Individuals being audited potentially learn how to exploit the weaknesses inherent in any audit methodology if they face the same method many times. Hence, an auditor better deters fraud by randomizing her choice of methodology over time, thereby frustrating a would-be fraudster’s ability to learn. In the extreme, an auditor benefits from refusing to audit even though audits are costless to her.
A sudden need for liquidity prompts banks to sell their assets at a discount to obtain cash. This sale disturbs the economy and slows down growth because the buyers of the assets reduce their investments in positive NPV projects. Small banks do not internalize their own impact on prices, which encourages them to start a fire sale too early. A (relatively) small probability of a liquidity shock might trigger a fire sale, causing a real crisis. Big banks internalize their own price impact, which reduces the severity of a crisis. Their sale decision is more in line with that of the social planner because they are too big to rush to sell their assets.
The U.S. Constitution includes many checks and balances that necessitate the ruling party to compromise with the opposition. I develop a model in which this feature prompts the President to compromise on the strength of the candidates nominated for positions in the federal government and judiciary. I test the model by using data of the nominations of federal judges from 1989 to 2014. Because federal judges are appointed for life, appointments of competent younger judges extend the productive period they spend on the bench and improve welfare. Consistent with the predictions of the model, and controlling for each candidate’s competence with the rating assigned by the American Bar Association, I find that the confirmation in the Senate is more likely and faster when the President compromises on the strength of the candidate by nominating an older individual. These findings suggest that the system of checks and balances comes with a price.