax evasion as a portfolio problem deriving the optimal consumption of the risky asset unreported income under the assumption of a fixed probability of detection the purpose of this paper is to examine some of these issues in tax compliance starting from a different set of assumptions in particular we compare alternative audit policies to the standard random audit policy we focus on an audit cutoff policy in which an agent triggers an audit if his or her reported income is too low and is not audited if reported income is sufficiently high this paper establishes two major results first random audit rules are weakly dominated by audit cutoff rules it can be shown given lump sum taxes and fines that these audit cutoff rules are the least cost policies which induce truthful reporting of income second the dominance of audit cutoff rules over random audit rules holds for lump sum as well as proportional taxation in fact the equilibrium consequences of the two are equivalent

disease forecasts and livestock health disclosure a shepherd s dilemma we analyze how to induce sellers to disclose food safety with repeated interactions and safety correlated over time cash transfers alone do not ensure disclosure perfect but costly testing ensures disclosure with a complex lottery that may be difficult to implement in practice in contrast even a noisy quality forecast allows the buyer to induce perfect disclosure with a simple pricing scheme forecast introduction may benefit or harm sellers after introduction sellers may suffer from increases in forecast precision as an illustration we cast our model in the context of rift valley fever in an east african livestock market copyright 2010 oxford university press

using cost observation to regulate firms the paper emphasizes the use of accounting data in regulatory or procurement contracts when the supplier 1 has superior information about the cost of the project and 2 invests in cost reduction the main result states that under risk neutrality the supplier announces an expected cost and is given an incentive contract linear in cost overruns this optimal contract moves toward a fixed price contract as the announced cost decreases an investment choice is then introduced and the use of a rate of return regulation is studied

peer discipline and incentives within groups abstract we investigate how a collusive group can sustain non nash actions by enforcing internal discipline through costly peer punishment we give a simple and tractable characterization of schemes that minimize discipline costs while preserving incentive compatibility we apply the model to a public goods contribution problem we find that if the per capita benefit from the public good is low then regardless of whether peer discipline is feasible or not only small groups will contribute to the good if the public good benefit is significant but peer discipline is infeasible it remains the case that only small groups contribute on the other hand if the public good benefit is significant but peer discipline is feasible then full contribution takes place regardless of group size we reconcile this result with olson s idea that small groups are more effective by considering the case where the per capita benefit of the public good varies with group size

tax evasion concealment and the optimal linear income tax this paper incorporates tax evasion into the analysis of optimal linear income taxation taxevaders can influence the probability of being caught if audited through expenditures on concealment it is proved that tax evasion can make a given tax system more as well as less progressive depending on the concealment technology the paper derives and interprets simple formulas for characterizing the optimal tax rate and audit probability it also gives sufficient conditions under which tax evasion lowers the optimal tax rate while showing that an increase in the optimal tax rate is also possible

partially verifiable information and mechanism design in a principal agent model with adverse selection we study the implementation of social choice functions when the agent s message space is a correspondence which depends on this true characteristic we characterize such correspondence for which the revelation principle is valid returns must not contradict easily observable elements of the taxpayer s lifestyle in this paper we present a model of two person organizations in which these considerations are important we ask whether the restrictions on fallacious statements inherent in the system are sufficient to achieve the goals of the organization we show that the optimal way of eliciting the agent s response may not be to establish incentives for truthtelling in all instances in our model there is one player the agent who observes the state of the economic system another player the principal takes an action based on the information presented to him by the agent this class of models is often referred to as the principal agent problem in the extensive and growing literature on this problem it has always been assumed that the agent could lie to the principal and therefore that he had to be properly motivated to act at least partially in the principal s interest our formal way of modelling the partial verifiability of information is to introduce the restriction that the agent s responses must lie in a set m o that varies with the true state 0 it is assumed that this set always admits the possibility of responding with the true state the way in which the allowable response set varies with the true state is known to the principal in other respects we retain the usual principal agent formalization in particular the principal is the stackelberg leader in this game he can commit himself to choose a collective action as a function of the message transmitted by the agent whether the variation of the message space with the true observation is purely technological or whether it is induced by the severity of potential actions of the principal

corruption extortion and evasion corruption evasion and the abuse of power and the possibility thereof are pervasive features of economic activity a prominent instance is tax collection this paper examines the implications of corruptibility and the potential abuse of authority for the effects and optimal design of potentially non linear tax collection schemes amongst the findings are that the distributional effects of evasion and corruption are unambiguously regressive under the kinds of schemes usual in practice and collecting progressive taxes without inducing evasion or corruption may require that inspectors be paid commission on high income reports but not on low with the cost of this potentially creating what seems to be a previously unnoticed trade off between equity and efficiency

