Error Rates, Detection Rates, and Payoff Functions in Auditing.

Abstract A stylized game theoretic model of auditor-auditee interactions is constructed. We derive Nash equilibrium strategies for the auditor and auditee, and then examine the effect of changes in the auditor-auditee payoff functions on error and detection rates. In particular, changes in auditors' payoffs in our model are shown to have unambiguous implications for the probability of undetected errors and the probability of incorrect rejection. In contrast, changes in auditees' payoffs may either increase or decrease undetected errors or incorrect rejections through a dual impact on error rates and detection rates. In addition, we compare the predictions of our game theoretic approach to those of a single person decision theoretic analysis.