# Research on Audit Supervision of Internet Finance

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## Abstract

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## 1. Introduction

## 2. Materials and Methods

#### 2.1. Behavioral Analysis of the Government Audit Supervision of Internet Finance

#### 2.2. Evolutionary Game Analysis of Internet Finance Government Audit Supervision

- As an endogenous system of national governance, government auditing plays a crucial role in preventing Internet financial risks and safeguarding national financial security (Cao and Xiong 2018). As one party of the game, “financial audit offices” are national audit departments which carry out auditing and supervision on the other party to the game (Internet financial institutions) on behalf of the public and the central government. The decisions made by government financial audit are in real time, rather than on a regular basis, which means auditors are able to make decisions at any time based on the situations of Internet financial institutions, and carry out audit immediately. This hypothesis guarantees the consistency of the game process.
- As another party of the game, “Internet financial institutions” are companies involved in providing financial services using Internet technology. The healthy development of Internet finance needs supervision from government audit. Their legitimate business operations help to boost local economic development and enhance the effectiveness of government audit offices (Zhou 2017). If compliance is not emphasized, the subjects of liability will be held accountable and penalized after audit offices conduct audits and discover problems. These financial institutions subsequently will be unable to make profits from business operations and might receive harsh penalties.

- Suppose the profits made by Internet financial institutions through legitimate business operations are I
_{1}, their expenditure is C_{1}, bonuses, the rewards gained through legitimate business operations are D_{1}, and fines imposed by audit offices due to non-compliance are L. - Suppose the expenditure for carrying out audit supervision by the financial audit supervisory departments is C
_{2}, and the social economic benefits resulting from the cooperation in audit supervision between Internet financial institutions and financial audit supervisory departments are I_{2}. Due to the scarcity of auditing resources, it is impossible for government audit offices to focus solely on Internet financial institutions. The compliance of the latter helps to create a positive environment for financial operations, which in turn reduces the pressure on financial audit departments and generates an opportunistic benefit (D_{2}). - Suppose the probability of choosing “compliance” and “noncompliance” by Internet financial institutions in the game is x (where 0 < x < 1) and 1 − x, respectively; the probability of carrying out “audit supervision” and not performing this function by the financial audit offices is y (where 0 < y < 1) and 1-y (respectively).

#### 2.2.1. Utility Model of Internet Financial Institutions

_{1}. The following equation can be proposed:

#### 2.2.2. Utility Model of Financial Audit Supervisory Departments

_{21}; when they choose not to carry out audit supervision, the utility is set as u

_{22}. The following equations can be proposed:

_{2}. The following equation can be proposed:

## 3. Results

#### 3.1. Analysis of Internet Financial Institutions Stability

- When $y=\frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}$, $F(x)\equiv 0$. X is the evolutionary stability strategy of Internet financial institutions.
- When $y\ne \frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}$, based on the stability theorem of differential equations and the nature of evolutionary stability strategy, it can be inferred that ${x}^{*}$ is the evolutionary stability strategy if $F({x}^{*}{)}^{\prime}<0$.

#### 3.2. Analysis of Financial Audit Supervisory Departments’ Stability

- When $x=\frac{{C}_{2}}{{I}_{2}-{D}_{2}}$, $F(y)\equiv 0$. Y is the evolutionary stability strategy of financial audit supervisory departments.
- When $x\ne \frac{{C}_{2}}{{I}_{2}-{D}_{2}}$, based on the stability theorem of differential equation and the nature of evolutionary stability strategy, it can be inferred that ${y}^{*}$ is the evolutionary stability strategy if $F({y}^{*}{)}^{\prime}<0$.

#### 3.3. Evolutionary Stability Analysis of Both Parties of the Game

#### 3.4. Evolutionary Analysis of Model Parameters

- The parameter of cost. C
_{1}and C_{2}represent the cost of choosing “compliance” by Internet financial institutions and choosing to carry out audit supervision by financial audit supervisory departments. As C_{1}decreases, $\frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}$ decreases and point E moves downward. The replicator dynamics phase diagram shows that, under such a condition, the area of Quadrangle ADCE decreases while the area of Quadrangle ABCE increases, which means there is a higher probability that the initial state is in Quadrangle ABCE and a higher probability that the gaming system will evolve to the equilibrium strategy (1,1). Similarly, as C_{2}decreases, $\frac{{C}_{2}}{{I}_{2}-{D}_{2}}$ decreases and point E moves towards the left, resulting in a higher probability that the gaming system will evolve to the equilibrium strategy (1,1). The above analysis shows that in the game of Internet finance government audit supervision, the lower the costs of both parties are, the higher the probability of the system converging to (1,1). - The parameters of benefit. I
_{1}and I_{2}represent the benefit of choosing “compliance” by Internet financial institutions and choosing to carry out audit supervision by financial audit supervisory departments. As I_{1}increases, $\frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}$ decreases and point E moves downward. There is a higher probability that the gaming system will evolve to the equilibrium strategy (1,1). Similarly, as I_{2}increases, $\frac{{C}_{2}}{{I}_{2}-{D}_{2}}$ decreases and point E moves towards the left, leading to a higher probability that the gaming system will evolve to the equilibrium strategy (1,1). The above analysis shows that in the game of Internet finance government audit supervision, the higher the benefits of both parties are, the higher is the probability of the system converging to (1,1). - The parameter of penalty. L represents the penalty imposed on Internet financial institutions when they choose “noncompliance” and financial audit supervisory departments choose to carry out audit supervision. As L increases, $\frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}$ decreases, $\frac{{C}_{2}}{{I}_{2}-{D}_{2}}$ remains the same and point E moves downward, resulting in a higher probability that the gaming system will evolve to the equilibrium strategy (1,1). When financial audit supervisory departments carry out audit supervision and discover non-compliance of Internet financial institutions, the latter will face heavier losses and in turn they will have a stronger motivation to choose compliance so as to reduce losses. As a result, the system converges to (1,1).

