Regulatory Performance of Audit Tournaments and Compliance Observability

This paper reports an experimental study of two stochastic audit schemes for enforcing regulatory compliance. In the Random Audit mechanism firms are randomly chosen for inspection. In the Tournament Audit mechanism the probability of inspection increases with the degree of estimated under-reporting. The experiment also varies the observability of identity, output, and compliance decisions. Optimal output is theoretically independent of the auditing schemes, but equilibrium reporting is higher under the Tournament mechanism than Random auditing. Experimental findings are consistent with the theoretical predictions for reporting, but not for output. In particular, we find that average output is lower and reporting is higher in the Tournament treatment compared to the Random Audit treatment. At the individual level, a majority of participants misreported in most periods. Social observability does not affect output or reporting significantly in either of the audit treatments.