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Auditors Dilemma

 §1. Using game theory, Prisoners dilemma problem and its equilibrium on confession by both prisoners we can analyze the audit game. In prison problem, two prisoners are given option individually, if they confess and other party doesn’t confess, confessing one will be free from prison term. In this way, for both prisoners confessing is best strategy and both of them end up behind bars. 

§2. Similar equilibrium can be obtained for auditors( internal and other assurance provider). In the audit game, let us assume two players viz. auditor and client. Auditors calibrate amount of work and client manage auditors by incentives or money to auditors. Maximum incentive for the given work is 50Lakhs, and maximum work to be done is 500 Hours (say). (Complete lack of information about others strategy is somehow not exactly same for auditors problem)

§3. In this game, suppose, client is of knowledge or estimation that there are errors and even frauds. Client will loose its reputation, agents their compensation, given the discovery of errors and fraud if any. While, auditors will loose reputations and ultimately their audit practices given non-discovery of errors. Later discovery of frauds also impair auditors image though they are not expected to fraud audit. 

§4. Here, client will offer lower or medium incentive say 50% of maximum required. In response to such strategy, auditors will lower their work from maximum (holding ethical and other legal requirements absent), say 50% of maximum required. Also, it is beneficial for auditors to lower the required hours to lower their cost of performing audit work. Lowering audit work is dominant strategy for auditors. Hence, low/medium incentive and low/medium work will be performed in case of client’s knowledge of possible errors and fraud, holding our assumption of absent ethical requirements. 

§5. Hence, the chance of discovery of errors by auditors in circumstances of errors and fraud by clients knowledge is not achievable goals for public at large. Game can be pictured as followings:


 Note: exactly the prisoners dilemma may not hold true and dynamic game may be required. It is my attempt to visualize the audit game in light of game theory. Hope to get Valuable suggestions and corrections.

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