the economics of taxpayer compliance there is now a great deal of evidence suggesting that tax evasion is fairly widespread throughout european and north american economies estimates of the so called black economy indicate that perhaps 10 per cent of economic activity in these countries has been driven underground in the attempt to evade payment of tax for a detailed survey see pyle 1989 chs 2 4

endogenous punishments in agency with verifiable ex post information the article studies an adverse selection model in which a contractible imperfect signal on the agent s type is revealed ex post the agent is wealth constrained which implies that the maximum penalty depends on the contracted transaction e g the volume of trade first we show that the qualitative effects of the signal can be unambiguously tied to the nature of the problem e g whether the agent is in a buyer or a seller position second the distortions caused by informational asymmetries may become more severe although more information is now available finally the signal can actually serve to increase the agent s informational rents

fraud deterrence in dynamic mirrleesian economies abstract insurance schemes rely on legal consequences to deter fraud and tax evasion this observation guides us to introduce random state verification in a dynamic economy with private information with some probability an agent s skill becomes known to the planner who prescribes punishments to misreporting agents deferring consumption can ease the provision of incentives creating a motive for subsidizing savings in an infinite horizon economy the constrained efficient allocation converges to high consumption full insurance and no labor distortions for any positive probability of state verification

why are bad products so hard to kill it is puzzling that firms often continue to invest in product development projects when they should know that demand will be low we argue that bad products are hard to kill because firms face an inherent conflict when designing managers incentives rewarding success encourages managers to forge ahead even when demand is low to avoid investing in low demand products the firm must also reward decisions to kill products however rewarding managers for killing products effectively undermines the rewards for success the inability to resolve this tension forces the firm to choose between paying an even larger bonus for success and accepting continued investment in low demand products we explore the boundaries of this argument by analyzing how the timing of demand information affects product investment decisions

self reporting investigation and evidentiary standards abstractself reporting schemes have become a substantial part of law enforcement this paper analyzes the optimal use of such schemes when the authority cannot commit to an ex post investigation effort i show that this leads to a negative relationship between self reporting incentives and investigation effort three main conclusions arise first violators self report with a probability of 1 if and only if full amnesty is offered second self reporting schemes are not efficient when the level of harm of the act is high finally authorities can increase the incentives to self report when they convict without hard evidence however a hard evidence standard provides more deterrence and is weakly welfare superior

auditing claims in the insurance market with fraud the credibility issue abstract this paper characterizes the equilibrium of an insurance market where opportunist policyholders may file fraudulent claims we assume that insurance policies are traded in a competitive market where insurers cannot distinguish honest policyholders from opportunists the insurer policyholder relationship is modelled as an incomplete information game in which the insurer decides to audit or not the market equilibrium depends on whether insurers can credibly commit or not to their audit strategies we show that a no commitment equilibrium results in a welfare loss for honest individuals which may even be so large that the insurance market completely shuts down we also show that transferring monitoring costs to a budget balanced common agency would mitigate the commitment problem

the desirability of a permanent tax amnesty abstract there are two main concerns about tax amnesty first if it is anticipated it may increase cheating and reduce the efficiency of the tax system second amnesty may be inequitable by letting cheaters off the hook however several federal governments currently hold a policy of long term or permanent tax amnesty in apparent defiance of these concerns this paper examines fully anticipated tax amnesty and finds that it is possible for a permanent tax amnesty to actually increase rather than decrease the efficiency and equity of the tax system

tax evasion and optimal commodity taxation abstract this paper incorporates tax evasion into ramsey s optimal taxation problem it provides i a precise and intuitive characterization of the tradeoff between optimal tax rates and audit probabilities and ii a modified version of the ramsey equation it also proves that in the presence of tax evasion a the well known requirement of proportional reduction in compensated demands b the traditional result on the optimality of uniform taxation when income is exogenous and c the equivalence of wage and uniform commodity taxes are no longer valid

stochastic monitoring and moral hazard the phenomenon of monitoring subordinates actions and local environments so commonly observed in large firms is an attempt to alleviate the moral hazard problem induced by central managers principals being unable to costlessly observe subordinates agents actions and the state of their environment these monitoring activities take many forms and are generally performed in a stochastic manner for example supervisors make surprise checks on workers and investigations are often triggered by standard cost variance reports the information gathered from monitoring activities is used to penalize or reward subordinates agents thus altering their incentives and behavior it is intuitively clear that the monitoring policy that will be employed depends upon the contract to be enforced in a sense every type of contract has both benefits and associated monitoring costs the purpose of this paper is to study the simultaneous optimal choice of contracts and stochastic monitoring policies in a single period principal agent paradigm townsend 1979 first studied monitoring or verification in the context of a simple trading economy where the endowments of consumers were stochastic and known only to themselves however in townsend s analysis verification policies were constrained to be deterministic that is states were verified with probability one or not at all with deterministic verification townsend found that in the nondegenerate case unfavorable outcomes were verified and more favorable outcomes were

