Abstract: Corruption is a widespread phenomenon around the world. Yet, models of hierarchical agency relationships tend not to predict collusion. The paper demonstrates that allowing collusion may be optimal if the principal cannot commit to an incentive scheme once and for all. The optimal extent of corruption depends on the efficacy of the legal system. It must be risky for the guilty parties to engage in corruption in order to make it worthwile curbing it.
44 pages, April 1995
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