The endogenous transaction costs of delegated auditing

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. (C) 1999 Elsevier Science B.V. All rights reserved.