This paper studies the sequential equilibria of signaling games. It introduces a new solution concept, divine equilibrium, that refines the set of sequential equilibria by requiring that off-the-equilibrium-path beliefs satisfy an additional restriction. This restriction rules out implausible sequential equilibria in many examples. We show that divine equilibria exist by demonstrating that a sequential equilibrium that fails to be divine cannot be in a stable component. However, the stable component of signaling games is typically smaller than the set of divine equilibria. We demonstrate this fact through examples. We also present a characterization of the stable equilibria in generic signaling games.

A risk neutral principal wishes to exact a payment from a risk neutral agent whose wealth he does not know, but may verify through a costly auditing procedure. We characterize efficient schemes for the principal when he is allowed to choose schedules for preaudit and postaudit payments and audit probabilities, subject to the constraint that only monetary incentives can be used and that the principal may never make a net payment to the agent. The main results are that efficient schemes involve preaudit payments which are increasing in the agent's wealth, audit probabilities are decreasing in the agent's wealth and also satisfy certain constraints as equalities. In general, such schemes involve stochastic auditing and rebates after an audit.