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Bijkerk, Suzanne H.
Karamychev, Vladimir A.
Swank, Otto H.
Year of Publication: 
Series/Report no.: 
Tinbergen Institute Discussion Paper 13-131/VII
We analyze the reporting strategies of firms and the investigation strategies of auditors in an archetype principles-based financial reporting system. To this end, we add a verification stage to a standard cheap-talk game, and apply the resulting game to financial reporting. We show that for a principles-based system to work properly, firms should bear a sufficient share of the cost of a thorough investigation. Furthermore, we find that a principles-based system is a mixed blessing. On the one hand, it leads to a plausible investigation strategy of the auditor, in which suspected reports receive most attention. On the other hand, a principles-based system only indirectly weakens firms' incentives to report aggressively.
Cheap Talk
Financial Reporting
Principles-based Regulation
Stochastic Auditing
Document Type: 
Working Paper

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