the capital budgeting process incentives and information we study the capital allocation process within firms observed budgeting processes are explained as a response to decentralized information and incentive problems it is shown that these imperfections can result in underinvestment when capital productivity is high and overinvestment when it is low we also investigate how the budgeting process may be expected to vary with firm or division characteristics such as investment opportunities and the technology for information transfer there is general agreement that investment decisions are the most important decisions made by corporations the choice of projects and the level of investment is critical not just for stakeholders of the firm but also for the economic well being of society as a whole it has been alleged that u s firms invest too little and tend to overemphasize short term results for example porter 1992 citing poterba and summers 1992 asserts that u s firms use hurdle rates to evaluate investment projects that are higher than their estimated costs of capital to understand the investment behavior of firms one must consider both the process by which external capital is made available to firms and the process by which internally and externally raised capital is allocated to investment projects within the firm considerable attention has been paid to how firms raise external capital the fundamental insight in this area is the celebrated result of modigliani and miller mm that capital structure is irrelevant in the absence of capital market frictions accordingly in the three decades since their contribution research on how external capital is raised has focused on market frictions including information and incentive problems relatively little research has focused on the internal allocation process and its relationship to the organization of the firm modern finance theory prescribes allocating capital according to the net present value npv rule just as the mm result itself provides no theory of the arrangements under which

the excess burden of tax evasion an experimental detection concealment contest abstract tax evasion may cause social welfare losses due to the incentives of taxpayers to invest in the concealment and of tax authorities to invest in the detection of tax evasion reducing the investment of both parties at the same time would then lead to a pareto improvement given that concealment and detection costs are hardly measurable in reality we show in a controlled laboratory experiment that the welfare losses from a concealment detection contest depend positively on the prevailing tax rate but not on the penalty which is imposed in case of detected tax evasion hence policy makers who are concerned about socially inefficient concealment and enforcement costs should focus on tax rates rather than penalty rates

samurai accountant a theory of auditing and plunder a risk neutral principal wishes to exact a payment from a risk neutral agent whose wealth he does not know but may verify through a costly auditing procedure we characterize efficient schemes for the principal when he is allowed to choose schedules for preaudit and postaudit payments and audit probabilities subject to the constraint that only monetary incentives can be used and that the principal may never make a net payment to the agent the main results are that efficient schemes involve preaudit payments which are increasing in the agent s wealth audit probabilities are decreasing in the agent s wealth and also satisfy certain constraints as equalities in general such schemes involve stochastic auditing and rebates after an audit in this paper we analyse the problem of a principal extracting wealth from an agent who is reluctant to part with it and is also better informed than the principal as to the amount he owns we assume that the principal has a costly means of discovering the agent s

tax enforcement problems we study an income tax enforcement problem using a principal agent model where the government sets the tax and inspection functions these are announced to the agents and there is no commitment problem the penalty function for dishonest taxpayers is given exogenously and satisfies certain social norms we prove that for a large family of penalty functions this policy is such that honesty implies regressiveness this result does not depend on the fact that agents know the true probability of inspection

stochastic costly state verification and dynamic contracts abstract i consider a dynamic costly state verification environment in which a risk averse agent enters into a contract with a risk neutral principal the agent has random income which is unknown to the principal but can be verified at a cost the principal can commit to executing random verifications i extend the standard recursive methods to study the problem and show that it is optimal to set verification probabilities strictly less than 1 if the agent s absolute risk aversion declines sufficiently slowly the principal will use verification regardless of its cost if the agent s income is verified then he would get consumption and continuation utility strictly higher than if his income were not verified

delegation as commitment the case of income tax audits in this article we study the value of delegating authority over income tax audit policy arising from the incompleteness of contracts consider a utilitarian government whose ability to commit is limited to aggregate dimensions of its audit policy as publicly verifiable information about detailed allocations of audit budgets is not available we show that the welfare level associated with the full commitment solution can be attained by delegating authority over audit policy to a manager the latter is offered a simple incentive scheme based only on the aggregate variables which are publicly observable in contrast if the government retains authority direct commitment to these same variables does not allow the full commitment welfare level to be achieved thus despite sharing a common informational basis delegation may perform better than centralized arrangements in the presence of incomplete contracts