Understanding Contract Audits: An Experimental Approach

Abstract

SUMMARY 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. Contract audits are frequently used in monopolistic or oligopolistic markets, as in government procurement. We draw upon three distinct literatures to develop hypotheses (transaction cost theory, the theory of planned behavior, and social preference theory) and test these hypotheses using data obtained in a laboratory experiment. Our results show that contract audits are widely used, a phenomenon that cannot be explained by traditional economic reasoning. Their demand is well explained by the theory of planned behavior, however. Our data show that contract audits decrease transaction costs by increasing the probability of successful negotiations. Audits lead to an increased share of the trade surplus for the buyer, but this increased welfare may be offset by the audit costs. They also yield lower transaction prices.