The following table depicts a non-cooperative game between an investor in a firm’s shares and the firm's auditor.

The investor has two strategies—invest or not invest. The auditor can choose to work for the investor by ensuring that the firm's financial statements are free of opportunistic earnings management, or to work for the manager by allowing opportunistic earnings management, which may mislead the investor but benefit the manager.
The number pairs in the table represent the utility payoff to the investor and auditor respectively, for each strategy combination. The rationale for these payoffs is as follows:

Required

a. Identify the Nash equilibrium of this game and explain why this is the predicted outcome of the game.

b. Identify the cooperative solution. Explain why it is unlikely to be attained in a singleplay of this game.

c. Outline three possible ways that the cooperative solution may be attained.
Pierre's small business has grown to the point where he plans to hire a full-time manager.
Pierre, an architect, has little inclination and ability to manage a medium-sized, fast-growing business himself. He plans to semi-retire, devoting his working hours to consulting on issues of design and project management. Pierre's accounting system is quite simple. There is no R&D or other recognition lags. Consequently, the firm's payoff and its net income for the year are equal.

Transcribed Image Text:

Auditor Work for investor Work for manager Invest 5,4 Investor Do not invest 3,1 2,6 3,3