Conducting Inaccurate Audits to Commit to the Audit Policy

Using a principal-agent model, we study the structure of an optimal audit policy when it is not contractible. In our model, auditing technologies are distinguished according to the accuracy and the frequency of audits. Our analysis reveals that audits take place with the highest frequency, but the accuracy of audits is compromised in equilibrium. We also find that without commitment to the audit policy, the first-best outcome cannot be achieved even when auditing is costless.