The importance of reputation in the auditing of companies: A game theory analysis

Numerous, mainly empirical, studies of auditing behaviour have recently looked at the “reputation” of the auditor and the size of fees it attracts. Our model of the auditing market advances the study of the fundamental principles involved in determining behaviour in relation to the rewards and penalties using an extensive-form game of the auditing process. We set up a two-player fraud detection game with bribes, bonuses and fines faced by an auditor. Our model yields that the auditor’s reputation, reflected in the size of bonuses, is critical to establishing a non-fraudulent behaviour by the client. Hence the model confirms expected behaviour. We further find the new insight, that while the existence of penalties deters fraud by the client, their size is not critical. This is a new understanding of what determines auditor behaviour. It is the perception of a possible penalty that moves the auditor in the direction of executing a thorough investigation using his acquired expertise

A tree formulation for signaling games

We provide a detailed presentation and complete analysis of the sender/receiver Lewis signaling game using a game theory extensive form, decision tree formulation. The analysis employs well established game theory ideas and concepts. We establish the existence of four perfect Bayesian equilibria in this game. We explain which equilibrium is the most likely to prevail. Our explanation provides an essential step for understanding the formation of a language convention. Further, we discuss the informational content of such signals and calibrate a more detailed definition of a true (“correct”) signal in terms of the payoffs of the sender and the receiver

Independent review of ESO regulatory and incentives framework

The ESO will be legally separated from the National Grid Plc in April 2019. This change in governance is necessary to reflect the fast changes in the environment of the SO including smaller scale generation, intermittent sources of supply, distributed generation, demand side response, storage as well as increases in demand resulting from electric vehicles and electrification in transport. The ESO should balance the transmission system in the most cost efficient way, by removing information asymmetries, promoting competition through encouraging participation of existing and new participants into the market in a transparent way. To ensure that this happens the ESO needs to operate without any conflict of interests in terms of transmission assets infrastructure. Ofgem has decided that this legal separation necessitates that the ESO will get its own specific licence. This decision is correct. Depending on the experience of the success of the ESO to achieve the roles listed above following this separation, it may be needed to further this into an ownership separation

Charter Review price setting models - a rail and road comparison study

This report, by Dr Xeni Dassiou, looks at how the Office of Rail and Road applies price setting for Network Rail and Highways England, and how lessons from these models could be applied to advising Government on the level of licence fee

Greece in Economic Crisis: The Case of Health and Education

In 2010 the Greek economy entered a deep economic crisis. This was the result of an accumulation of structural problems in the economy, including overspending and loss of competitiveness during the previous decades, translating into persistently large budget and trade deficits. In 2015, under its third EU and IMF bailout, Greece has entered a spiral of depression that has led to its economy shrinking by one-third and unemployment skyrocketing to more than 25 percent, both a result of the austerity measures introduced as required to receive bailout funding. As a consequence, the health and education sectors have each experienced a reduction in public spending of more than one-third. We look at these two sectors before the crisis in the early 2000s, finding that a combination of delays, lack of enforcement, and reversals of urgently needed reforms resulted in obvious weaknesses not being corrected. This has prevented these two systems from delivering the social principles of equity in provision, equal opportunities for all, universal coverage, accessibility, and affordability. Healthcare and education both lack oversight and evaluation mechanisms to ensure quality of service for its users. Additionally, there are no cost containment/efficiency mechanisms on the procurement side to avoid wasting taxpayers’ money and valuable resources. This means that Greece has high cost/low outcome education and health systems. When the economic crisis struck, the ability of these two systems to deliver the above mentioned social objectives further deteriorated, as lower per capita spending on education, health and social protection lowered entitlements, benefits, and outcomes while increasing the burden of out of pocket expenses, user charges etc. We conclude by arguing that there is a need for a radical change in the institutional framework and governance of these two systems, by establishing truly independent regulators or agencies, answerable only to parliament) that can effectively exercise oversight over both the quality and the cost in the provision of health and education

