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    Understanding Contract Audits: An Experimental Approach
    research summary posted June 6, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions 
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    Title:
    Understanding Contract Audits: An Experimental Approach
    Practical Implications:

    Very little literature currently exists on contract audits and their consequences. These audits aim to decrease the information asymmetry between a buyer and seller, but the conditions in which they existences is still largely unknown. The results of this study serve as a starting point for further experimentation that will help to further understanding of the reasons why contract audits exist and the consequences of them when they are indeed used. 

    Citation:

    Bertrand, R. M., A. J. Schram, and E. H. Vaassen. 2013. Understanding Contract Audits: An Experimental Approach. Auditing 32 (1).

    Keywords:
    contract auditing; experimental economics; value of the audit; government purchasing
    Purpose of the Study:

    A contract audit is a buyer-initiated audit of prices and other conditions, which aims to decrease the information asymmetry between a buyer and a seller. These contracts are widely used, especially in monopolistic or oligopolistic markets, but current literature provides little insight into the conditions under which buyers will initiate a voluntary contract audit. The effects of contract audits are also widely unknown. This study attempts to identify the factors that explain this decision and investigate how transaction prices are affected by contract audits through a series of laboratory experiments. 

    Design/Method/ Approach:

    The authors initially used three distinct literatures (transaction cost theory, the theory of planned behavior, and social preference theory) to develop the following hypotheses:

    H1A: Contract audits increase the probability of agreement in the negotiations.

    H1B: Contract audits result in shorter negotiations.

    H2A: The more positive the buyer’s attitude toward contract auditing is the more likely he or she is to initiate a contract audit. 

    H2B: As the pressure to initiate a contract audit increases, the buyer will more often initiate a contract audit.

    H2C: If a buyer believes a contract audit is relatively easy to organize, he or she is more likely to initiate one. 

    H3: Contract audits result in lower prices compared to prices based on negotiations with no contract audit. 

    H4: Prices are higher when sellers know the outcome of a contract audit than when they do not. 

    These hypotheses were then tested in ten experimental sessions run in November 2007 at the laboratory of the Center for Research in Experimental Economics and Political Decision-making in Amsterdam. The 228 participants were students from the bachelors and masters programs at the University of Amsterdam. Each of the students participated in independent negotiation sessions to determine the validity of the previously developed hypotheses. 

    Findings:
    • The results confirm the H2A, H2B, and H2C hypotheses. 
    • A positive attitude toward audits and pressure to have audits conducted all positively contribute to the probability that an audit will be undertaken. 
    • Audits reduce transaction costs and increase gross efficiency by yielding more negotiations that are successful.
    • Prices tend to be lower than those predicted by the subgame perfect Nash equilibrium of our setup. 
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions
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