## 4. Discussion

_{1}= 4, C

_{1}= 5, D

_{1}= 3, D

_{2}= 2, I

_{2}= 10, C

_{2}= 4, L = 2. Based on computing experiment simulation platform and the analysis of evolutionary game model (INITIAL TIME = 0, FINAL TIME = 100, TIME STEP = 1), we conducted the formulation calculation as follows:

- 1.
- The influence of the initial value of x (the probability of Internet financial institutions strategy choice). According to our analysis of the evolutionary game model, in this example, ${x}^{*}=\frac{{C}_{2}}{{I}_{2}-{D}_{2}}=0.5$ and ${y}^{*}=\frac{{C}_{1}-{I}_{1}}{{D}_{1}+L}=0.2$. When $0.2<y<1$, if the initial value of x is higher than 0.5, then x = 1 is the evolutionary stable point; otherwise, x = 0 is the evolutionary stable point. Suppose the initial value of y is 0.3 and the variation of the initial value of x is between 0.1 and 0.9. If one simulation is carried out whenever the initial value of x changes by 0.1, the simulation results are as shown in Figure 3 and Figure 4.
- 2.
- The influence of the initial value of y (the probability of financial audit supervisory departments’ strategy choice). According to our analysis of the evolutionary game model, in this example, when $0.5<x<1$, if the initial value of y is higher than 0.2, then y = 1 is the evolutionary stable point; otherwise, y = 0 is the evolutionary stable point. Suppose the initial value of x is 0.6 and the variation of the initial value of x is between 0.1 and 0.9. If one simulation is carried out whenever the initial value of y changes by 0.1, the simulation results are as shown in Figure 5 and Figure 6.

- 3.
- The influence of penalties on Internet financial institutions. To simulate the influence of the severity of punishment of Internet financial institutions by financial audit supervisory departments, suppose the initial value of x is 0.6, the initial value of y is 0.3, and the other variables remain constant but the amount of fines increases gradually from L = 1. We conducted three simulations (L = 4, 7, and 10); the results appear in Figure 7 and Figure 8.

## 5. Conclusions

## Author Contributions

## Funding

## Conflicts of Interest

## Appendix A

- I
_{1}: the income from compliance operation of Internet financial institutions; - C
_{1}: expenditure cost of compliance operation of Internet financial institutions; - D
_{1}: extra rewards given by Internet financial institutions under the condition of compliance with business operations; - L: punishment for non-compliant operation of Internet financial institutions;
- The above variables mainly describe the operation of Internet financial institutions, and relevant data can be referred to the P2P industry data provided by the “home of online loans”.
- C
_{2}: expenditure cost of financial audit supervision by financial audit supervision department for Internet financial institutions; - I
_{2}: social and economic benefits generated by mutual cooperation between financial audit supervision departments and Internet financial institutions in audit supervision; - D
_{2}: networked financial institutions maintain a state of compliance operation, which will create a good ecological environment for financial operations and reduce the working pressure of audit supervision for the financial audit department, thus bringing opportunities and benefits to the department.

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Strategies Chosen by Both Parties of the Game | Financial Audit Supervisory Departments | ||
---|---|---|---|

Carrying out Audit Supervision y | not Carrying out Audit Supervision 1 − y | ||

Internet financial institutions | compliance x | I_{1} − C_{2} + D_{1}, I_{2} − C_{2} | I_{1} − C_{1}, D_{2} |

noncompliance 1 − x | −L, −C_{2} | 0, 0 |

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**MDPI and ACS Style**

Liu, H.; Ge, S.
Research on Audit Supervision of Internet Finance. *Int. J. Financial Stud.* **2020**, *8*, 2.
https://doi.org/10.3390/ijfs8010002

**AMA Style**

Liu H, Ge S.
Research on Audit Supervision of Internet Finance. *International Journal of Financial Studies*. 2020; 8(1):2.
https://doi.org/10.3390/ijfs8010002

**Chicago/Turabian Style**

Liu, Hua, and Sheng Ge.
2020. "Research on Audit Supervision of Internet Finance" *International Journal of Financial Studies* 8, no. 1: 2.
https://doi.org/10.3390/ijfs8010002