A Tree Formulation for Signaling Games with Noise

The paper provides an analysis of a sender-receiver sequential signaling game. The private information of the sender is transmitted with noise by a Machine, i.e. does not always correctly reflect the state of nature. Hence, a truthful revelation by the sender of his information does not necessarily imply that the signal he sends is correct. Also, the receiver can take a correct action even if the sender transmits an incorrect signal. The payoffs of the two players depend on their combined actions. Perfect Bayesian Equilibria which can result from different degrees of noise are analysed. The Bayesian updating of probabilities is explained. The fixed point theorem which makes the connection with the idea of rational expectations in economics is calculated. Given a number of equilibria, we comment on the most credible one on the basis of the implied payoffs for both players. The equilibrium signals are an example of the formation of a language convention discussed by D. Lewis

Optimal decisions in two-stage bundling

We develop a generalised framework for pure bundling where buyer tastes for two goods are assumed to follow a normal distribution. In the literature optimal bundling decisions have been considered under the assumption that the weights of the two goods are Öxed and equal. The only consideration is then to choose the proÖt maximising optimal price. Our approach is di§erent and much more realistic. The monopolist Örst decides on the optimal weights of the two goods and in the second stage derives the proÖt maximising bundle price. Welfare and policy implications of our approach are derived and comparisons are made with those of the Öxed weights approach

Market Structure and Exchange Rate Exposure: The Case of Consumable Goods

We examine the impact of exchange rates on profits and prices in differentiated consumable goods markets. We model the exchange rate exposure of exporting firms operating within a Bertrand or a Cournot setting where between and within competition co-exist. We show that market structure and these two forces determine pass through and exposure. Empirical tests of real and bilateral exchange rate exposure using stock price and profit data confirm a link between the ability of a firm to pass on the exchange rate changes to its customers and the magnitude of the exposure on their rivals

Trade and Linked Exchange; Price Discrimination Through Transaction Bundling

In this paper we try to explain how price discrimination can cause bilateral trade patterns of the type seen under countertrade agreements. We interpret countertrade as a form of transaction bundling which can discriminate between potential trading partners and we combine characteristics from both explanations as to the existence of countertrade. There is both price discrimination through transaction bundling, and informational asymmetry in the form of uncertainty in the quality of the goods produced by trading partners in less developed countries (LDCs) leading to a partner preference from the side of the Western (DC) firm. Our paper shows that although the ability of firms in LDCs to overcome their creditworthiness constraints by engaging in countertrade arrangements may be restricted by this quality uncertainty as it reduces the willingness of a firm in a DC to exchange, the trade volume prospects of a firm in a LDC can be considerably enhanced if a countertrade transaction does occur. Our paper goes beyond the case of linked exchange, which is only one of the three cases of transaction bundling examined. The other two cases are that of the Western firm being a monopoly selling a bundle of two goods used as a benchmark case, and the more interesting case of the Western firm being the buyer of two goods and setting both two separate buying prices and a bundling (i.e. package) purchase price. Many procurement decisions are not simply a matter of price, but also the identity and reputation of the supplier matters, especially when the supplier is located in an LDC. We show than when bundling its purchases, the Western firm buyer will be willing to offer a bundled price greater than the sum of the two separate prices, as the option of a bundled purchase would increase its pro…ts even if there are no complementarities between the goods bundled. In our model the argument is that just as it is profitable for a monopolist to offer mixed bundling at a bundled price which is lower than the sum of the individual prices (hence exploiting the average willingness to pay), it is also profitable for a monopsonist to offer a bundled purchase price which is higher that the sum of the individual prices on offer (hence exploiting the average willingness to sell). Equally interestingly, it is found that a LDC can substantially increase its sales of a good with a high degree of quality uncertainty by being offered to bundle it with the sale of a more basic good with a low degree of quality uncertainty