Bounding the bene®ts of stochastic auditing: The case of risk-neutral agents

In the context of a costly-state-veri®cation model with a riskneutral agent having limited liability, it has been postulated that allowing stochastic auditing reduces the asymmetric information problem to a trivial one: i.e., the ®rst best can be approached arbitrarily closely with feasible contracts. This paper proves the postulate to be false: the surplus from feasible contracts is bounded strictly below the ®rst-best surplus level. The bound is straightforward to compute in examples. The paper thus removes a justi®cation for the restriction to deterministic auditing commonly made in the literature.