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A principal can
bring litigation against an agent for overstating the realized
production costs. The lawsuit functions much like an audit; the
principal's ability to bring suit against the agent can reduce the
information rent and increase production efficiency by penalizing
the agent misreporting costs. The principal benefits from higher
trial awards depending on the ability of the principal to commit to
a litigation strategy comprised of a frequency of and expenditure in
litigation. While higher awards increase the agent's expected
punishment for shirking, they also encourage excessive litigation
expenditures by both parties ex post. When the principal can
pre-commit to a probability of bringing suit, for large stakes in
trial, the principal reduces the probability to maintain a constant
expected punishment. Alternatively, if the principal were able to
commit ex ante to a probability and intensity of litigation, even
when stakes are large, the principal would litigate with certainty
but reduce litigation intensity below what is ex post rational. |