ABSTRACT
We consider a principal-agent model in which the principal designs contracts for the agent specifying a transfer, an allocation, and an audit rule. With auditing, the principal can verify a breach of contract and impose a fine defined by exogenous contract law. However, the agent can make the principal’s audit fail by engaging in avoidance. Avoidance has two implications for the principal’s optimal contracts: (i) the expected transfers to the principal decrease, and (ii) the probability of signing the contract decreases. If the latter effect dominates the former, it is possible that the agent’s ability to engage in avoidance is disadvantageous not only for the principal but also for the agent ex ante.
Palonen, Petteri and Pekkarinen, Teemu, Avoidance, Auditing, and Optimal Contracts. Posted to SSRN 15 July 2026.
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