Auditing, disclosure, and verification in decentralized decision problems

Abstract

We study the relative performance of disclosure and auditing in decentralized institutions. We consider the information transmission problem between two decision makers who take actions in sequence at two decision dates. The first decision maker has private information about a state of nature that is relevant for both decisions, and sends a message to the second. The second decision maker can commit to only observe the message (disclosure), or can retain the option to observe the action of the first decision maker (auditing) or, at some cost, to verify the state. In equilibrium, state verification will never occur and the second decision maker effectively chooses between auditing and disclosure.When the misalignment in preferences reflects an agency bias – a bias in a decision maker's own action relative to that of the other – then the second decision maker chooses to audit in equilibrium. When the misalignment in preferences reflects an ideological bias – one decision maker prefers all actions to be biased relative to the other decision maker – then, for a large enough misalignment, the second decision maker chooses disclosure in equilibrium. Our results indicate that the ability to commit to forego the audit has value in the latter case.