Dynamic Incentive Contracts in Multiple Penalty Systems with No-commitment to Tenure-track Auditing

Abstract

This paper generalizes Khalil's (1997) static model to a multiperiod one in the tenure-track auditing. Three penalty systems considered are full-transfer-dependent, partial-transfer-dependent, and transfer-independent ones. It is found that the equilibrium under the tenure-track auditing is also an equilibrium under the periodic auditing. The conditions under which the principal prefers the periodic auditing, or is indifferent between the two auditing schemes are derived. Incentive contracts may vary in different penalty systems. For instance, the equilibrium with principal’s sure ex post auditing exists only under the partial-transfer-dependent and transfer-independent penalty systems. And the equilibrium with the first-best contract as the first-period optimum appears merely under the transfer-independent penalty system.