Essays on Auditing, Banking, and Political Bargaining

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School of Business | Doctoral thesis (article-based) | Defence date: 2016-05-24
Degree programme
Aalto University publication series DOCTORAL DISSERTATIONS, 77/2016
This dissertation consists of three essays and an introductory chapter. The first essay deals with learning in dynamic audit games. I argue that the efficacy of an audit methodology reduces if it is used repeatedly. Individuals being audited potentially learn how to exploit the weaknesses inherent in any audit methodology if they face the same method many times. I show that an auditor better deters fraud by randomizing her choice of methodology over time, thereby frustrating a would-be fraudster's ability to learn. In the extreme, an auditor benefits from refusing to audit even though audits are costless to her. In the second essay, I analyze a market failure in the banking industry. In particular, I show that the competitive market structure encourages banks to accumulate more liquid funds than is socially desirable. Banks accumulate liquid funds by selling their assets at a discount. This sale disturbs the economy and slows down growth because the buyers of the assets reduce their investments in positive NPV projects. Small banks do not internalize their own impact on prices, which encourages them to start a fire sale too early. A (relatively) small probability of a liquidity shock might trigger a fire sale, causing a real crisis. Big banks internalize their own price impact, which reduces the severity of a crisis. I show that their sale decision is more in line with that of the social planner because they are too big to rush to sell their assets. In the third essay, I identify an inefficiency caused by the system of checks and balances. I first develop a model in which checks and balances prompt the President of the Unites States to compromise on the strength of the candidates nominated for positions in the federal government and judiciary. I test the model by using data of the nominations of the U.S. federal judges from 1989 to 2014. Because federal judges are appointed for life, appointments of competent younger judges extend the productive period they spend on the bench and improve welfare. Consistent with the predictions of the model, and controlling for each candidate's competence with the rating assigned by the American Bar Association, I find that the confirmation in the Senate is more likely and faster when the President compromises on the strength of the candidate by nominating an older individual.
Thesis advisor
Keloharju, Matti, Prof., Aalto University, Department of Finance, Finland
Välimäki, Juuso, Prof., Aalto University, Department of Economics, Finland
audit, learning, banking theory, fire sales, political economy, bargaining
Other note
  • [Publication 1]: Deterring Fraud by Looking Away. RAND Journal of Economics, forthcoming. The full text of this publication is not included in the pdf-file of the dissertation.
  • [Publication 2]: Too Big to Rush. The full text of this publication is included in the pdf-file of the dissertation.
  • [Publication 3]: Compromising Welfare. The full text of this publication is included in the pdf-file of the dissertation.